The motivation behind the federal government’s mandatory code of conduct for landlords and tenants outlined last week sounds simple enough: to shelter both parties from the tidal wave of COVID-19-driven financial stress and place each in the best position to resume operating as normally as possible once the pandemic abates. Yet as the Commercial Tenancies Code framework unfolds under different state legislatures, there are teething problems aplenty.
The code is mandatory for tenancies that have a turnover of less than $50 million and meet the 30 per cent loss of revenue threshold, affecting thousands. Guidelines issued by Prime Minister Scott Morrison include a directive to landlords to neither terminate leases or draw on their tenant’s security. If owners refuse to negotiate with tenants, the prime minister warned they would “forfeit their way out of a lease”. Likewise, tenants must honour their lease. The ultimate goal is to preserve the commercial landlord-tenant relationship.
The tricky issue of evictions was tackled some weeks prior, when at the end of March, the federal government advised a short term, temporary moratorium on evicting any tenant unable to pay rent due to severe financial hardship caused by coronavirus.
The mandatory code was first announced at the same time Australian Bureau of Statistics (ABS) figures revealed over a third of Australian businesses had already embarked on renegotiating leases and rental agreements. Almost half of enterprises had also drastically changed the way they operated mainly via staff cuts and/or work from home arrangements.
An individual ideal
Lease renegotiations now hinge on calculating proportionality - whereby the tenant’s loss of revenue is in proportion to any rent relief provided by the landlord. The duration of relief should be consistent with the period of disruption COVID causes to the tenant’s business.
But while welcoming the principle, SMSF Alliance practice principal David Busoli states that one important party has been left out of consideration when in comes to lease negotiations – the landlord’s bank.
“Essentially, the code gives a tenant, with a reduction in turnover of at least 30 per cent, a rental accommodation for the COVID-19 period of at least that amount,” Mr Busoli says. “The concession is based on the tenant’s reduction in turnover, not their ability to pay.
“In contrast, the landlord must make the accommodation without reference to their ability to withstand the income deficiency, though there are some negotiable points at the margins that take the landlord’s financial capacity into account. The government’s expectation is that the landlord’s bankers will assist — but this is by no means guaranteed — creating a very real possibility that the landlord will be affected far worse than the tenant.”
Veteran accountants such as Rohan McCoy with decades of commercial contract negotiation behind them are also concerned. “They (the government) is trying to share the pain between all parties,” Mr McCoy says. “But the only party that’s not agreeing to share the pain is the actual bank
“I’ve had a client who’s gone to the bank and asked what can they do about their commercial loans. The bank agreed to defer payments for six months, yet interest will continue to accrue, added to the outstanding balance of the loan and he is to pay back the loan within the fixed term. So he actually gains nothing. He gains cash flow now, but in six months’ time, his cash flow is worse.”
The answer of the bank in question above, however, is in line with the ABA’s response to the mandatory code and decision to extend the six-month deferral of loans. In its response the ABA states “interest is capitalised – meaning either the term of the loan is extended or payments are increased after the deferral period.”
Mr McCoy cannot see the logic. “That is not kicking the can down the road - it’s kicking a snowball down the road which will get bigger.”
The problems lie in the fact the mandatory code is “exceptionally complex”, Mr McCoy says. “Everybody’s circumstances are different,” he says. “This will prove very thorny. I’m advising clients to stay as calm as possible and negotiate the best deal they can. And be kind to each other.”
But what if….?
With the code intended to apply ‘in spirit’ to all existing leasing arrangements, much appears left to be settled. Property and commercial law expert Erin Priest with leading firm Broadley Rees and Hogan says while the federal government’s announcements are welcome news, the question must be asked: what do they truly mean for in a landlord/tenant relationship?
“There may be other reasons why tenants have not paid their rent,” Ms Priest says. “Is COVID-19 going to give them the opportunity to obtain a moratorium on action?
“Will a landlord be able to call on a security it holds for breaches that pre-date COVID-19 or even take steps to terminate the lease in those circumstances?
“Terminations for financial hardship may disguise other issues and the landlord's position must be taken into account. Even debt-free landlords have responsibilities to meet financial obligations – pay property expenses, maintain buildings as safe places and provide returns to investors, many of whom will be members of superannuation companies.
“As these matters are considered, specific attention will need to be given to the meaning of "financial hardship" and whether COVID-19 is the underlying cause of such hardship.
“It's easy to sympathise with the decision-makers trying to anticipate all scenarios. No matter how broadly this is addressed, exceptions are to be expected. We expect further details will emerge before long in answer to some, if not all, of these questions.”