Tuesday October 20, 2020

Top tips for lease negotiations: tenants are protected from forfeiture until December, what then?

With COVID-19 continuing to put the UK’s businesses under pressure, the government has extended its protection from forfeiture provisions – a measure that stops commercial tenants being evicted from premises – until the end of the year, and similarly extended the restriction on landlords using Commercial Rents Arrears Recovery (CRAR) to enforce unpaid rent on commercial leases.

Some businesses have been unable to pay their rent over the course of the pandemic so far, and question marks hang over how many will be able to pay pre-pandemic rent levels once the forfeiture and recovery provisions are lifted, let alone pay back any arrears.

With the protection measures soon to cease, and temporary protections for directors from wrongful trading claims already expired, the coming months offer a crucial window for landlords and tenants to negotiate mutually agreeable arrangements that protect each party’s interests – ensuring landlords aren’t left with empty properties, and tenants without a place of business, or a business at all.

Here, we speak with Phil Reynolds, Partner in our Restructuring Advisory team, to find out more about the circumstances facing tenants and landlords, and what they should each keep in mind when it comes to negotiating changes to tenancies in the wake of COVID-19.

What is forfeiture protection, and what are you expecting to happen in the coming months?

The coronavirus pandemic crisis has significantly hindered some business’ ability to trade, and consequently their ability to meet overheads – rent often being a significant fixed cost among them.

Recognising this situation, the government introduced a ‘forfeiture moratorium’ as part of the Coronavirus Act 2020, which ensured that commercial landlords cannot forfeit a lease for the non-payment of rent during an initial three-month period. This was extended until September and has since been extended again until the end of December 2020. On top of this, the government has also extended measures preventing landlords enforcing the non-payment of rent by stopping the use of CRAR – rules that allow landlords to claim goods in lieu of unpaid rent – unless at least 366 days’ rent is outstanding to 25 December 2020.

These measures have been designed to give tenants who were struggling to make rent payments some space to maintain their operations while their income was impacted.

The end of protection from wrongful trading claims at the start of October means that directors now need to be sure that taking advantage of the additional relief is based on a credible strategy – the forfeiture moratorium means that liability for rent is simply deferred, it has not been forgiven.

For those who know, or anticipate, that their current lease arrangements are unsustainable, the coming months provide time to negotiate with landlords to reach an arrangement that allows tenants to continue trading on a consensual basis.

What are the first steps that tenants seeking concessions should take?

Firstly, it’s important that tenants facing difficulties don’t ignore the situation and recognise that making the most of this additional breathing space is vital.

Getting the negotiation process right first time is essential – tenants will only have one real chance at reaching an arrangement with landlords to avoid an insolvency event, and an incorrect starting position can derail the prospects of reaching a mutually acceptable solution.

A consensual solution will save costs and enable the business to continue without any risk of operational disruption, so will likely be the best strategy for a business to pursue in the first instance, if it’s viable to do so.

It might be that a business has previously tried to engage with their landlords to secure rent concessions, with no success. In these cases, they could consider seeking the support of a specialist adviser – they can act as an intermediary and re-approach the landlord to explain a business’ circumstances, and what support they might need to continue.

This could be particularly helpful in situations where a landlord has been inundated with requests for concessions from other tenant businesses that may have been taking advantage of the COVID environment to seek discounts for their own benefit – having a professional appraisal of a businesses’ prospects can help to strengthen a tenant’s case.

The involvement of a professional adviser will also help to concentrate landlords’ minds on what the alternative will be if a mutually acceptable solution isn’t reached. In some cases, a Company Voluntary Arrangement (CVA) or an administration process may well be the next step to deliver the savings a business requires, or a business could enter liquidation.

If a business is viable and sees a path forward for negotiation, what next?

Once a business has decided to enter negotiations with its landlord(s), the next step is to determine the parameters.

The key is determining what the business needs in order to survive. What level of rent is sustainable? What would be ideal?

The second is to fully understand a landlord’s position and circumstances. An individual landlord whose site forms part of their pension fund income, for example, will have different drivers, responsibilities and leverage – and therefore may well take a different approach – to an institutional investor. The landlord’s drivers need to be factored into a successful discussion.

It will also be important to think about a landlord’s options for the property, or properties, in question. How long would it be empty if the tenant were to vacate? In current market conditions, what incentives would the landlord need to offer to attract a new tenant? What would be the achievable rent be, and what is the dilapidation exposure?

In some cases, such incentives will likely meet – or exceed – what an existing tenant would need in order to continue occupying the premises, providing a strong case for the landlord to offer concessions to the business already in situ.

Once these factors have been determined, a tenant can then formulate a set of options for their landlord to consider –  in effect a menu of options that would work for the tenant, but can be shaped to fit the landlord’s needs.

