What Are Covid Clauses and Will They Become Standard in New Leases?
Government restrictions to prevent the spread of Covid-19 have resulted in many tenants being unable to utilise their premises while remaining liable to pay rent.
This is an unprecedented situation. Currently, commercial leases do not cater for the imposition of government restrictions that can force the closure of premises or dramatically change the way in which tenants can occupy and utilise them. Rent suspension clauses are common but these are normally designed to apply only if the property is damaged or destroyed by an insured risk.
During Covid-19 some landlords have considered short-term rent concessions for tenants who were previously trading relatively well and are confident of a bounce-back once restrictions are lifted. When considering such concessions, landlords want to ensure that the value of the reversionary interest is not diminished, the property remains good collateral for lenders and that the reduced rental income is commercially acceptable to the landlord’s business. In the future, can this scenario be pre-empted and catered for in leases?
What are Covid clauses?
The aim of Covid clauses is clear. It is an attempt to share the burden of the loss caused by restrictions which reduce a tenant’s economic activity or profitability.
They can achieve this by providing for a rent reduction, suspension, or even a right to terminate, in the event of the government imposing Covid_19 type restrictions which prevent or limit a tenant’s use of the property. The concept of such clauses has only just started to evolve and there is no market standard yet.
Are landlords likely to agree to include a Covid clause in new leases and/or on renewal?
The extent to which landlords will agree them is unknown. It will be interesting to see how the market reacts and what sorts of clauses parties seek to negotiate to allocate the commercial risks that may arise from future public health crises or other unexpected and significant events.
It is clear to see why they are not attractive to most landlords, although in some sectors, where there is confidence that they will bounce back after restrictions are lifted, a rent suspension or reduction provision might assist with keeping occupancy levels high.
Has there been any indication of market reaction to Covid clauses?
The retail sector has been the first to respond. We have seen two lower court decisions which have provided an insight into the approach of both the Courts and the retail sector.
Firstly, in the case of Poundland Ltd v Toplain Ltd (unreported) 7 April 2021 a tenant argued that, on a renewal under the Landlord and Tenant Act 1954, a Covid clause should be inserted into the lease because it amounted to modernisation, which is permitted. The landlord disagreed on the grounds that there is no market precedent for the inclusion of such clauses and that the Covid clause would fundamentally change the parties relationship (the clause reduced the annual rent and service charge by 50% during any period where the property could not be used). The Court found in favour of the landlord because it was not fair and reasonable to change a previously agreed risk and how that risk was shared. The Court also felt that the landlord had no control over the risk it faced, whereas the tenant might be able to control their risk through government assistance e.g. reliefs and other government backed schemes.
In a second lease renewal case, (WH Smith Retail Holdings Ltd v Commerz Real Investmentgesellsschaft mbH (25 March 2021)) the Court was not asked to rule on the inclusion of a Covid clause because the parties had already agreed to include it. Instead the Court was asked to rule on the trigger event giving effect to it. What is interesting to note from this case is that both parties had agreed the inclusion of a Covid clause. The judge even went as far as saying that such clauses have “become something that all tenants want, and that the market has now priced it in”.
This comment was made in the context of the retail sector, by a judge in a lower Court who had not been asked to rule on the inclusion of the clause, just the trigger of it. Not all sectors have had the same experience as retail. Landlords in sectors that have seen an increased demand, such as warehousing and storage facilities, might be more likely to resist such clauses.
We continue to watch developments within all sectors with interest and foresee more cases on the subject as the market practice evolves.
Here to Help
To discuss the legal side of a property development with our Commercial Property team, please get in touch with Rachael Spalton, Partner and Head of Commercial Property.
Please note the contents of this blog are given for information only and must not be relied upon. Legal advice should always be sought in relation to specific circumstances.