Negotiating a lease in the pandemic landscape

Empathy, pragmatism and playing the long game are key in current lease negotiations. Damian Botherway offers this useful guide to leasing for business owners.

The Covid pandemic has caused economic turmoil for business the effects of which are likely to be felt for some time yet.

The vast majority of SMBs operate from leased premises and it goes without saying that the effects of this uncertain landscape are spilling over to both tenants and landlords.

What we are seeing as this pandemic rolls along are businesses suffering reduced turnover, reduced business confidence and a softening in demand for commercial rental space as businesses close or relocate.

Putting aside the specific terms of Deed of Lease for a moment there is an overriding need for both tenant and landlord to take a reasoned approach to lease negotiations at this time. 

This may be in the form of a negotiation for a rent reduction, a rent review, rent reduction or a tenant seeking to assign or sublet.

Let’s look at those options a little closer, to help you find the best approach for you:

Subleasing

Subleasing some or all of the space to another business is one way to recoup some of the costs of rent. Under a sublease, the tenant essentially takes over many of the responsibilities of the landlord with respect to the subleased space, such as collecting rent and fielding complaints, and is responsible for ensuring that the subtenant meets their lease obligations. The tenant remains responsible for paying the rent and outgoings to the landlord.

Assignment

Under an assignment arrangement, the new tenant essentially replaces the original tenant and assumes all the rights and obligations of the lease.

From a contractual standpoint, the difference between subleasing and assignment is that under a sublease, the original tenant retains a contractual relationship with both the subtenant and the landlord, while there is no contractual relationship (privity) between the subtenant and the landlord.

Under an assignment, the replacement tenant’s only contractual relationship is with the landlord (for example, the replacement tenant pays rent directly to the landlord) and the original tenant has no further property rights or obligations. The original tenant isn’t completely off the hook, however, as they can still be sued by the landlord if the replacement tenant breaches any terms of the lease.

Both subleasing and assignment allow the original tenant to reduce their rent burden and give landlords what they want, which is consistent payment of the rent. However, assignment only makes sense for the original tenant if the space is no longer useful to them and they do not plan to return.

Rent relief

Your lease may or may not have an abatement (rent reduction) clause to address restricted access to the premises. In any event, tenants and landlord’s should plan for beyond the period that any abatement (rent reduction) clause applies.

Where an abatement (rent reduction) clause does not apply to any particular time (whether during or after the lockdown), a tenant suffering or anticipating cashflow or profitability issues, will likely want to try and reach a deal with its landlord for some form of rent relief.

Assuming a tenant wants to try to reach a deal with the landlord to help the tenant’s business:  What issues should both the tenant and the landlord consider when negotiating a deal on rent relief?

The following should be considered:

General position of the parties

Landlords will want to keep good tenants in place and operating for the long term. On that basis, a landlord may be willing to negotiate a deal for rent relief with its tenant.

Tenants need to keep in mind that rent relief is not guaranteed and a landlord does not have to reach any deal with a tenant (keep in mind that when we refer to rent relief, this is over and above any rent reduction which is already provided in the lease under any abatement (rent reduction) clause).

Tenants need to approach this with the understanding that the landlord is operating a business as well. The outgoings paid by the tenant under the lease cover some of the landlord’s holding costs of the property. The rent paid by the tenant is the landlord’s income. A landlord may have mortgage repayments to maintain for the property from that income.

Tenants need to be reasonable in any approach to the landlord. Landlords do not have an insurance response to any reduction in lease payments, so rent relief directly impacts the landlord as well.

Tenants should approach the landlord with information on its proposed cashflow and business continuity plan, taking into account disruption from COVID-19, to support its approach for rent relief. This will help the landlord to understand the tenant’s business better and how rent relief can help the tenant occupy the premises successfully longer term.

Options for relief

There are essentially two options for rent relief. First, deferring lease payments to a later date. Second, reduction of lease payments. The two options can apply together or separately.

You need to be specific as to which lease payments are subject to the relief. These can include rent and outgoings/operating expenses. 

You need to identify the type of relief applying to each type of lease payment, and the relevant month(s) it applies to. For example, a deal may grant an immediate reduction in rent for a month and then defer the next two monthly rent payments.

Deferring lease payments

If deferring payments is agreed to, then you need to identify when the deferred payment is due. For example, the deferred payment can be split into equal monthly instalments with a start date and an end date for those monthly payments. Any balance would be payable at the end of the lease or an earlier assignment of the lease by the tenant.

Conditions

A deal should be conditional on the tenant observing the lease. This is a driver for the tenant paying its future lease payments and meeting its other lease obligations.

A deal should be conditional on the tenant remaining solvent during the rest of the lease term. This is to ensure that, in the case of the tenant being insolvent, the landlord retains a higher amount of unsecured debt against the tenant than it would otherwise have with the rent relief applying. This gives the landlord a chance of receiving more from a liquidation of the tenant as an unsecured creditor, than it would otherwise receive.

Depending on the actual extent of the disruption to a tenant’s business resulting from COVID-19, the parties may need to revisit rent relief on a rolling basis over a number of months. 

For example, the parties could initially agree on rent relief for a two-month period and then (without binding the landlord to do so) look at the position again in two months if required. This would involve regularly reassessing the actual performance of the tenant’s business and future projections.

Rent review

The rent relief should be recorded as being disregarded for the purposes of any future rent review under the lease. This will ensure that the rent relief does not affect the rent payable from any rent review date, including reducing the amount of any ratchet amount on rent review.

Additional benefits to the landlord

There should be flexibility for give and take between the parties. The landlord may negotiate additional benefits in return for rent relief. An example is for rent relief to be conditional on either the tenant agreeing to extend the term of the lease or exercising a right of renewal.

Conclusion

These are abnormal times and have led to sectors of the economy being affected particularly those in the hospitality sector. Using the measures above it may well pay for landlords (if they can afford it in the short term) to play a long game and seek to have sensible conversations with their tenants. As an example, if a café has been operating successfully for a decade and is now struggling with their lease payments, it would seem a better bet to work with them and share some short-term pain, to ensure another decade’s worth of successful operations.

Damian Botherway is the principal and founder of Botherway Legal. Based in Hamilton, he works with owners and SMEs to provide commercial legal advice tailored to their needs. Damian’s focus is to work alongside his clients so that he can help protect them from any unforeseen business risks, and also help them to gear up and structure themselves for success.