COVID-19: briefing note on issues arising in real estate
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The Government support revealed so far has contained little comfort for owners or occupiers of commercial property, with the exception of the rates holiday covered in our briefing note for businesses and the restriction on eviction of commercial tenants announced on 23 March 2020.
At the time of writing there is no similar rates relief for landlords of vacant retail or leisure space and some of the trends we are seeing in the market are only adding to the pressure they face in what is acknowledged as the most challenging trading period any of us is likely to experience.
We set out below some of the issues facing the owners and occupiers of commercial space and those contracting with them in a construction or development context. We don’t have all the answers at this stage and anticipate that the landscape will continue to evolve here. We may see greater Government intervention if the parties to these exchanges do not interact with each other fairly and reasonably, we will update this note as and when any such changes occur.
Many commercial occupiers find themselves unable to trade or comply with their contractual obligations on their property portfolios given the enormous impact social distancing and mandated lockdown has had (and will continue to have) on commerce. We have seen a number of tenants writing quickly to landlords, seeking monthly rental payments or requesting rent holidays. Some landlords have unilaterally deferred the March payment for all tenants.
In recognition of the mandated lock down, government has now intervened and ordered protective measures for commercial tenants during this period. Any tenant unable to meet its rental obligations will benefit from a temporary moratorium on forfeiture during this period. For tenants this should present some much-needed breathing space, albeit that, given the extent to which the pandemic is affecting business, for many it will not be enough.
It is important to remember that the rents due are not being 'written off' by the change in law, and the tenants will still be liable for these in the medium term. Government is working in tandem with landlords to continually assess the impact on their cash flow and attempt to balance the interests of both parties.
Maintaining a dialogue will be beneficial to both parties, who will need to negotiate the repayment of the arrears in the coming months.
Landlords need to consider any requests for changes to rental arrangements or non-payment of rent with the impact on the agreements with their lenders, which may expressly prohibit any amendments to the rental pattern or require notification of tenants' failure to pay rent.
For landlords, transparency and open communication lines with lenders remain key. Certain lenders are, so far, taking a pragmatic approach on the impact of Covid-19. However, most lenders will have a high volume of customers they are trying to work with, so providing them with information they may need to assess any changes to banking facilities will be important. That could include revised rental projections, an assessment of each tenant's on-going covenant strength and the status of rent negotiations and proposals with tenants.
The key impacts of changes to rent receipts will be on serviceability of the landlord's banking facilities and compliance with the usual financial covenants. In some cases, there may be funds set aside to cover a reduction in rents. If there aren't, any agreement with tenants to reduce rents or change the basis on which rents are paid could require consent from lenders and require changes to the interest, financial covenant and repayment provisions of the loan agreement.
For landlords whose finance facilities contain forward looking financial covenants, the rental income elements of those covenants will need to be reforecast to see if there will be any breach.
Tenants may also need to take some steps if their lease is approaching expiry and they will (ultimately) want to rely on their statutory right to renew.
The accepted position is that the tenant is required to be "in occupation" at expiry and in a number of cases this may not happen, either due to a mandated lock down, or a tenant decanting all stock for insurance or other reasons.
Tenants need to show they still “control” the unit. Where a tenant is concerned a landlord may abuse the uncertainty over occupation, tenants should either serve a s26 R now or ASAP, or gently incorporate within their correspondence with the landlord that they remain in occupation. The latter may expose the tenant less, and therefore be preferable for many. However, current best thinking is that tenants will be considered to be in control of the premises even during this period and as such not denied their right to renew.
For some tenants there will be an argument that service charges should not be payable for a period that they cannot occupy, however, if England follows the example of other countries, supermarkets and pharmacies will continue to trade and for schemes with those operators the scheme will need to remain partially open and some services will need to be provided.
Some leases require a tenant to trade or risk enforcement action by the landlord. Where a tenant is mandated to close by government, it is likely they could rely on the requirement in their lease to comply with all laws to rebut any suggestion that they should continue to trade.
Where the tenant elects to close to respect government guidance on social distancing there may be other provisions in the lease which could be referenced in support of any argument for closure. Keep open clauses are likely to be unenforceable in the current climate and it is unlikely that there would be an award of damages against any tenant in a claim for breach.
Tenants with recently exchanged agreements will need to check their obligations regarding completion and establish if they and the landlord can both satisfy any pre-conditions (see below regarding issues for construction and planning).
Early dialogue is necessary to ensure that agreement is reached on any amendments to those agreements, as we would predict public policy issues in using the courts to seek to enforce such contracts, where one party could be accused of acting inequitably, which could prove fatal in specific performance and injunctive proceedings.
