Commercial leasing – rent relief and good faith in a time of Covid-19

Not the Covid-19 Omnibus (Emergency Measures) Act 2020

Victoria’s Covid-19 emergency measures to assist commercial tenants now have formal legal force with the proclamation of the Covid-19 Omnibus (Emergency Measures) (Commercial Leases and Licences) Regulations 2020.

Some of the new temporary reforms are drastic. For example, paying rent will effectively become optional in the short term for many commercial tenants. And landlords who even attempt to evict such tenants for non-payment will be guilty of an offence.

The new pro-tenant measures will apply to a vast range of retail and non-retail commercial leases for the six months between 29 March 2020 and 29 September 2020.

The changes are effected mainly by the deeming of new terms into commercial leases and licences, but a crucial detail easily overlooked is that the entire scheme is underpinned by the Commonwealth’s JobKeeper scheme. A commercial tenant who is not a qualified participant in the JobKeeper scheme will be effectively excluded from the protections offered by the new rules.

The wide focus

First, a quick refresher and backgrounding for recently arrived Martians and/or anyone too overwhelmed by recent events to have maintained focus.

Retail leases (a very broad concept that commonly includes the leases of shops, offices, serviced apartments and the premises of many other small and medium businesses) are governed by Victoria’s Retail Leases Act 2003. (Although note that the “retail” character of any commercial lease is suddenly less important as the new regime temporarily extends parts of the Retail Leases Act to non-retail commercial leases as well.)

Since March 2020, the snowballing Covid-19 crisis has caused Australia’s federal and state governments to order the partial or complete temporary closure of many businesses nationwide. (In Victoria this has been done mainly by orders under the  Public Health and Wellbeing Act 2008.)

The Federal Government has sought to mitigate the widespread financial disruption resulting from these closures with measures including the JobKeeper scheme. The JobKeeper scheme is expected to subsidize the earnings of millions of private sector employees (and some small business principals) for at least six months until September 2020.  But it is primarily concerned with maintaining employment relationships. It offers no direct help to landlords or tenants suffering financial distress as a consequence of the Covid-19 crisis.

On 3 April 2020 the National Cabinet announced a Mandatory Code of Conduct for Small and Business Enterprises to impose  “a good faith set of leasing principles to commercial tenancies” affected by Covid-19 shutdowns and downturns.

As commercial tenancies have never been considered within the Commonwealth’s constitutional powers and the National Cabinet has the same constitutional status as unicorns under the Australian Constitution (namely none),  the Code of Conduct’s claim as of early April to be mandatory was very optimistic in the absence of supporting state statutes and regulations.

The states have accordingly in recent weeks been legislating to give the National Cabinet’s various pronouncements practical legal effect in state-governed areas such as leasing (and much else besides). Victoria’s legislation for this purpose is the evocatively-named Covid-19 Omnibus (Emergency Measures) Act 2020 (“Omnibus Act”) which commenced operation on last Anzac Day , 25 April 2020.

The Omnibus Act is a thumping 299 pages but commercial landlords and tenants need concern themselves with only a slim bite of it. That portion, Part 2.2, sets out parameters for the supporting regulations but, absent those regulations, it has no real practical utility.

However, we now have those regulations. They were promulgated last Friday, 1 May 2020 as the Covid-19 Omnibus (Emergency Measures) (Commercial Leases and Licences) Regulations 2020 (“Omnibus Regs”) but have effect from 29 March 2020 (note the retrospectivity) until 29 September 2020 when they expire (see regs 3 and 25). The regulations aim to give legal force in Victoria to the National Cabinet’s Mandatory Code.

The highlights

The first thing to note about the new regime is that a given tenant’s eligibility for and participation in the JobKeeper scheme is a threshold test.

Only tenants with an “eligible lease” will benefit from the new scheme and the chief criteria for any lease’s eligibility is that that the tenant concerned should be a small or medium enterprise and also a qualified participant in the JobKeeper scheme (see Regs 10(2) of the Omnibus Regs).

Tenants under eligible leases who withhold all or part of their rent will in the short term be deemed not to have breached their leases provided they request rent relief from their landlord in writing,  together with prescribed information including showing their eligibility for the JobKeeper scheme (regs 9 and 10).

A landlord receiving such a request from a tenant is then required to offer rent relief to the tenant within 14 days. The actual amount of rent relief required of the landlord is not specified anywhere in the Mandatory Code, the Omnibus Act or the Omnibus Regulations but at least half of that unquantified relief must be in the form of a waiver of rent.

So what then is the amount of the rent relief to be? The answer is that the amount is to be negotiated “in good faith” (per reg 10(5) of the Omnibus Regs) having regard to factors including the reduction in the tenant’s turnover during the six months from 29 March 2020 to 29 September 2020 (which I will call here the “Covid Window”),  the amount of time (if any) that the tenant was unable to operate its business at the leased premises, and the landlord’s “financial ability to offer rent relief” (Reg 10). (This “financial ability” concept is intriguing. It might even become the subject of a future blog — after I have dusted off the writings of Mother Theresa, Karl Marx, Robin Hood and Alan Bond.)

