The future of leases: industrial

In the third and final article in their lease series, Jennifer Ayris and Guy Whitehead look at how Covid-19 has affected the industrial sector. Our previous two articles looked at the impact Covid-19 may have on leases in the retail and office sectors, specifically looking at the effect on rental provisions, service charges, tenant covenants and lease duration. In this final article we look at the industrial leasing sector. Many manufacturing processes cannot be carried out remotely, with employees being required to work in close proximity, leaving manufacturers vulnerable to virus outbreaks. The economic downturn has created less demand for products, and supply chain disruptions are causing bottlenecks that mean it can be difficult for manufacturers to fulfil orders on time. Rental provisions Rent suspensions and deferrals: The issue for the manufacturing sector will be how to determine the trigger point for the type of rent suspension or deferral mentioned in our previous articles. For shops and offices, there is a clear marker: an order to close or for all staff to work remotely. For manufacturers, although employees were still allowed to work during the lockdown, many had to close, reduce output or assist with the national effort to produce ventilators and PPE. Across the sector, margins were (and continue to be) severely affected, impacting on the manufacturer’s ability to pay rent. Will we see the introduction of a royalty-based lease, with the rent paid by the manufacturer calculated wholly, or partly, by production? Tenant covenants User clause: Occupiers will need more flexible user ratios between office, industrial and storage and distribution space to allow for changes in operating practices. There may be an increased storage requirement for materials to safeguard against another supply chain disruption, with landlords being asked not to enforce temporary planning breaches. Opening hours: Occupiers will require flexible hours to allow 24-hour shift work to catch up on lost time and manage social distancing. Alterations: Manufacturers will need flexibility to make emergency alterations, such as changes to the layout of a factory floor to implement social distancing or to manufacture different products, without landlord’s consent (which can be a slow and expensive process). Duration of lease Term: There will have been delays to projects owing to the lockdown. This will impact on property requirements if a unit has been leased to deliver a particular project. We anticipate an increased requirement for reversionary leases and call options so that if the rent has been suspended for a certain period due to a pandemic, the tenant can call on the landlord for a new lease for the corresponding period. Landlord’s covenants Quiet enjoyment: Landlords will wish to state that closing any shared areas due to a pandemic event is not a derogation of grant or a breach of quiet enjoyment to avoid any possible claim of a landlord’s repudiatory breach by the tenant. In the event of recession, landlords may request the flexibility to partially close common parts if large swathes of the property are unoccupied or certain occupancy thresholds are not met. Remedies for default Forfeiture and commercial rent arrears recovery: Tenants may request that the temporary protection provisions legislated for in response to Covid-19 – namely the suspension of forfeiture, CRAR (unless an amount equal to not less than 189 days’ rent is overdue) and the service of statutory demands and winding-up petitions – are written into leases in case another pandemic event occurs. Tenants are concerned about a perceived cliff edge when the current restrictions are lifted on 30 September 2020 and may wish to agree the length of any future moratorium to suit their own circumstances or allow the provisions to be implemented if there is a local lockdown which is not accompanied by protective national legislation. Service of notices: Landlords may want to serve notices for tenant breaches by email to avoid issues with the availability/delays of postal services during future pandemics. The storage and distribution sector Distribution facilities have seen exponential growth as a result of the pandemic. There is a huge demand for warehousing space as online retailers respond to increased demand. Larger online retailers will want to commit to shed space, and agreements for lease will need to include pandemic safeguards, such as extensions to longstop dates caused by delays in the planning or construction processes. Final thoughts Our journey though the anticipated lease amendments required for each sector demonstrates just how extensive the changes to current leasing practice could be. If changes to leasing practice are far reaching, we foresee difficulties for Landlord and Tenant Act 1954 renewals, where the leading case of O’May v City of London Real Property Co Ltd [1977] 1 EGLR 76 states that the new lease should be on the same terms as the existing lease unless a party is able to demonstrate that changes are fair and reasonable and are not required just to fit with market practice. The courts will ultimately decide if pandemic-related clauses are fair and reasonable in this context. If there is no radical change, it will be interesting to see the extent to which the government may step in. The Code of Practice for commercial property arrangements during the Covid-19 pandemic is limited in extent, voluntary and, with no sanctions for non-compliance, there are already early signs it is being ignored. Other areas for government legislation could include the abolition of upward-only rent reviews and/or the implementation of the Law Commission’s 2006 recommendation to abolish forfeiture and replace it with a new, fairer system for dealing with tenant defaults. The fact that the report is still on the shelf after 14 years, together with the still-voluntary nature of the Code for leasing business premises, is indicative of successive governments’ unwillingness to interfere with the landlord and tenant relationship. Only time will tell what the leasing legacy of Covid-19 will be. Jennifer Ayris and Guy Whitehead are both senior associates at Irwin Mitchell LLP READ PART ONE: The future of leases: retail READ PART TWO: The future of leases: offices Photo: Ray Tang/LNP/Shutterstock