There are also practical issues with completion, with signatories not located in the same place and lacking the facilities to print engrossments. Documents to be sent to the Land Registry must have wet ink signatures. Lawyers will need to ensure that the Law Society guidance on executing documents by virtual means is complied with if they intend to complete using PDF or Word copies of documents and will need appropriate undertakings in place to ensure that the wet ink signed originals will make their way to them. In some cases, we may need to prepare hard copy engrossments and circulate in the usual way which will present timing issues for completion of documents.
If you have any queries and would like to get in touch with us, a coordinated team of experts are leading our support and can be contacted collectively using our dedicated inbox: [email protected].
From a developer perspective there are potential issues with land/property-related contracts and contracts in negotiation.
The developer will need to consider whether there is a risk of the counterparty seeking to delay or terminate the contract or which contracts might they themselves wish to delay or terminate.
Where there are existing agreements to which the developer is party, whether those are option agreements or agreements which have already completed, there may be difficulties in delivering on obligations contained in those agreements and a full review should be undertaken to establish what those obligations are, whether there are issues with compliance and whether a discussion with the counterparties is needed to agree to amend the agreement.
If the contract was recently exchanged, then normally site investigations follow and in some circumstances the contract could require these to be carried out within a specific time frame. There may be issues here in sending personnel to site to carry out those investigations in a manner which would comply with government guidance on social distancing.
Most contracts are conditional upon planning consent and they normally require planning to be submitted and achieved within a specific time frame. See below for the issues we foresee in the planning system.
The time periods within the contracts can require strict compliance and we would recommend that those agreements are reviewed to establish what those time periods are and whether there will be issues in complying
The parties to any development agreement or contract may require advice on whether the contract is now frustrated, whether the pandemic gives rise to a right under any force majeure clause (if indeed there is one), the relevant agreement should be reviewed in each case so that the client can be fully advised on their rights, obligations and the issues they may face in the event of a breach of covenant.
Sales rates could be affected by a number of factors, including consumer confidence, marketing suites being closed, staff and potential buyers self-isolating. A drive towards using more online and digital marketing tools may attract some buyers still keen to move but the drop in footfall will inevitably impact movement in the sales pipeline. Depending upon the length and severity of the virus outbreak the impact on sales rates and therefore cash flow and revenue needs to be planned for. Again, we may see contractual issues with those plots that have sold off plan but where the contractual completion date cannot be met.
Early engagement is necessary to agree amendments to contractual obligations where possible to avoid any issues around breach of contract. As we write some construction companies are closing their sales operations but not their construction sites, but the position may evolve further if and when changes to self-employed pay are introduced.
If you have any queries and would like to get in touch with us, a coordinated team of experts are leading our support and can be contacted collectively using our dedicated inbox: [email protected].
It is reasonable to assume that there will be some significant disruption in the supply chains of China and across Europe as a consequence of Covid-19, particularly in European countries more closely associated with materials production (such as Italy, Germany and Spain). It is pertinent to note that, as of October 2019, the UK was importing £2,800 Million worth of construction materials from China (accounting for 16% of all imports) and £1,000 Million of construction materials from Italy.
The potential for supply chain disruption is self-evident, which will be compounded as attempts to contain the virus in multiple jurisdictions cause further disruption.
Supply chain disruption may lead to delays in build commencement and/or completion. In addition, attempts to contain, delay and mitigate Covid-19 may themselves lead to other delays. For example, even without Government directing that construction activity must cease, active sites or management hubs may need to be closed for a period of time due to an outbreak on a particular site, perceived fears for worker safety (e.g., an inability to maintain social distancing), transport problems, or even reputational damage. Key staff or contractors may need to self-isolate, including those who might be essential to project operation, safety and security, or sign-off.
In even a moderate spread in the UK (which is looking less likely by the day), key personnel, such as finance teams and lenders' technical advisers, may be affected, delaying cash collection, invoice processing, drawdown of funds and payments. Whilst the Chancellor's recent announcements of support for business may provide welcome help, some tough decisions will still need to be taken by businesses about cash flow, who and what to pay and when.
We're hearing a lot about how Force Majeure might be relevant where affected suppliers, contractors, sub-contractors and the like seek to use force majeure clauses to avoid or vary their contractual obligations to perform works or services, deliver materials, etc. Could delays due to supply chain disruption or other factors cause a delay in the performance of such contracts? If so, will such a delay be treated as a Force Majeure event, or a breach of contract? Will any Covid-19-related duties, or liabilities flow through into sub-contracts, or is there a risk of disparity between these that might cause further cash flow issues?
