The National Cabinet of the Commonwealth and State and Territory Governments in Australia, which has been regularly meeting to lead Australia through the COVID-19 pandemic response, recently released the ‘COVID-19 National SME Commercial Leasing Code’ (the Code). You can read the Code here.
The Code states that it is designed to ‘impose a set of good faith leasing principles for application to commercial tenancies’ in Australia during the COVID-19 pandemic and ‘to aid the management of cashflow for SME tenants and landlords on a proportionate basis – as a result of the impact and commercial disruption caused by the economic impacts of industry and government responses to the declared Coronavirus COVID-19 pandemic”.
Despite these good intentions, it may fail to achieve the stated intentions fairly because it deploys the same blunt turnover test used by the Federal Government to push JobKeeper stimulus payments into the economy, to determine whether a Landlord must discount and/or waive rent for its commercial tenant. While this may be an appropriate approach for the provision of stimulus by a Government into the hands of workers (and business) like the JobKeeper payment, it is not an optimum approach to intervening into complex commercial leasing arrangements between private enterprises, where one party (the Landlord) as a consequence of the test may be required to subsidise the other party (the Tenant).
The consequence is that unless each State and Territory Government when legislating the Code clarifies the intent of the Code (explained below), commercial landlords may be required to provide rental waivers, deferrals and lease extensions to tenants using a Tenant turnover reduction test that does not necessarily evidence the Tenant’s inability to meet lease repayments in current trading conditions.
Some tenants may remain, despite a turnover drop, sound, profitable businesses, capable of paying their commercial rent payments, yet on one reading of the Code be entitled to a discount and waiver of part of their commercial rent for the duration of the COVID-19 pandemic and a currently undefined ‘reasonable recovery period’ under the Code.
This is because:
One of the ‘overarching principles’ stated in the Code is that any agreements reached under it: “will take into account the impact of the COVID-19 pandemic on the tenant, with specific regard to its revenue, expenses, and profitability.
“Such arrangements will be proportionate and appropriate based on the impact of the COVID-19 pandemic plus a reasonable recovery period.”
- Fairly considered, the Code fails to achieve this stated intent.
The balance of the Code, including the specific ‘leasing principles’ mandated within it are inconsistent with the notion that specific regard is had to a tenant’s profitability or expenses/cost base when determining whether a waiver and/or deferral or rent is needed.
The Code states that it applies to all tenants in ‘financial stress or hardship”.
Financial stress or hardship is defined in the Code to include: “…SME tenants which are eligible for the federal government’s JobKeeper payment are automatically considered to be in financial distress under this Code.”
The problem is that ‘eligibility for the Federal Government’s JobKeeper payment’ does not require demonstration by the business owner seeking the JobKeeper payment of the business’ underlying profitability or capability to pay its debts, including lease payments. Instead, it requires the business (with less than $1bn in income) to show an actual or forecast 30% or more drop in turnover using a monthly, or quarterly comparison to the corresponding prior year period (the business can choose the period to use to demonstrate that it meets the turnover fall test). Once that turnover test has been satisfied, the business then “remains eligible and does not need to keep testing turnover in following months”.
Proving an impact on turnover only with no consideration to the actual underlying profitability of the tenant is further endorsed at leasing principle 3 of the Code which states: “Landlords must offer tenants proportionatereductions in rent payable in the form of waivers and deferrals (as outlined under “definitions,” below) of up to 100% of the amount ordinarily payable, on a case-by-case basis, based on the reduction in the tenant’s trade during the COVID-19 pandemic period and a subsequent reasonable recovery period.”
- ‘Proportionate’ is specifically defined in the Code to mean: “the amount of rent relief proportionate to the reduction in trade as a result of the COVID-19 pandemic plus a subsequent reasonable recovery period, consistent with assessments undertaken for eligibility for the Commonwealth’s JobKeeper programme.”
Again, it calls up the JobKeeper turnover test with no mention of any assessment of ‘profitability’ of the tenant claiming hardship or its actual continued capacity to, notwithstanding turnover reduction, pay its rent.
Fairly considered, it is not inappropriate to deploy the JobKeeper payment turnover test to test eligibility for the JobKeeper payment. It is a deliberately broad test, designed to be simple to apply by the ATO who must administer it and those businesses who wish to claim the payment and it easily transcends all businesses, in all industries, allowing the Federal Government to achieve its goal of rapidly deploying billions of dollars in stimulus payments to an ailing economy. Put simply, it is a blunt instrument, by design.
The issue with using this same method to mandate intervention between private commercial leasing arrangements of commercial landlords and tenants is because: in business turnover does not always equate to profit, and a drop in turnover does not necessarily equate to an inability of the business to reasonably continue to pay rent.
A business’s cost base comprises of fixed and variable costs.
Most businesses in Australia affected by the COVID-19 pandemic have already moved to substantially reduce both variable and fixed costs, as much as possible, to attempt to cushion the impact of a decline in revenue and steady the business for the lean economic conditions ahead. Yet, the blunt turnover test the Code applies does not have any regard for the actual adjusted current cost base of the business or its underlying current profitability (and ability to pay its rent) in current trading conditions.
Similarly, different products and services offered by businesses to different customers usually attract different profit margins.
If the turnover drop experienced by a business arises from less or no demand for a low margin product or service offering, or a product offering with high variable costs that can be avoided when there is no demand for them, the bottom-line impact to the business’ profitability will be less severe than the drop in turnover intimates. Similarly, if the business had a bumper previous year or period being analysed now to meet the JobKeeper eligibility turnover drop test, it may still remain profitable today at lesser turnover, and capable of paying rent.
If one stated intent of the Code really is to: “take into account the impact of the COVID-19 pandemic on the tenant, with specific regard to its revenue, expenses, and profitability” then it appears to fail to achieve that intent by allowing reliance to be placed on the JobKeeper eligibility turnover test (that has no regard to the profitability or expenses of the Tenant) in order to trigger an entitlement to rental relief under the Code.
Before commercial landlords are obliged to endure the financial hardship of giving of material waivers and deferrals of commercial rent, for an uncertain duration of time, it seems reasonable to expect the Tenant to reasonably demonstrate hardship, in the form of inability to pay rent due to reduced profitability of the Tenant’s business in current trading conditions.
State and Territory Governments have an opportunity to address this issue before the Code is legislated in their jurisdictions.