Peter Blakemore rounds up some of the major factors to be taken into consideration when agreeing a potential pandemic clause in a lease.
Just over a year ago many of us experienced one of the few “I was there when…” moments, as Boris Johnson announced to the nation that the first lockdown of the UK would come into force from 23 March 2020. The 2019 novel coronavirus disease (Covid-19) dominated the news and has been at the forefront of dealings with commercial property ever since.
As we gradually ease from the third lockdown (at a slightly different pace across the UK and the devolved nations), the attentions of the landlord and tenant commercial property market are moving from closures and downsizing to the requirement for new or renewal leases that take into account the possibility of future pandemics – something that has not been contemplated in heads of terms for leases until now.
Landlords and tenants quickly found that the usual standard insured risks did not cover a pandemic and ways out of leases (for example, the doctrine of frustration) were explored but not practically possible. The market has found a way through the difficulties of payments and recoveries of rent (landlords do not want properties with tenants that cannot pay the rent on the other side of the lockdown periods, but equally tenants cannot afford to keep paying rent for properties they are unable to use) through the agreement in many cases of some form of rent relief/incentive agreement, reached through co-operation and outside the terms of the actual lease (as traditional rent suspension/cessation clauses only contemplate suspension through destruction of the property or estate, and not closure due to mandatory measures).
In our interconnected world, containment of disease is increasingly difficult and so unfortunately a pandemic clause is now a genuine negotiation point for a lease. This article will look at the still developing requirement to address the after effects of Covid-19 plus any future epidemic/pandemic in leases. It will be based primarily on a retail property perspective but will also try to consider hospitality and offices where possible.
Agreeing the clause
As a starting point and practically speaking, if the parties agree in principle to have a “pandemic clause” inserted into the lease, whether on renewal or in a new lease, it would be useful to agree the key terms in heads of terms. While landlords may be reluctant to agree a complete rent suspension for an entire period of lockdown, there are many alternatives available to a complete suspension.
The trigger
Covid-19 (or SARS-CoV-2 to use its exact designation) is the cause of the current pandemic. Another epidemic or pandemic could be a century away – or could be next year. As we have learnt in the past year, anything is possible. It is therefore important to consider what will trigger the rent suspension.
In the early part of the Covid-19 pandemic, some retailers closed their properties voluntarily before mandatory measures came into effect. Therefore, some points to consider when drafting/agreeing the trigger for the clause taking effect include:
• Defining Covid-19 (it is worth checking the latest definition of the disease) to cover future lockdowns due to Covid-19.
• A definition of other epidemics/pandemics, and who must declare them (for example, the World Health Organisation declaring Covid-19 to be a pandemic). It is possible that future outbreaks could be more localised. As we are aware, it took some time for Covid-19 to move from an epidemic to a pandemic.
• Is it only closure that will result in the clause taking effect? For example, a non-essential retailer may be forced to close completely; there may be an occupier that does not have to close but the wider shopping centre does; a hospitality operator may have to close to customers but continue takeaway orders; or an office occupier may only be able to operate at a certain capacity under lockdown measures. Different measures may have different effects on the clause (see below for more on this) and the way the rent will be dealt with.
• Who declares the implementation of mandatory measures? As we have seen in the UK in the past year, some regional/devolved governments have imposed lockdowns/mandatory measures on social distancing at different times and with different outcomes, so it is important to recognise in the clause that the closure/reduction in capacity must be due to a mandatory measure being imposed by the relevant authority. As we saw at the outset of this pandemic, some tenants closed their operations before they were forced to, and so it is important to agree and define at what point the rent suspension/concession should apply and the use of the property (and consider whether closure alone is a trigger or, in the context of office space, for example, a major reduction in the use of the property).
• What if closure is voluntary? Should there be any compensation for that period? The context here would be that a landlord may wish to close the centre before it is forced to do so or a tenant may seek to close when it is not obliged to – should a joint decision be made where applicable in an increasingly corporate social responsibility-led world?
When thinking about the clause and how it should operate, it is worth considering the context of the transaction in question. Setting this out clearly in heads of terms will assist with the drafting.
The effects
Consideration should be given to the effects of the clause and what it aims to achieve.
At its simplest level, the clause should suspend or reduce the payment of the main rent. It is important to record correctly what effect it will have. Some commentators have suggested that a staged rent may be a fairer option. Consideration should also be given to any additional sums due, such as service charge, that may be payable.
In a retail/hospitality scenario, a change to a turnover rent may be a possibility – this may be particularly relevant where click and collect/takeaway may be permitted but no other trading can take place. This should be carefully thought through as it may be difficult to apply a turnover rent for an indefinite period without regular obligations to provide trading data – there would essentially need to be a turnover rent clause in the lease, but which only takes effect when appropriate under the terms of the lease. This could be very difficult to apply in reality unless it is carefully drafted. If there is already a turnover rent, however, a suspension of the base rent may be possible, but thought should be given to any turnover threshold and whether or not that should also be reduced during the period to ensure that turnover payment will kick in.
A rent deferral is a further possibility – this will allow tenants to keep cash in the business during the lockdown period and provide some comfort to landlords with potential repayment in the future, but consideration should be given to the effects of increased rent repayments after the end of the period on tenants’ balance sheets.
The end of the period
Like any agreement, there needs to be a trigger for the end of the period.
The simplest way to end the period is to fix a set duration – for example, a maximum of one month/one quarter (this could be stepped, for example 0%-50%-100%). It is also worth considering how many times the clause can apply. During Covid-19 there have been three lockdown periods in England.
A second trigger for the end of the period (or another stage back to 100% of rent) is a partial reopening. For example, restaurants being permitted to operate takeaway services or shops running click and collect services – while they are not fully utilising the property, they are gaining some benefit from it.
It is also worth contemplating what happens in the event that the tenant receives some form of government or other subsidy or compensation in respect of loss of utility of the property or loss of income for the closure period. It may be worth considering having a mechanism for repayment of any balance in the event that this is received or offsetting/apportioning a certain amount to recover some of the concession allowed.
Finally, a landlord may wish to cover the possibility of the tenant benefiting from the concession and shortly afterwards seeking to assign the lease or exercise a break clause. They may wish to require a repayment be made in the event of this taking place.
Financial Conduct Authority v Arch Insurance (UK) Ltd and others [2021] UKSC 1; [2021] EGLR 12
The Supreme Court has ruled in this test case on business interruption insurance that the wording of certain standard business interruption clauses in insurance policies covered the insured businesses for losses incurred as a result of the Covid-19 pandemic and government responses to the pandemic.
The FCA website has published a list of policies that, based on the ruling, in principle may provide cover for policyholders for business interruption caused by the Covid-19 pandemic.
A policy checker is available at: www.fca.org.uk/firms/business-interruption-insurance/policy-checker
Covid-19 lockdown periods
For illustrative purposes, the following lockdown periods applied for non-essential retail and restaurants/pubs in England. Different periods applied across the devolved nations and within regions.
Lockdown 1
23 March 2020 – 15 June 2020 (non‑essential retail reopened)/4 July (pubs/restaurants reopened)
Lockdown 2
5 November 2020 – 2 December 2020 (but reopening was based on regional tiers)
Lockdown 3
6 January 2021 – 12 April 2021 for non-essential retail and restaurants/pubs (outside areas only). 17 May 2021 is the target date for indoor areas of restaurants/pubs with a target for full reopening on 21 June 2021.
Peter Blakemore is a senior associate in the investment and property management team at Brabners