There are myriad ways in which contracts might define or describe (or even curtail or preclude) Force Majeure events and their effects. Even if Covid-19 or its effects appear to be listed as a Force Majeure event under a particular contract, there are often other pre-requisites to contractual relief, such as the event also having to be unforeseeable, something the parties could not foresee, or, having foreseen, could not have provided against, have been fully mitigated.
Entitlements to claim relief from performance, or compensation under contracts may have strict duties to notify (perhaps within relatively tight timescales) any contractual effects and potential claims, or rights to do so may be prejudiced, or lost completely.
International supply chains may take a very different approach to Force Majeure, some countries and their legal jurisdiction having legally codified descriptions and protections. In the UK, if Force Majeure isn't dealt with expressly in contracts, there is no statutory or common law rule of Force Majeure in the legal jurisdictions of England & Wales, or Scotland or Northern Ireland that might operate to give relief. However, all may not be lost in these legal jurisdictions and there are certain common law doctrines that might still offer some limited comfort, although failure to perform contractual obligations due to legal impossibility, or frustration, are much more complex issues and require careful consideration to avoid claims for breach, repudiation and the like.
Early checks will need to be made across all relevant contracts, as there is unlikely to be a one-size-fits-all approach to Force Majeure in any business' supply chain contracts.
Early conversations should be considered with all counterparties, from a pragmatic and practical point of view, whilst taking care to reserve rights and not to prejudice any future entitlement to contractual relief or compensation, which is a difficult path to tread.
If you have any queries and would like to get in touch with us, a coordinated team of experts are leading our support and can be contacted collectively using our dedicated inbox: [email protected].
The planning system has a role to play in terms of allowing businesses to be flexible without fear of the threat of enforcement either for change of use or breaches of condition that may limit the scope of use. The Government has immediately proposed that secondary legislation will allow cafes, restaurants, pubs and bars to temporarily change use to hot food takeaways. Local planning authorities have also been encouraged to take a relaxed approach to enforcing conditions that may limit delivery times to food stores.
Local authorities will be under resourcing limitations similar to any business and this will inevitably impact on the smooth running of the planning system, particularly in relation to processing planning applications. Most local planning authorities will have suspended public meetings such as Planning Committee meetings for example. The Royal Borough of Windsor and Maidenhead has delegated the power to determine applications to planning officers in order to overcome such hurdles to decision making, however, developers have already expressed concerns that this presents a risk of legal challenge where the public has been denied the opportunity to be heard at public meetings.
The courts have not made any changes to procedures thus far, so any legal challenges will have to be made within the strict deadlines that apply to them and be made on paper where the relevant procedural rules do not allow for electronic filing. This means that anyone making a challenge should give adequate time to allow for preparation, filing and serving documents which may also necessitate using process servers.
Similarly the deadlines for appeals against the refusal of planning permission will still apply, although the Planning Inspectorate is much more engaged with dealing with matters electronically. It has, however, had to postpone public hearings and inquiries and is working up procedures to replace them with electronic solutions such as the use of video conferencing. This will also impact on other consenting regimes that use the Planning Inspectorate's resources such as applications for Nationally Significant Infrastructure Projects.
The limitation on local planning authority resources will have to be taken into account by applicants particularly where infrastructure agreements such as Section 106 agreements need to be negotiated and where conditions need to be discharged. The discharge of pre-commencement conditions prior to the expiry of planning permissions may be a particularly pressing matter and adequate time to programme that into processes will be critical especially as there is no current mechanism to extend planning permissions, despite such a mechanism having been introduced in the mid-2000s to address the global economic downturn at that time.
Local authorities may increasingly ask applicants to agree extensions to the statutory target for determining planning applications. Applicants should bear in mind that agreeing to any extension will result in losing the right, under the Planning Guarantee, to a refund of the application fee if no decision has been made after 26 weeks.
Parties to planning conditional agreements may have to consider the impact of the limitation on decision making resources and the likely change in the property market on their ability to comply with contractual obligations. The renegotiation of long stop dates may be of real importance, but this may also present an opportunity for parties wanting to exit positions in the face of uncertain market conditions to do so.
Where the change in market conditions causes financial pressure on developers they should consider whether Community Infrastructure Levy payments can be phased or whether any reliefs or exemptions may apply in extraordinary circumstances. Similar Section 106 obligations may need to be revisited where viability becomes an issue, possible by introducing viability mechanisms for re-assessment prior to commencement of development and later at completion.
The planning system will no doubt continue to flex in response to the ongoing implications of the social and market changes that will be experienced in the coming months. Developers, occupiers, contractors and project managers will also have to factor in the impact on local planning authority resources, their own financial resources, and contractual obligations into their programming and decision making for the foreseeable future.
If you have any queries and would like to get in touch with us, a coordinated team of experts are leading our support and can be contacted collectively using our dedicated inbox: [email protected].
