18 June 2020
The real estate sector has been impacted heavily by the outbreak of COVID-19. And while some asset classes have fared better than others (consider the comparative fortunes of hospitality and non-food retail with those of logistics and food retail) none have been completely immune.
Our comprehensive team of lawyers is at the forefront of advising the real estate community on the diverse issues facing our sector during this period of intense uncertainty and change. In this document we explore just some of these challenges, from how commercial landlords can respond to non-payment of rent with the June quarter day fast approaching, to ensuring a safe return to the workplace (whether that's a construction site or office building), to managing the potential reputational implications of making difficult but necessary business decisions over the coming months.
While this document outlines some of the key questions that our clients in the sector are thinking about it is by no means exhaustive. We have focussed on the challenges, but there are doubtless opportunities as well. Please feel free to reach out to any of our team members if you have your own questions or concerns about any of the issues covered by this document or more generally.
Some asset classes such as logistics and food retail have fared extremely well from rapidly-changing consumer habits. But in the harder hit sectors we saw a number of tenants approaching their landlords for rent concessions when coronavirus triggered a national lockdown. Many have been able to use good commercial relationships to agree one or more of the following:
Extreme care must be taken with the documentation of any concession, to ensure that no arguments arise at a later stage concerning the enforceability of any guarantees or the "contracted out" status of the tenancies (if this applies).
The majority of concessions to date have focused on assisting existing tenants with the pressures of the March quarter date. For the most part landlords are not giving up on the rent entirely, but seeking to help tenants find more realistic payment plans, often as part of negotiated packages that involved quid pro quo re-gears or term extensions.
What if a concession has not been agreed? Most commercial tenants are due to pay the next quarter of their annual rent on 24 June. The expectation is that there will be higher levels of non-payment of rent across a number of sectors as tenants feel the full force of the lockdown. However landlords' abilities to take enforcement for breach have been progressively tied by statutory intervention over the past few months.
Back at the start of lockdown Parliament rushed through measures to help protect commercial tenants unable to pay their rent, preventing landlords of business tenancies from exercising their right to forfeit for non-payment of rent (given the widest meaning of any sum a tenant is liable to pay) until 30 June, or from evicting a tenant if forfeiture proceedings have already commenced. The legislation left scope for the 30 June end date to be extended. This moratorium has now been extended to 30 September 2020.
The forfeiture moratorium has been controversial from the outset, but the extension comes as no surprise, as the peak of the disease fell within the last rent quarter and the Government has failed to implement any alternative scheme to assist tenants to pay off their arrears over a deferred period. This was always going to leave a "cliff edge" that tenants in difficulty were going to be unable to avoid. With this extension, it seems that this problem has now been kicked down the road for another day.
Statutory amendments have also been made to the commercial rent arrears recovery (CRAR) procedure (which involves the removal and selling of a tenant's assets) the cumulative effect of which is that CRAR may now only be exercised where there is at least 189 days of unpaid rent outstanding rather than the usual seven days.
The Government has subsequently published the Corporate Insolvency and Governance Bill, which (once enacted) will prevent the winding up of a company based on deemed insolvency following the failure to comply with a statutory demand served during a period commencing on 1 March. The end date for the period is yet to be determined - the original draft of the bill stipulated 30 days from enactment, but the most recent proposed amendments push this out to 30 September. For further updates on the status of the legislation please visit our website.
Any winding up orders made after 27 April 2020 but prior to the enactment of the proposed corporate insolvency legislation will likely be reviewed at a further hearing in which the court will need to consider whether it would have made the order had the legislation already been in force. For landlords, serving a statutory demand will therefore (for now at least) be less of a threat, and less likely to result in the payment of rent.
In the absence of an agreed concession and taking into account the various statutory interventions, what can a landlord do a tenant fails to pay its rent on the June quarter day?
For some landlords, an overriding consideration will be the reputational implications of being seen to be too aggressive, with Government guidance suggesting that landlords should be compassionate with tenants unable to pay their rent due to the coronavirus, and encouraging them to agree payment plans once the situation improves. However this assumes that landlords are in a financially stronger position than their tenants, which is not always the case. Some landlords might not have any choice but to take action, particularly if they are unable to service interest on their loan agreements. A number of landlords are also frustrated that some tenants in the stronger performing sectors are not paying their rent and that the usual remedies are not available to them to deal with this.