Collectively, the changes are overwhelmingly pro-tenant. Tenants can waive some or all their new entitlements, but landlords are hamstrung.  A landlord who even attempts to evict a tenant under an eligible lease for non-payment of rent or to call up bank guarantees in response to  non-payment of rent will potentially in each instance be guilty of an offence punishable by a fine of 20 penalty units (being $3304.44) (Reg 9)

Tenants, however, don’t get a perpetual free kick. In the absence of a renegotiated lease (which might include rent deferrals and lease extensions on top of the compulsory rent waiver), the parties are to mediate their dispute through the Small Business Commission (reg 20) and, failing success there, litigate it (reg 22). Reg 22 suggests that VCAT will retain its current exclusive jurisdiction for retail lease disputes and will additionally acquire non-exclusive jurisdiction for non-retail commercial lease disputes. VCAT’s “no costs” presumption is likely to apply to both retail and non-retail lease disputes (see s. 92 of the Retail Leases Act 2003 and s. 109(1) of the Victorian Civil and Administrative Tribunal Act.)

None of this is likely to be good news for landlords.

Commercial tenants large and small are struggling. Cash flows across the economy are faltering. Commercial vacancies are climbing.  Reliable replacement commercial tenants are likely to become very rare birds.  And, to top it all off, the Business and Property List of VCAT (which will hear this type of dispute) is functionally closed for the foreseeable future. When VCAT does eventually reopen, it will inevitably be gummed up by the backlog of cases that have gone unheard during its closure. And that is even before the coming avalanche of Covid-19 rental disputes hits the Tribunal.

This looming traffic jam at VCAT must cast a shadow over rent relief negotiations between tenants and landlords.

The Mandatory Code and the Omnibus Regulations both require landlords and tenants to negotiate their revised arrangements in good faith. As ever in these things, our lawmakers’ attempt to compel good faith seems oxymoronic. Either good faith exists in a given relationship and the formal requirement for it is redundant or bad faith exists and nothing in the Code or the Omnibus Regulations will cure that problem.

A cynical tenant might cut its cloth accordingly. The tenant and landlord who cannot voluntarily agree to a revised rental arrangement will join a long and growing queue to have their squabble determined in VCAT and (assuming the tenant’s compliance with reg 10) the tenant is most unlikely to be evicted for non-payment of rent any time before the hearing

Smart (or desperate) landlords caught in this bind might well prefer the short-term certainty of agreeing to a steeply discounted rental income to the uncertainty of waiting a long time to argue their case in VCAT.

Finally, the disclaimer. The Covid-19 commercial rent regime is new and untested. It is likely to be tweaked in the coming months. My thoughts and summaries above are both general and incomplete. If you are a tenant or a landlord you should not rely upon this blog as a substitute for legal advice tailored to your particular circumstances.

 

 

Is Covid-19 a frustrating event?

mona lisa with face mask

Photo by cottonbro on Pexels.com

Is Covid-19 a frustrating event? To almost anyone but a contract lawyer that is a stupid question deserving a terse and emphatic response.

But any decent contract lawyer’s answer is unlikely to be short or sweeping.

In contract law, ‘frustration’ is the discharge of a contract as a consequence of some supervening and unanticipated event rendering some or all of the agreement’s obligations incapable of performance. The reported ‘frustration’ cases involve a litany of  catastrophic surprises ranging from the appendicitis-induced postponement of King Edward VII’s coronation in 1903[1], through various wars[2] to (most familiar to Australian lawyers) the legal consequences of a contractor being injuncted from working 24/7 to build Sydney’s Eastern Suburbs Railway line[3] in circumstances where the construction contract was effectively predicated on ‘round the clock’ work.

The Covid-19 coronavirus is plainly a supervening and unanticipated event. It has already caused history’s first postponement of the Olympic games. It has closed all of your local gyms and eateries. It has largely shut down Victoria’s court system.  And just when we lawyers thought things could not get worse, it is even causing surprise outbreaks of law and order. But none of these extraordinary developments alone answers the question of whether the current crisis is a frustrating event for the purposes of any particular contract.

Here is a quick refresher on the frustration of contracts:

