New proposals for Covid rent arrears – how landlord friendly are they?

Covid-19 and associated lockdowns resulted in the government, to try to protect the economy as a whole, stepping in to introduce a number of emergency measures. Some of these, through the Coronavirus Act 2020, aimed to protect commercial tenants from landlords who might otherwise take action against those who were unable to pay their rent as a result of the pandemic.

These measures included:

• a prohibition on forfeiture of leases in respect of commercial property
• preventing the presentation and progression of winding-up petitions in respect of tenant companies, unless the petitioning creditor was able to demonstrate that the inability to pay was caused other than as a result of Covid-19 (this has since been relaxed in part)
• preventing enforcement under Commercial Rent Arrears Recovery (CRAR).

The provisions invariably saved many tenants in financial difficulties as a result of the pandemic and enforced lockdowns. But they also led to acrimonious disputes with landlords where property owners found themselves unable to exercise real property rights, and where landlords may also have encountered financial difficulties as a result of being unable to pay monies owing to lenders as a direct result on non-payment of rent.

Following the introduction of the emergency measures, many tenants elected to withhold rent, largely in order to preserve cash flow, and to contact landlords to seek concessions such as rent reductions or rent-free periods. Yet the emergency measures were only supposed to afford protection to tenants who were unable to make payments as a result of the pandemic.

Impending end of the moratorium

The all-encompassing moratorium that currently prevents landlords from forfeiting commercial leases is due to come to an end on 25 March 2022.

Whilst there are many tenants and landlords who have been able to reach an agreement to date, there are many that have not. Landlords will shortly have to consider whether to take enforcement action by way of forfeiture, or CRAR proceedings, to the extent they are able to.

The government is conscious of the significant amount of unpaid rent that arose during the pandemic, estimated at c. £7bn, which resulted in the laying before parliament of the Commercial Rent (Coronavirus) Bill (the Bill).

The Bill in brief seeks to:

• Introduce a binding code of practice. This follows the Code of Practice for Commercial Property Relationships During the Pandemic, which was introduced during the course of 2021, but which did not have any force of law, and consequently there was no obligation on landlords to comply with it
• A compulsory arbitration scheme in the event that the landlord and tenant cannot reach an agreement.

The Commercial Rent (Coronavirus) Bill 2021

The Bill was announced on 9 November 2021, together with the new Code of Practice, and is intended to provide a limited continuing moratorium and binding arbitration scheme in respect of certain liabilities arising under a lease.

It is envisaged it will be passed into law before the current moratorium comes to an end on 25 March 2022.

Relevant debts under a lease

The Bill only applies to ‘protected rent debts’, namely:

• Rent, service charge, interest and VAT that falls due under a tenancy to which Part II of the Landlord & Tenant Act 1954 applies
• Subject to the whole or part of the business or premises being required by Coronavirus regulations to close;
• Any monies pursuant to 1 above are restricted to such liabilities that fell due during the period between 21 March 2020 and whichever is the earlier of:
  • The last date the business or premises were required to close or subject to regulation as to how the business was run or the way the premises were to be used; and
  • 18 July 2021 (Wales 7 August 2021).

The Bill does not appear to provide for more than one ‘protected period’, which appears to be illogical since there were several lockdowns. On the current drafting of the Bill it appears that even if a tenant was able to re-open between March 2020 – July 2021 for a period of time, they can take advantage of the entire protected period under the Bill in order to try to reach an agreement or enter into compulsory arbitration with the landlord.

Under most leases rent is ordinarily payable quarterly in advance. The Code of Practice suggests in such circumstances, in order to determine the amount of the rent that falls within the protected period, apportionment applies.

Arbitration in respect of unpaid rent

The Code of Practice stresses that negotiations ought to be progressed between a landlord and a tenant before invoking the arbitration provisions under the Bill.

Specifically, where affordable, a tenant should pay their liabilities due under the lease in full, and where a tenant is unable to pay in full the parties ought to attempt to negotiate a settlement. The Code contains guidance as to how parties ought to approach such negotiations.

Binding arbitration

Where a tenant and landlord are unable to reach a settlement and remain in dispute over the payment of a protected rent debt, either party is entitled to refer the dispute to a binding form of arbitration.

Any arbitrator appointed, and an arbitrator must be approved by the government in accordance with awaited guidelines to be set out in the legislation, in practice has to resolve the following issues:

• Whether there is a protected rent debt as defined in the Bill, and the amount of the same
• Where there is a protected rent debt, whether the tenant should be given ‘relief from payment’, which can include writing off all or part of the debt, giving time to pay by way of instalments over a period of up to 24 months, or reducing any interest payable.

Arbitration is a form of dispute resolution. Ordinarily an arbitrator is asked to resolve a dispute that has arisen between parties following a dispute, which largely involves a legal analysis as to whether a debt is owed.

However, in arbitration under the Bill there is no actual dispute, since a tenant cannot argue that no liability is due under the terms of a lease if the rent has not been paid. It appears that arbitration under the Bill involves a financial analysis as to what amount a tenant can afford to pay, and what amount a landlord can afford to accept, based upon an analysis of financial information of both parties.

Any arbitrator appointed under the Bill has to have regard to the fundamental principles in the Bill, namely:

• That any award should be aimed at preserving or restoring the viability of the tenant’s business, subject to it being ‘consistent with preserving the landlord’s solvency’; and
• That the tenant ought to be required to meet their obligations under the terms of the lease, subject to this being consistent with preserving the viability of the tenant’s business.