At the same time as introducing the moratorium on forfeiture for commercial tenants, the Government also enacted an extensive package of measures designed to protect residential tenants, and to a lesser extent their landlords. The key provisions included:-
The key message from the Government is that residential landlords and tenants should, wherever possible, keep the lines of communication open at this time. There seems every possibility that the extension period on possessions may be extended further, beyond the current 90 days. The Government also retains the power to extend the notice period for possessions from three months to six months.
For the most part, contractual and statutory interventions to date have made it abundantly clear that the rent debt already outstanding has not been relieved, but merely delayed. The situation is not a long-term solution. Tenants are facing a mounting debt which will have to be repaid at some point. Most are presumably hoping that there will eventually be a surge in their business which will make up for the current loss of trading – that remains to be seen. But others will be considering restructuring or insolvency options such as an administration or company voluntary arrangement, which we have already seen for the likes of Debenhams, Carluccio's and Travelodge.
In addition to the statutory interventions outlined above, the Government has also just published a new code of practice for the commercial property sector. But guidance alone is unlikely to provide a significant shield for tenants unless it is backed up by further measures. The speed of economic recovery will undoubtedly dictate whether there is another extension to the moratorium on forfeiture in September – watch this space!
Force majeure provisions tend to feature in serviced office agreements allowing some operators to avoid liability. We have also been advising on whether such agreements have been frustrated in law by the pandemic. However, the position is different with leases.
In the most troubled sectors, we anticipate pressure increasing on landlords and tenants to agree flexibilities in lease term or floor space, and perhaps to incorporate new force majeure mechanisms. Force majeure provisions tend to feature in serviced office agreements, allowing some operators to avoid liability, but not generally in leases. While some parties are already seeking to turn future coronavirus pressures into explicit termination rights, it is far too early to speak of market trends or commonality.
In the absence of force majeure provisions, with rental liability stacking up, some tenants might well argue that their existing leases have been frustrated by coronavirus. Again, this is something we have already been advising on in relation to serviced office agreements. But there has never been a successful application of this doctrine to a lease in England and Wales (despite some high profile attempts, such as the case bought last year by the European Medicines Authority when its Canary Wharf occupation was compromised by Brexit). It is however technically possible, and these, as we are frequently reminded, are unprecedented times.
Another potential option for tenants will be to claim that coronavirus ought to have triggered the rent suspension provisions in their lease and that their landlord should have claimed on their loss of rent insurance policy. Whether or not this is a viable argument will ultimately come down to the specific wording of the lease and the landlord's insurance policy. For many, the argument stretches the construction of a typical rent suspension clause too far, as such clauses are usually stated to be triggered by physical damage or destruction only. But, again, these are wholly unusual times. Others take the view that if a tenant has contributed to the cost of a policy containing a pandemic clause in the loss of rent cover then the tenant should be entitled to benefit from that clause.
One thing is for certain: insurers have so far been highly resistant to coronavirus business interruption claims (and by extension loss of rent claims), although some insurers are now starting to reverse their position. In the public interest and to avoid numerous business interruption policyholders seeking guidance from the courts at considerable expense, the Financial Conduct Authority (FCA) intends to seek a judgment to resolve some of the contractual uncertainty. Taylor Wessing has partnered with trade association UKHospitality in relation to the FCA action. The team's expertise will support UKHospitality as it considers how the FCA court action impacts on the business interruption insurance claims of policy holders in the hospitality sector.
For the time being, we would advise landlords to notify their insurers as soon as possible if they think there is even a remote possibility of one or more of their tenants bringing a claim for (potentially retrospective) rent suspension. Otherwise landlords might find out further down the line that they are out of time to bring a claim on their loss of rent cover, having failed to comply with the notification requirements.
As we saw after the Brexit referendum, the lockdown announced on 23 March will have an impact on valuation.
For example, any rent review effective from the March or June quarter date will be very difficult to assess. What would the hypothetical landlord / tenant be willing to accept / pay for premises which cannot be used due to the lockdown? What additional incentives would be needed? The same difficulty arises with dilapidation claims for leases which expired during lockdown. Such claims are capped by the diminution in value of the premises caused by the disrepairs. But what would the premises be worth in lockdown and has the value been diminished by the disrepairs? Some very difficult questions ahead and litigation is likely.
To end this section on a more positive note, there is a chance for landlords and tenants to co-operate more meaningfully on issues that touch on proactive asset management, as we move from the understandable situation whereby concessions were made to address immediate and uncertain rental pressures in March.
For example, in the short-term, we have been advising a number of our clients on licences which enable tenants in the food & beverages sector to operate outdoor "pop-up" concessions until such time as they can trade from indoors again.
