The future of leases: retail

As a result of the Covid-19 pandemic, it is inevitable that both landlords and tenants will seek to introduce novel provisions into new leases. This will be to protect their cashflow in the event of another shutdown, respond to market conditions and reflect their new ways of operating. Landlords and tenants will have to continue to adopt the transparent and collaborative approach we have seen emerge in recent months and we expect to see a considerable shift in leasing practice. All lease provisions will be under the microscope, but those likely to be subject to most scrutiny will be discussed in this series – including offices and industrial. But we begin with the long-term influence of coronavirus on retail leases – and specifically the rental provisions, service charge clauses and tenant covenants usually found in such leases. The retail crisis The severe impact of enforced store closures on all retailers except essential shops will be a tipping point for the industry from which some traders (those without significant cash reserves or an online presence) will never be able to recover. The new restrictions on the way merchants are allowed to operate puts additional pressure on already squeezed revenue streams. We shouldn’t overlook the significant effect that Covid-19 has had on landlords, with retailers seeking concessions or in many cases simply withholding rental payments. Many have had to contend with legislation which prevents them from taking enforcement action and, at the same time, puts them at risk of breaching their own banking covenants, as we have seen recently with intu’s collapse into administration. Rental provisions Many of the rent arrangements usually contained in retail leases will be analysed and reviewed. Inclusive rents: More retailers are likely to request the certainty of “all-inclusive rents” as they seek to crystallise the amount of their monthly or quarterly outgoings. Turnover rents: There is likely to be hesitancy from landlords to offer turnover rent leases until such time as they are confident that footfall has increased to pre-lockdown levels. Pandemic rent suspensions and deferrals: Tenants will undoubtedly seek to have rent and service charge suspensions or deferments written into their leases, with such measures applying while a store is unable to open during a pandemic. On the March and June quarter days, tenants were entirely reliant on the goodwill, financial strength and transparency of their landlords and will attempt to ensure that, in the event of a further lockdown, the rental position is agreed in advance. The Code of Practice for commercial property relationships during the Covid-19 pandemic issued by the government in time for the June quarter day sets out the full range of possible options available, from a full rent suspension to a partial rent deferment for pre-defined periods (or any combination in between) or a temporary switch to turnover-only rents (including the period of closure). Payment periods and payment terms: In order to ease tenants’ cashflow, we are likely to see a move towards monthly rather than quarterly rental and service charge payments, with longer grace periods before landlords can charge interest. It’s even possible that retailers could seek to pay in arrears. Rent review: Retailers are likely to be reluctant to accept upwards-only open-market rent reviews and we foresee requests for upwards/downwards rent reviews to enable rent to be reduced to “market rent” in the event of a prolonged and severe economic downturn. Rent security: Tenants may be unwilling to provide guarantors that can be called on during a pandemic, with an increased number of landlords requesting rent deposits or bank guarantees that can be used to discharge unmet rental liabilities. Service charge provisions Variations to the service charge provisions contained in retail leases are likely to be as follows: Additional services to be provided: Retailers will want to impose obligations on their landlords to provide any additional services that are required to comply with guidelines given by the government in respect of common parts. Now that shopping centres have re-opened, we have witnessed the extensive measures landlords have had to put in place for the health and safety of staff and customers, including: managing social distancing at entry points of the shopping centre and shops; floor stickers to regulate queuing; using footfall technology to monitor the reduced capacity of a centre; revising car park capacity; increased deep cleaning, and cleaning regimes for risk-prone areas, such as lift buttons and handrails; providing hand sanitiser; providing PPE for cleaning staff; and installing new contactless technology on areas such as toilets, interactive centre guides and parking machines. As a result, we are likely to see a shake-up of the standard list of services to be provided by landlords, and landlords insisting on wide sweeper clauses to mop up additional costs. Cost savings to be passed on: Tenants will be keen to ensure that service charge payments are reduced if the closure of the shopping centre results in costs savings, with these savings to be passed on immediately rather than waiting until the reconciliation at the end of the year. Service charge caps and exclusions: Tenants will be seeking service charge caps especially if a significant burden is placed on landlords to increase the range and frequency of services (such as intense cleaning regimes). There is likely to be far more examination around service charge exclusions, with landlords keen to ensure there are no recoverability gaps and tenants keen to ensure they are receiving value for money. Exclusion from liability to provide services: Landlords will want to exclude their liability to provide services in the event that they are unable to do so because of a lockdown. They will want to exclude liability if it becomes uneconomical to open common parts for a small number of essential retailers or their closure is beyond the guidance of Public Health England at that time. Tenant’s covenants A retail lease contains a vast array of tenant’s covenants, none of which are immune from scrutiny: Opening provisions: It is anticipated that tenants will seek to introduce caveats that they will not breach their keep-open covenant if store closures are imposed by the government. They may want a release from their keep-open covenants if: the shop is forced to close because pandemic footfall has dropped below a certain specified level, meaning it is not viable to open; PPE for staff is not available; or the supply chain has broken down and no stock is available. Tenants are likely to seek the flexibility to unilaterally amend their opening hours. For example, essential stores may want to be able to open for longer if they have introduced NHS staff shopping hours or, on the exit from a pandemic, if retailers have to stagger shop opening hours to manage customer numbers and staff arrivals. User: Retailers have been forced to find innovative ways to operate during lockdown. One consequence is that tenants are likely to demand wider user clauses to give them scope to change their operations without landlord consent during a pandemic (to benefit from different income streams such as takeaway/delivery) provided any such alternative use is authorised by planning. Yielding up: Retailers will be keen to ensure that they are not frustrated from being able to comply with the yielding up provisions if they are unable to instruct contractors to carry out any remediation works due to a pandemic. They may ask for yielding up obligations to be deferred until such time as the retailer is able to access the premises, with landlords being prevented from serving a schedule of dilapidations in the meantime. Alterations: Retailers will want to be allowed to make alterations to their premises required by the government without landlord’s consent (which can be expensive and slow), as part of the protective measures that are put in place to protect both their staff and customers. Additionally, retailers will want to be able to quickly respond to the effect that changes in shopping habit may have on the layout of the store, for example, fewer changing rooms and more “click and collect” and return points. Part two looks at the effect of the Covid-19 pandemic on office leases, with an emphasis on the length of the lease commitment. Jennifer Ayris and Guy Whitehead are both senior associates at Irwin Mitchell LLP. READ PART TWO: The future of leases: offices READ PART THREE: The future of leases: industrial