The Bill appears to be ‘tenant friendly’. In practice, what the arbitrator is truly determining is what the tenant can pay, and what is the minimum the landlord can accept in respect of rent. This will invariably involve an analysis of a tenant’s balance sheet, and cash flow forecasts, which suggests the regulated individuals most likely to be considered to be appointed arbitrators in such instances are likely to be accountants and/or insolvency practitioners. Similarly, the arbitrator must consider the impact on the landlord’s solvency by reference to the landlord’s balance sheet or any other supporting financial information.

To undertake the requisite financial assessment of the landlord and tenant, the arbitrator has to disregard the possibility of the either party borrowing money or restructuring its business.

Commencement of arbitration

Any arbitration under the Bill has to be started within six months the Bill becoming law.

The party who wants to start arbitration begins the process by serving notice of intention on the other party and allowing the other party 14 days to reply. The matter can be referred to an arbitrator either 14 days after a reply is received, or, if no response is received, 28 days from the initial notice.

Any referral to an arbitrator must include the parties’ formal proposals for resolving the matter, which would ought to include any proposals put forward under the Code of Practice.

The arbitration itself can either take place at a hearing, or the arbitrator can consider the same ‘on paper’. The arbitrator is obliged to consider any proposals put forward by the parties, and if the arbitrator forms a view that any particular proposal is consistent with the principles (see above), then the arbitrator ought to rule in favour of the said proposal.

The costs of the arbitrator are paid by the applicant. Any arbitration award is binding, although there are limited rights of challenge/appeal to the court.

Restricted moratorium on landlord’s remedies as a result of the Bill

In order to allow landlords and tenants to progress arbitration, if necessary, the Bill provides for a temporary moratorium on enforcement in respect of Protected Rent Debts (see above), which would include preventing a landlord from:

• Issuing a debt claim
• Exercising Commercial Rent Arrears Recovery (CRAR)
• Forfeiting a lease
• Drawing down on a rent deposit
• Presenting a winding-up petition or bankruptcy petition on certain grounds.

Commentary

Unusually, even though the Bill is not in force, once it passes into law it will have retrospective effect. So, any actions taken against debtors between 10 November 2021 and the date upon which the Bill passes will be affected by the relevant legislation.

For example, any debt recovery proceedings during that period will be subject to an automatic stay of proceedings. Unfortunately, it is not entirely clear what will happen if judgment has already been obtained in respect of such debt recovery proceedings. Moreover, a landlord cannot present a bankruptcy petition against individual tenants and cannot pursue guarantors in respect of protected debts under the restricted moratorium in the Bill.

The Bill will not:

• Have any impact on any existing rent concessions that have been agreed between the landlords and tenants, so tenants/landlords who have already reached an agreement cannot seek to invoke arbitration under the Bill
• Affect any existing Company Voluntary Arrangement (CVA) that has been entered into by a tenant.

But when an arbitrator has made an award under the Bill it creates a ‘ringfenced debt’ that cannot be included in any restructuring for a period of 12 months after the conclusion of the arbitration.

Consequently, if the arbitration award is significantly more than in practice the tenant believes that it can pay, and it subsequently encounters financial difficulties, any future CVA would not absolve the tenant company of its obligation to pay the arbitration award if a CVA were to be progressed within 12 months. That may mean that we see a decline in CVAs of tenant companies in the short term.

The provisions under the Bill are far more extensive, and arguably too complex, than similar schemes in other jurisdictions. For example, in Australia the government simply introduced a scheme whereby tenants during the relevant period would benefit from six months’ rent forgiveness and six months’ rent deferment.

The precise basis of the proposed analysis of the financial position of both tenant and landlord is not clear, as the legislation has yet to be approved in its final form, so we simply do not know what the final provisions will say.

That uncertainty includes several other points, including:

1. What analysis of a tenant’s company balance sheet will an arbitrator be expected to make; could they seek, for example, to reduce any dividend/remuneration drawn by directors or directors/shareholders?
2. The position of guarantors, who ultimately may benefit from the arbitration award as it would effectively reduce the amount under their guarantee. The Bill does not currently allow them to invoke the arbitration process; they must rely on the tenant doing so.
3. When taking into account what a tenant can afford, would any arbitrator also make a suitable provision for uncertainties (for example a further lockdown in the event of a further variation)?
4. There are no payment limits, so if the tenant cannot pay, and the Landlord’s solvency would not be affected, theoretically the arbitrator could reduce the rent and other liabilities payable to zero.
5. The Code of Practice, and the Bill, suggest that where a proposal from a tenant is reasonable, taking into account what it can afford, and where a landlord can effectively accept a reduction as suggested by a tenant then the arbitrator will implement the tenant’s proposal.

But it is not clear whether an arbitrator will consider, in determining whether a landlord can afford to accept the proposed reduction, lending agreements with the landlord based upon the value of the property with defaults allowed based on loan to value (LTV), or any agreement with minimum rent covenants involved.

6. How this will affect the use of CVAs, which often give landlords an option (for a finite period of time) to forfeit a lease as opposed to accepting reduced rental. The Bill effectively imposes a specific award/reduction and does not therefore allow a landlord to forfeit the lease even if it wished to regain control of the property, although any rent that does not fall within the protected period does have to be paid in full.
7. Before the announcement of the draft Bill, there had been a number of cases determined before the courts that were ‘pro landlord’. The Bill seeks to redress the balance and is ‘tenant friendly’ to the detriment of a landlord’s real property rights.

It remains to be seen whether the new arbitration process under the Bill would be successful in resolving Covid arrears disputes, and it is intended to be the last resort as parties are encouraged to negotiate in order to avoid arbitration. Indeed, the Code of Practice suggests there is an expectation on landlords to waive some or all rent arrears ‘wherever possible’.

As the Bill allows the parties to enter into a compulsory form of dispute resolution process, it is vital that tenants and landlords engage now with a view to trying to avoid the costs and pitfalls of the binding arbitration process introduced by the Bill.