In the longer term, and in the context of a general (pre-coronavirus) direction of travel, many landlords were already thinking strategically about their future in the provision of services alongside bricks and mortar. They were considering the monetisation opportunities available from installing tech on curated estates or understanding the need to capture sustainability data for investment benchmarking. Targeted portfolio reviews might meanwhile highlight vulnerabilities relating to the new building safety regulatory regime or the shifting minimum energy efficiency standards. All of this gives landlords the opportunity to think creatively; to leverage the offer of new rental incentive packages and make amendments that help them become a new kind of landlord for the brave new (post-coronavirus) world.
Since lockdown, we have seen the pipeline for new business slow considerably as lenders and their Credit teams become pre-occupied with waivers for financial covenant breaches and requests for interest / amortisation payment holidays in respect of their existing books. In addition, we are seeing lenders dealing with requests for extensions of time for specific development milestones and waivers around MAE clauses.
Generally speaking, it appears that as long as borrowers can service their interest payments, lenders are looking favourably on financial covenant waivers / extensions. However, acceptance of such requests may be subject to change following the June quarter date as the rental income streams being received by landlords potentially slows further.
Waiver requests in relation to MAE clauses don't seem to be getting much traction as lenders steer away from the arduous task of trying to place parameters on what does and doesn't fall within such a waiver. However, it doesn't look like this is something that lenders will call on in the short term. The key to a successful waiver request seems to be keeping an open and honest dialogue between lender and borrower / sponsor. It should also be noted that regulated UK banks have been guided by the Prudential Regulation Authority not to take knee-jerk enforcement action due to coronavirus related issues.
In the longer term, we expect more wide-ranging restructurings as lenders and borrowers acknowledge that the impact of coronavirus is likely to need more than a waiver of a quarter or two of financial covenants. We have seen some activity in this respect already. In terms of such restructurings, similar considerations to those taken into account in 2008 will apply again, although there may be more scrutiny on lenders' actions this time around, as the liquidity requirements brought in by regulators for banks following the 2008 crisis mean such entities should be in a much stronger position to help borrowers weather the consequences of coronavirus.
While Government guidance for some sectors has been very clear (for example the comprehensive closure of the hospitality industry), for other sectors there have been shades of grey, and this is true in particular for the construction industry.
When lockdown was first announced, a number of contractors and employers were uncertain as to what this meant for them and whether they could (and should) continue operating on site. Some contractors almost immediately downed tools across all of their sites while they tried to work this out. Others remained on site and endeavoured to operate social distancing as best they could, but in some cases were the target of critical social or mainstream media stories for jeopardising the safety of workers.
And while the nature and scale of the impact on construction projects still cannot be predicted with any accuracy, it is inevitable that most construction projects have been and will continue to be subject to at least a degree of disruption, due to ongoing labour and supply chain issues.
Whether the contractor or the employer bears the risk for the costs ensuing from the pandemic will ultimately come down to the terms of the contract. Almost all UK construction contracts will contain extension of time and loss and expense clauses, but will lack specific terms allocating the risk of infectious disease outbreaks. Parties will therefore need to rely on provisions such as force majeure to determine who bears the risk.
With the support of the Government, the Construction Leadership Council (CLC) has subsequently provided practical guidance to the construction industry, including its Contractual Best Practice Guidance (CLC Guidance), which offers useful advice for both employers and contractors on measures to be taken to avert economic hardship and to recognise the unique circumstances we all face. Contractors and employers are asked to engage in collaborative discussions regarding payment and revision of contractual clauses. The intention is to encourage parties to mitigate the effects of the pandemic and constructively resolve contractual disputes.
The Government clearly wants to ensure that as and when the lockdown is eased there remains a ready supply chain to help get the economy back on track. Whether this happens will depend on attitudes of both employers and contractors to resolving issues. But the message from Government is clear, we all need to act fairly and responsibly when performing and enforcing contracts, so as to achieve just and equitable contract outcomes, protect jobs and help the economy recover.
The Government has also announced planning measures that are designed to support developers during this period:
We anticipate that there will be more of this to follow, as the Government looks to get us all back to business as close possible to normal, and as soon as possible. Further measures could include a relaxation of the permitted development rights regime in order to facilitate the short-term repurposing of space without the need to go through a time-consuming planning process.
And, finally, despite the significant disruption that we've all recently been facing, the Government published in May its long-awaited proposals to reform the regulatory regime where building safety is concerned. There is no indication when a draft bill will be available but you can read a summary here.
Now, more so than ever, businesses will be judged by their behaviour and will be under scrutiny from regulators, the press and their employees to take responsible decisions. Expectations on HR teams are immense. At Taylor Wessing we understand HR. Our international network of employment lawyers are leaders in these issues and can help our clients navigate them.
