What’s next? Understanding the Commercial Leasing Mandatory Code of Conduct

09 April 2020

In brief

On 7 April 2020, the Prime Minister of Australia announced the substantive details of the highly anticipated Mandatory Code of Conduct (Code) that will apply to certain commercial tenancies for the duration of the COVID-19 pandemic. The Code has now been released (you can access a copy here), ending speculation regarding if and how the Government would step in to regulate the commercial tenancy market during the pandemic.

Although the Code still needs to be legislated by each state and territory, the publication of the Code provides a framework to work through the numerous competing challenges that businesses around the country are navigating.

In detail

Who does the Code apply to?

The Code seeks to mandate a set of “good faith leasing principles” to apply to all types of commercial tenancies (including office, retail and industrial premises) that are governed by the Code.  The Code applies to all tenancies that:

• are eligible for the Commonwealth Government’s JobKeeper programme; and

• have an annual turnover of up to $50 million (with the threshold to be applied at the franchisee level in relation to franchising arrangements and at the group level in relation to retail corporate groups).

While not mandatory for commercial tenancies which do not meet the JobKeeper eligibility and turnover criteria, landlords are encouraged to apply the Code to all leasing arrangements for affected businesses, having fair regard to the size and financial structure of those businesses.

The leasing principles will apply to negotiation of amendments to existing leases and are intended to “aid the management of cashflow for SME tenants and landlords on a proportionate basis”.  The Code will apply for the duration of the period that the JobKeeper programme remains in force.

A binding mediation process will apply in circumstances where the parties are unable to reach an agreement amongst themselves.  Further, state based Industry Code Administration Committees will be set up to promote awareness of the Code, encourage its application and monitor operation of the Code.

What are the guiding principles?

The purpose of the Code is to ensure that the financial impacts of the COVID-19 pandemic are shared between landlords and tenants in a proportionate manner.  The Code recognises that this objective can only be achieved if leases are considered on a case-by-case basis so that each landlord and SME tenant can develop a bespoke solution that suits their particular needs.  

The overarching principles that underpin the Code, and which are intended to guide negotiations between affected parties, include:

• landlords and tenants must work together and discuss issues honestly and transparently with the aim of achieving mutually acceptable outcomes;

• parties must assist each other in dealings with other stakeholders, such as banks/financial institutions, government and utility companies;

• any agreed arrangements must take into account the financial impact of the COVID-19 pandemic on the tenant, including a reasonable recovery period; and

• the application of the Code should be appropriately modified for tenants that are in administration or receivership.

In addition to the leasing principles, the Code also contains a number of prescriptive measures.

What must landlords and tenants do?

The Code mandates certain requirements for arrangements agreed between parties, which must be applied as soon as practicable on a case-by-case basis.  These leasing principles include:

• landlords must not terminate leases or call on security (bank guarantees, bonds or personal guarantees) for non-payment of rent while the pandemic continues or during a subsequent, reasonable recovery period;

• tenants must continue to comply with the terms of their lease, other than as varied by arrangements agreed in accordance with the Code (and a failure to do so will result in forfeiture by tenants of any protections provided by the Code);

• landlords must offer tenants reductions in rent proportionate to each tenant’s loss of trade as a result of the COVID-19 pandemic during the pandemic and a reasonable recovery period;

• waivers of rent must account for at least half of the total rent reduction offered to tenants;

• payment of deferred rent must be amortised over the greater of the residual lease term and 24 months (although the parties can agree to shorten this period) and landlords cannot impose interest or other fees in relation to these deferral arrangements;

• tenants should be offered an extension of the term of their lease to cover any period when deferred rent is being paid;

• landlords must not penalise tenants for ceasing to trade or reducing their trading hours due to the pandemic;

• any reduction in statutory charges (such as land tax and council rates) or insurance must be passed on to tenants;

• landlords must not increase rents during the pandemic period or during a subsequent, reasonable recovery period;

• landlords should aim to share any benefits received from financiers, such as deferred loan repayments; and

• where appropriate, landlords should waive other expenses and outgoings payable by tenants and landlords are entitled to reduce services provided to tenants accordingly.

