Real Estate Blog: On the Horizon - Some clarity on how rent arrears are to be dealt with by the Commercial Rent (Coronavirus) Bill

Background

Following the severe impact of COVID-19 on commercial landlords and tenants in the UK, the government has legislated to protect tenants impacted by the pandemic in a number of ways, including preventing forfeiture for non-payment of rent (this restriction has now been extended until 25 March 2022), restricting insolvency procedures (including the issue of winding up petitions) and the use of Commercial Rent Arrears Recovery (CRAR).A Code of Practice for commercial property relationships during the COVID-19 pandemic was also introduced to assist parties in coming to settlements on rent that tenants had struggled to meet as a result of COVID-related closures and restrictions. However, this Code was expressly stated not to change the underlying legal relationship between landlord and tenant, and so many landlords have insisted throughout the pandemic on the full rent falling due for periods of closure.

Introduction to the Bill

As part of the extension of its COVID-19 support measures, the Commercial Rent (Coronavirus) Bill (the “Bill”) had its first reading before parliament on 9 November 2021 and the government has now published a new Code of Practice for commercial property relationships following the COVID-19 pandemic (the “Code”). The Bill can be viewed here, and the Code can be viewed  here.The objective of the new measures is to ensure that commercial rent arrears (including service charges, insurance rent and interest on these sums) accrued from 21 March 2020 are “ring-fenced” for commercial tenants that were adversely affected as a result of subsequent COVID-19 business measures.This “protected rent debt” cannot be pursued by landlords. The Bill also elegantly seeks to introduce a system of binding arbitration to be undertaken where agreement cannot be reached between landlord and tenant on how much of the “protected rent debt” should be paid, after providing for relief from payment.

How the Bill operates

The Bill applies to debts where:

• the lease is a business tenancy, as defined by Part II of the Landlord and Tenant Act 1954 (this means most business tenancies);
• the premises at which the tenant’s business was carried on were fully or partially subject to a requirement imposed by coronavirus regulations to close for business; and
• the rent debt accrued during the protected period.

The “protected period” during which the protected rent debt must fall due is the period from 21 March 2020 to the last date that either closure or operating restrictions were removed for the premises in question. It is for this reason that we conclude that the Bill primarily applies to sectors such as hospitality, leisure and non-essential retail tenants, rather than the businesses of tenants, who were not required to shut their premises, such as pharmacies, offices and industrial premises. Identifying the correct period is a complicated matter, albeit Annex A to the Code contains a helpful timeline to which parties can refer to clarify the position. By way of a hospitality-specific example, for pubs in England, the end date is 18 July 2021: when all restrictions were lifted. If rent arrears have accrued since then, then they will not be protected and will eventually have to be dealt with, one way or another.

The Bill, which has a target date for coming into force of 22 March 2022 but also contains retrospective provision in respect of certain debt claims made beforehand, will restrict landlords from seeking certain remedies in respect of this protected debt from the date on which the Bill is passed until either the parties have settled the matter between them, or the timeframe for binding arbitration is over. More specifically:

• landlords will not be able to issue debt claims for protected debts until the end of the arbitration application period or the arbitration process;
• all existing claims for protected debt and any County Court or High Court judgment made in respect of them will fall within the scope of the binding arbitration process;
• landlords cannot now present bankruptcy or winding up petitions against tenants if those petitions are based upon protected debt; and
• landlords will be prevented from drawing down rent deposits to cover protected debt and, where landlords have already done so, then the resulting obligation on the tenant to “top-up” its rent deposit is suspended.

The protections from claims and bankruptcy petitions mentioned above apply equally to guarantors.For debts outside of the protected debt, landlords will be able to pursue their ordinary remedies through debt claims, bankruptcy petitions and other methods (subject to continuing measures such as the moratorium on forfeiture), much in the same way as they can at the moment.The practical effect of the Bill is to stymie existing debt recovery proceedings and encourage landlords and tenants to settle those claims. That has been our experience to date. There seems little to be gained for landlords by continuing with claims as they are at risk of tenants applying to stay the proceedings, despite the Bill not yet being in force.

The Arbitration Process– Headline Points

From 25 March 2022, the Bill will introduce an arbitration process for outstanding protected rent in England & Wales. The decision of the arbitrator will be legally binding, subject to challenge or appeal in the High Court.It should be noted that the process is intended as a last resort and negotiation outside of arbitration is, as it has been throughout the pandemic, encouraged in the Code.Indeed, parties must bear their own legal costs of the arbitration and so we envisage that many commercial landlords will be put off by this fact as most are represented, versus the more frequently unrepresented tenants. Either way, if parties are professionally represented then none of their arbitration costs will be recoverable from each other within the arbitration. This also largely reduces the impact of “Calderbank offers”, which is the process where one party makes an offer to another which is intended to use the recoverability of costs as a lever for settlement, as the only costs that the arbitrator can order a party to pay are his own.The arbitration comprises a number of stages starting with the notification of a party’s intention to arbitrate with a proposal for settlement. The other party will then have the opportunity to accept or make a counter-proposal. If no agreement can be reached then ultimately an application for arbitration can be made.Both parties will need to take a hard look at the financial position of themselves and the financial viability of their businesses, when it comes to making proposals over the protected rent debt. They should also consider any resources that may be available to them and, having regard to their duties, be willing to consider renegotiating rent, where possible, to ensure the continuation of viable businesses:

• where a viable tenant cannot afford to pay protected rent debt in full, the arbitrator will consider issues of affordability, taking into account what the tenant can afford to pay whilst ensuring that the landlord’s solvency is preserved.
• where a viable tenant is seeking to deviate from the terms of the lease in respect of protected rent debt owed, they will need to demonstrate why the payment is unaffordable and what payment or payment period might otherwise be affordable in the near future. That may include information about their assets and liabilities, the impact of COVID-19 counter-measures on their business, and other information about their financial position and expenditure.
• a landlord can also evidence what is affordable to them, for example that a proposed reduction in rent demonstrates a threat to their solvency. This strikes the writers as a high bar for landlords, and a low one for tenants.

If the arbitrator considers one of the proposals made by the parties to be in accordance with those principles of viability and affordability, then they must make an award on those terms.However, if both parties’ proposals are in accordance with the principles, the arbitrator will apply whichever is most consistent with those principles. Only if neither are deemed to be in accordance with the principles contained in the Code will an arbitrator be able to make some other award.Readers may also be interested to know that the Bill contains provision for reasoned Awards made by Arbitrators to be published, subject to the removal of confidential information which is carefully defined (but might not extend to the parties’ names).

Summary

The Bill has been carefully drafted and is an impressive piece of work. Overall, the intent is to protect trading businesses and jobs from the adverse effects of Coronavirus counter-measures, which it would appear are not envisaged to reoccur. This is clear from the long lead in period to its intended date for coming into force as an Act of Parliament, in March 2022, and the interim measures which will act to retrospectively unpick actions taken in respect of protected rent debt in the meantime.

How can we help

In the meantime, questions may arise in relation to particularly fine points. One example is what happens to increased rents as a consequence of rent reviews, which occurred during the protected period? Alternatively, parties may be entrenched in their positions, and the question is how can a party position itself best in advance of an inevitable arbitration process.One advantage we have is that we are not only specialists in property litigation, but:

• we are also specialists in statutory arbitrations, having directly represented parties in over 30, over the past four years; and
• we are well accustomed to reviewing viability reports, having done so in over 100 cases in other contexts.

If this article is of interest to you, then we would welcome a conversation. Please contact Mark Brown, Adam Boyd or Tristan Sharples.