With many businesses planning for a return to the 'normal' workplace (if not already back), there is scope for a wide variety of disputes to arise on whether it is actually safe to do so. Current guidance is to keep working from home where this is possible.
Where a return to work is planned, and where homeworking continues, employers need to carry out a specific Covid risk assessment to help them match health and safety measures to the current issues. Staff will need to be consulted on that.
Employees have the right to refuse to return to their workplace in circumstances of danger, which the employee reasonably believes to be serious and imminent, and which the employee could not reasonably be expected to avert. That can include danger to others - and may be even vulnerable family members who are being shielded. Compensation for any business dismissing an employee in these circumstances would be unlimited. There is little doubt that the pandemic is a circumstance of danger. The key question will be whether an employee's fear of imminent danger is reasonable in the circumstances at their specific place of work. For the employer, following government guidance will be the start, but not the end, of the story. It is an employee's individual circumstances that will ultimately determine whether they have a reasonable belief that working is not safe.
Almost every business has commercially sensitive information, personal data or big datasets underpinning its assets, revenue and growth strategy.
The issues facing many businesses in terms of data protection and cyber risk have been heightened as a result of the wholesale shift to home working during lockdown. Existing technological and organisational measures to protect against the unlawful access to personal data and confidential information may no longer be appropriate or sufficient in the face of a highly distributed IT network with a significant number of new and partially unknown risks, such as employee home network security (or the lack of it). Criminals are seeking to take advantage of the move to new working models, with security researchers reporting very significant phishing emails, which employees may be more likely to fall for when working remotely.
With many businesses now looking to incorporate at least some home working into their business models on a permanent basis, they will need to implement policies and measures to deal with these issues in the longer term. Our specialist data protection and cyber team has over 20 years' experience and is one of the biggest in Europe. We are exceptionally well positioned to take care of all challenges associated with data in an international context.
The coronavirus crisis has given rise to some pressing reputation-related issues, as businesses have to make difficult judgment calls, in some cases in order to ensure their survival. We have touched on some of the issues for our real estate clients in this document.
Unlike our competitors, as a full service international law firm, we are able to advise on and protect our clients from a full range of traditional, new and emerging threats across all the key areas of risk to corporate reputation. These threats include false allegations that a company is in financial difficulty as a result of the pandemic or is profiteering from the crisis or is mistreating others. Construction companies have in some cases been criticised for failing to take quick enough steps to enforce social distancing on site or forcing workers to return without proper measures in place. Lenders will inevitably be subject to scrutiny via traditional or social media if they decide to enforce security. Risks to reputation need to be dealt with quickly and clients need to know how to communicate effectively. And all this against a backdrop of ever changing government recommendations.
Our market-leading reputation management team has the bandwidth to assist clients with their internal and external communications, the expertise to handle media enquiries and the experience to deal with and try and stop the publication or broadcast of adverse or misleading social or mainstream media stories. Please see our corporate reputation web page for further information.
With all of the disruption caused to the real estate sector by coronavirus, it is easy for clients to overlook unrelated legal changes that could nonetheless have a substantial impact on their business.
Significant tax changes came into effect from 6 April 2020 for offshore corporate landlords holding UK investment property (both residential and commercial), intended to "level the playing field" with onshore structures. Jersey, Guernsey and the Isle of Man (for example) have historically been popular jurisdictions to hold UK real estate. Changes introduced in 2019 already mean that offshore companies are within the scope of UK corporation tax when they dispose of their properties, however until this year their rental income remained within the UK income tax rules.
From 6 April 2020, offshore corporate landlords are now subject to UK corporation tax on their UK rental income. At first glance this actually means a modest reduction in headline tax rates (offshore corporate landlords were previously subject to basic rate income tax at the 20% rate, whereas corporation tax is currently at a 19% rate following the Government's reversal of the proposed cut to 17%). However, the change will significantly increase the tax compliance burden for these offshore corporate landlords, given the complexity of the UK's corporation tax regime compared to income tax. For example, rules such as the corporate interest restriction regime (which can limit interest deductibility for tax purposes) will now apply to offshore corporate landlords. Tax filing requirements will also change – offshore corporate landlords will now need to file online tax returns in respect of accounting periods, rather than paper returns for the UK tax year ending 5 April. Whilst the changes are largely levelling the playing field with onshore structures, offshore corporate landlords will still need to register under the non-resident landlord scheme or otherwise suffer tax deductions from their rental income.