What details are outstanding?

Although the Code answers many questions that have been asked by landlords, tenants and other stakeholders over the past few weeks, it raises a number of others.  Some notable outstanding details regarding the implementation and operation of the Code include:

• National approach - The Code seeks to provide a national approach, however, it remains the job of the states and territories to enact legislation to implement the Code.  The Code states that it is “not intended to supersede such legislation, but aims to complement it during the COVID-19 crisis period”. Nuances in implementation - including the nature and extent of any relief from state taxes - may result in different outcomes across the country.

• Impact on financing arrangements - A key question that is causing many landlords angst relates to how their banks will support them during this period in light of their reduced rental income resulting from application of the Code.  Banks and financial institutions are not bound by the Code but the Commonwealth Government seems to be looking to these entities to support the operation of the Code. In his announcement on 7 April 2020, the Prime Minister stated that banks “also must come to the table here and provide the support to the landlords and I would particularly send that message to international banks operating in Australia, who are, in many cases, providing that support, particularly to many larger landlords”.  There is also a question around timing; as landlords are required to share benefits from financiers with their tenants, it is possible that a subsequent arrangement between landlord and bank could impact a prior agreement between landlord and tenant.

• Reasonable recovery period - Many provisions of the Code apply not only during the pandemic period but also during a “reasonable recovery period”.  At this stage it is not clear whether this will be a fixed period determined by the states and territories or by the parties themselves on a case-by-case basis.

• Turnover threshold and eligibility - There remain questions regarding which tenancies will be governed by the Code, some of which will be answered when the Government finalises its JobKeeper payments programme.  A key question relating to eligibility surrounds the period that will be used to calculate the AUD50 million turnover threshold. This is likely to be a significant point for many businesses given there are industries (such as the hospitality and accommodation industries) that may have a large number of businesses who exceeded this threshold a few months ago but whose turnover has now significantly diminished .

• Pre-existing deals - At this stage there is a level of uncertainty as to whether the Code will affect rent relief deals that were agreed early in the pandemic before the Code was announced.  The Code is stated to come into effect in all states and territories at some point after 3 April 2020, as determined by each state and territory. Given the temporary and urgent nature of the Code, it is possible that states and territories may seek to apply the Code retrospectively in certain circumstances, which could effectively undo or partially override some existing arrangements.

• Changes in circumstances - Given the pace at which the pandemic is unfolding and the ongoing uncertainty regarding how long various restrictions will endure, there is the possibility of agreed arrangements becoming manifestly inadequate (for either or both parties) over time.  It is unclear whether parties will be obliged to reassess and/or amend agreements in such circumstances. This could create further uncertainty for both parties when seeking to forecast their income and expenses based on agreed arrangements under the Code.

• Continuing solvency - One of the aims of the Code is to provide tenants with the opportunity to put their business into hibernation or reduced trading to reflect their cash flow circumstances.  Nevertheless, tenants will need to continue to monitor their solvency. In particular, tenants should consider modelling the cash flow impact of the increased rental and outgoings payments “on the other side” and potentially seek to negotiate a stepped approach so that they can gradually increase payments as they ramp up business in order to avoid a second cash flow squeeze during the recovery period.  

The takeaway

A number of questions remain regarding how the Code will operate, which won’t be answered until legislation is enacted by each state and territory.  Parties and their financiers may be reticent to formalise agreements until the final details are known and ancillary matters, such as tax implications, can be properly understood.  Further, the Code’s focus on financial impact as a key metric for determining appropriate relief means that many parties will need to work through detailed accounting records and financial modelling as part of their commercial negotiations.

Nonetheless, the release of the Code is a big step forward for landlords and tenants alike in terms of business planning for the COVID-19 pandemic period.  Many parties are already working together to try and solve their respective problems and reach mutually beneficial outcomes. Hopefully the release of the Code this week will facilitate landlords and tenants - both those who are covered by the Code and those who aren't - to engage in meaningful dialogue regarding potential options in their particular circumstances in line with the principles set out in the Code.