This could include:

• A release from current arrears
• A ‘turnover-based’ rent, where the rent is determined as a proportion of the turnover generated by a business, which is the current structure of choice
• A direct discount to the current passing rent
• A hybrid approach – part fixed rent, part variable with the ability to revert to normal terms should a tenant’s performance warrant it
• Offering to stay in rent free (bar service charges) on a flexible exit basis so the landlord can find a new tenant and not have to worry about an empty property or rates
• Offering other post-COVID windfalls (e.g. a profit ratchet or a return to prior lease terms, if performance warrants)

Where the tenant has multiple properties with a landlord there is also the option to agree a portfolio deal – exit certain leases but extend the terms of others, which may be attractive to the landlord.

As mentioned before, businesses will really only have one chance to negotiate properly.

A landlord will need to feel comfortable that, if they make concessions, a business won’t be coming back again asking for further deals to be struck and that any deal reached will deliver a stable business.

With that in mind, it’s essential that business leaders take the time to thoroughly develop the case for any concessions they’re seeking before starting negotiations to demonstrate their genuine need for support.

Throughout the negotiation process, it is essential that tenants be honest and open with their landlords. It’s natural to not want to disclose the challenges or pressures a business is facing, but being transparent will only increase the likelihood of securing a deal that is effective and sustainable.

If, despite their best efforts, a business isn’t able to secure the level of concessions it needs, it should then consider alternative paths, including formal options such as CVAs, or other consensual negotiations between parties regarding outstanding liabilities that void the costs and publicity of a CVA.

Preparatory work for a CVA or an administration can be carried out in parallel to the negotiation process to ensure that a business is ready to act quickly, should negotiations fail.

Landlords sit at the other side of the negotiating table. What do they need to think about?

Many of the principles for landlords are the same for tenants, although there are some specific factors landlords should keep in mind.

Firstly, landlords should proactively enter into discussions with their tenants to assess their situations. Being on the front foot will help catch any potential issues early on and give the maximum time to reach a workable solution – ultimately helping to protect a business’ tenancy and a landlord’s income.

When approached by a tenant seeking concessions, landlords should press tenants for information to support their request for help. This will aid them in determining the degree to which the business in question needs the support – some landlords might be wary of tenants that appear to be under no pressure taking advantage of the current situation to reduce their own overheads. It’s also essential for landlords to ensure that, as part of any agreement or in new leases, they have the right to receive regular management information, although this may be limited for PLCs.

As advised to tenants, landlords should review the circumstances a tenant is in to determine their parameters for negotiation. Think about what it would potentially cost a tenant to move to a new location – for example, how much it would cost to fit out a new premises, or what they might recoup on an initial investment by selling existing store or office fittings. Factors like these can then be discussed as part of the negotiation process and used to help reach an agreeable solution.

Landlords should be wary of locking themselves into long-term deals that could leave them at a disadvantage. These are fast-changing times, and tenants that are struggling now may not be in as difficult a position in the future. Landlords should consider keeping any new arrangements to a shorter timeframe, so that the option to revert to a different lease structure is there, should the market improve.

Landlords need to be careful that any turnover based rent can be correctly controlled and audited, for example that click & collect revenue is reflected in the store P&L and that if internet returns are sold in store that this revenue is also captured.

Landlords should also be mindful that whilst they may be willing to support, others may not. Landlords should seek payment undertakings only applicable in the event of a CVA from parent companies to prevent further dilution.

Negotiation processes aren’t always straightforward, and all parties involved will need to be ready to make concessions. It is ultimately a sign of a successful negotiation if all of those around a table come away feeling as though they’ve had to give some ground.

Finally, it’s advisable that landlords conduct negotiations on a confidential basis where possible to avoid setting precedents.

However, more influential tenants may have secured ‘equal favoured nations clauses’ that will require any concessions to be granted on their leases, so the wider impact of granting concessions needs to be carefully assessed.

Although it will be important to maintain confidentiality, it is recommended that landlords keep their own lenders informed of any negotiations and engage them as early as possible in the process.

If concessions are made by a landlord, it creates new considerations for their, and their tenant’s, lenders, for example creating a discounting of the underlying asset valuations, potentially leaving a bank having to impair and creating capital drag. Giving lenders the maximum time to address the implications will be appreciated and help bolster wider stakeholder engagement to secure an acceptable result for all stakeholders.

What do lenders need to consider?

Lenders need to recognise that in this environment, it will often be in the best interests of a tenant and their landlord to reach agreement. A well-developed strategy conducted with transparency and in good faith can help secure a positive outcome and maintain cash flow.

Lenders will need to be flexible, as these concessions may impact on the landlord’s own ability to service their debt or to meet yield and/or loan-to-value covenants – while lenders may need to change their investment horizon or re-profile repayments, they do have the chance to be part of an effective solution.