  • When looking at whether a contract has been frustrated, don’t be too distracted by the macro picture. Focus on the specific contract in question. Has the contract become largely or completely incapable of performance because of the Covid-19 crisis? (Obvious casualties would be, say, the catering contract for a large wedding party that would now be contrary to the Public Health and Wellbeing Act 2008, or the contract for the screening of TV advertisements during the telecast of the now-postponed Tokyo Olympics.) Or has the contract’s subject matter simply become less attractive or more onerous to one of the parties? (Examples in this twilight zone might include the marriage celebrant’s booking for that same large wedding — after all, the wedding itself is still permitted even if the attendance of more than 2 guests is prohibited — or the screening of TV commercials (themselves still clearly legal and feasible) promoting, say, holiday packages that are neither legal nor feasible in the current circumstances.)
  • Frustration is a binary concept. Some contracts will be discharged entirely for frustration. Some will be held not to have been frustrated at all and thus will survive the supervening event entirely unscathed. There is no legal middle ground in between which allows contracts to be amended but otherwise upheld on the basis that they were semi-frustrated.
  • Extreme pessimists (and possibly also those negotiating contracts very recently) might have had the foresight to address specifically the consequences of global pandemics in their agreements. They will have no need for the doctrine of frustration and will instead be governed by the force majeure clauses (aka ‘Act of God’ clauses) to which they have agreed. As frustration applies only where the supervening event is not anticipated by the contracting parties, frustration and force majeure clauses are best thought of as alternatives to each other.
  • Frustration ends a contract as a consequence of the supervening event. By contrast, force majeure clauses are bespoke provisions. They might end the contract but will commonly suspend rather than terminate the contract or reduce rather than eliminate a party’s entitlement to payment.
  • Frustration operates independently of the parties’ acts and intentions. Force majeure clauses are authored by the parties and as such will often require action or communication for invocation.

 

Consequences of frustration

Let’s suppose a given contract is frustrated by Covid-19. What next?

Melbourne’s Formula 1 Grand Prix last month is a high profile example. Armies of large and small contractors and sub-contractors were involved in setting up for the race and its various satellite events. The race was then cancelled at the last minute because of Covid-19 concerns. Myriad contracts must then have become incapable of performance. In each instance, the question arises of who should carry the cost of the food/ entertainment/equipment that was arranged and (mainly) delivered but ultimately wasted as a consequence of Covid-19?

There is no quick and confident across-the-board answer.

And don’t expect much help from the the frustrated contracts provisions of Part 3.2 of the Australian Consumer Law and Fair Trading Act 2012. In very crude summary, it provides that money paid or payable under a frustrated contract ceases to be payable and, if paid, is recoverable by the recipient EXCEPT where a court or VCAT considers it just to order otherwise.

Note that pandemic-sized exception.

Put another way, the answer as to who is to carry the losses of a frustrated contract  is ‘black’ except when a court or VCAT considers that it should be ‘white’ or some shade of grey (or perhaps some chequered-flag pattern for Grand Prix-related events).

This legislation gets more curious still. Its open invitation to litigation appears to have been accepted in Victoria on – wait for it – only a single occasion. That case was Foley v Afonso Building Solutions [2014] VCAT 1640.

In Foley v Afonso a landowner paid a builder a $10,000 deposit on a domestic building contract. It then transpired that the building permit necessary for the project was unobtainable. The owner wanted her deposit back. The builder refused as it was not his fault that the building permit didn’t issue. So the parties went to VCAT.

Senior Member Walker concluded that the contract had been frustrated by the impossibility of getting the essential building permit. He ordered that the owner was entitled to have most (but not all) of her deposit refunded. The builder was permitted to retain the $1800 he had spent on preliminary work (such as drawings and soil tests) but not the $8000 commission he paid the agent who had secured the contract.

The decision is short. It doesn’t mention any authorities or the word ‘restitution’ but the restitutionary flavour is unmistakable.

Presumably Covid-19 will soon ensure that Foley v Afonso is superseded by many more authorities on the consequences of frustrated contracts in Victoria.

 

Conclusion 1

Covid-19’s frustrations are suffocatingly obvious to most of us. But that doesn’t mean contracts affected by the virus will necessarily be themselves frustrated.

And whatever the answer on first principles to your particular frustration query, beware of the continuing cascade of government announcements and promised regulatory changes that might take your client’s situation beyond a ‘first principles’ analysis anyway.

With this in mind, follow resources such as –

 

Conclusion 2

A final thought over and above frustration.

In these extraordinary times, remember that your clients’ best Covid-19 solutions might not be in the legal textbooks at all.

The unexpected and supervening event of Covid-19 might, for example, trigger the business interruption insurance that your client has forgotten it holds and make the entire frustration discussion unnecessary. Check that insurance.

And while the C-19 maelstrom continues, remember also that the banking industry (see for exmple this Commonwealth Bank Covid-19 support page) and the laws of insolvency have both been temporarily transformed in recent weeks. (Your clients might have more time and options available than they appreciate.)

Stay safe!

 

 

[1] Compare Krell v Henry [1903] 2 KB 740 and Hearne Bay Steam Boat Co v Hutton [1903] 2 KB 683. Both cases involved sightseers disappointed by the coronation’s postponement. In the former case the contract was held to have been frustrated by the postponement; in the latter the contract was held not to have been.

[2] See for example Fibrosia Spolka Akcjyna v Fairbairn Lawson Combe Barbour Ltd [1943] AC 32 where a pre-war contract that required an English company to deliver machinery into Poland was rendered illegal and frustrated by the outbreak of World War 2.

[3] Codelfa Construction Pty Ltd v State Railway Authority of NSW (1982) 149 CLR 337.