Lease obligations – a Q&A on the impact of Covid-19 on lease terms

Lease obligations
A Q&A on the impact of Covid-19 on lease terms

Covid-19 has brought much uncertainty to all of our lives. The commercial property sector is an area where many questions are being asked, many of which centre around obligations to pay rent when premises have been closed.

We have noticed that landlords and tenants are unclear as to what their lease obligations are in these particularly extraordinary and unusual circumstances. We have prepared a note of the most frequently asked questions and answers below.

It is important to understand the legal position that common law underpins the law around commercial leases in Scotland. We have considered the most regularly seen adjustments made to the common law position. However, we must advise that each lease and each business is different. This article sets out some key points to consider that it is important that you consider the specific terms of your own lease in the circumstances of the premises or business operating be from.

For the purpose of this article we are considering that the tenant is a “non-essential” business which is closed in accordance with government advice.

Do I still have to pay rent to my landlord even though I cannot trade?

As a general rule, tenants are not entitled to a rent reduction or rent free period as a result of a downturn in trade. Normal commercial lease terms do not include rent suspension clauses for epidemic / pandemic events and it is unlikely that your lease would contain such a provision.

A standard rent suspension clause usually applies where there has been damage to or destruction of the property by a risk insured against by the landlord in terms of the property insurance. Epidemics / pandemics are not usually found in the category of insured risk, neither will it be easy to demonstrate that they result in damage or destruction to the property. For further detail on insurance, please see our answer to the insurance question below.

However, it is important to remember the landlord-tenant relationship is a relationship. Landlords have a longer term interest in supporting and retaining normally sound and reliable tenants.

It may be possible therefore, in the current circumstances, to negotiate a mutually acceptable compromise with your landlord on payment of rent. Options could include any or a combination of a rent holiday, rent reduction and / or extended time to pay. The duration of any concession or renegotiated outcome will need to be agreed, as will whether or not there is a compensatory payment to be made to the landlord later. Any agreement reached between you and your landlord should be formally documented. We can help you with that and with negotiations with your landlord or its managing agent.

Considering that it is not long until the May quarter day, which will constitute the next payment date in most leases which operate on the Scottish quarter days, it may be worth talking to your landlord or managing agent now to explore the scope for agreement. Allow time for negotiation rather than leaving it too late, as your landlord may (amongst other factors) need to secure it’s funder’s consent to any agreement tentatively reached with you.

I thought tenants could retain rent in certain circumstances?

At common law in Scotland, a tenant is entitled to retain rent in the event that the landlord is in breach of the lease. Parties can, and usually do, contract out of this in leases of commercial property.

Where it has not been contracted out of, retention of rent cannot be used simply because a tenant has experienced a downturn in trade or elected to close a unit.

The function of retention is to either compel performance by the landlord of its obligations or to secure damages. It is therefore not applicable where units or a larger building have been closed in compliance with a government order as in a shopping centre.

Similarly, the Court also has discretion on whether to allow retention in ‘special circumstances’, which may protect the landlord if a tenant tried to argue a breach by the landlord in closing a larger building of which a unit forms part when all but a few units have been required not to trade.

I have heard my lease has a ‘keep open’ clause in it – what is it and if I cannot open how can I comply with this. Can my landlord hold me in breach of the clause?

Some leases will contain ‘keep open’ clauses, requiring the tenant continuously to occupy and trade from their premises throughout the duration of the lease. However most ‘keep-open’ clauses will have certain exceptions from them, not requiring the tenant to keep open in cases where, for example, the tenant is prevented from doing so by some other cause wholly beyond the tenant’s control. You should therefore check the terms of your lease for any exceptions.

Even where there is no adjustment to the keep-open clause, it is highly unlikely that a court would uphold such a clause in the current circumstances. A court would have discretion on whether to grant an application to uphold a keep-open clause and will not do so in ‘exceptional circumstances’ – it is likely that Covid 19 measures would constitute such ‘exceptional circumstances’, particularly so when the Government has ordered a lockdown.

In the first instance, check the terms of the keep-open clause in your lease.

My lease mentions restricting or suspending payment of rent to my landlord – when can I use this clause?

At common law, rent abatement applies if the tenant loses the beneficial enjoyment of any part of the premises let to it either through the fault of the landlord or an unforeseen calamity which the tenant was not able to prevent. The case law on this is historic and involves situations where premises have been damaged or destroyed. A tenant may be entitled to argue for an abatement in rent as a result of unprecedented closures enforced due to Covid-19.

As with retention, rent abatement can be contracted out of by a specific lease clause. Leases often require payment of the rent ‘clear of all deductions whatsoever’. A landlord could therefore argue that means the parties have contracted out of the common law position in respect of abatement.

Most commercial leases will only provide for suspension of rent in the case of damage or destruction by an insured risk but as explained below that would not cover a pandemic situation.

In the event that there are any ambiguities in the terms of the Lease then it is likely the Courts will interpret these in a tenant friendly matter in circumstances that the population is in lockdown.

These matters are of course open to negotiation with your landlord. Given the unprecedented situation we find ourselves in it may be more prudent, and fruitful, to have commercial discussions with your landlord sooner rather than later in order to discuss rent reductions (for example abatement of rent or a rent ‘break’ or rent free period) rather than attempting to rely on interpretations of the lease once the rent payment has become due. Please see our comment at the first question above regarding rent holidays and rent free periods.

What is the position regarding insurance? Could that help me here?

When considering insurance, it is important first to distinguish between property insurance and business interruption insurance. Let’s look at each of these in turn.

Property insurance

In relation to property insurance, landlords will generally insure the premises in order to retain control over the insurance and over the reinstatement of insured risk damage or destruction, and the tenant will reimburse the landlord for the premiums.

The purpose of this insurance is to cover against damage to or destruction of the property rather than to cover against closure of the premises due to events not resulting from destruction or damage. It is therefore unlikely that landlord’s property insurance would cover business losses or expenses from the current situation other than if damage or destruction of the premises were to occur. Your own business insurance would be a more likely place to find insurance cover against the current circumstances. Please see our note below.

A tenant’s repairing obligations under a lease will usually exclude from the tenant’s responsibility damage or destruction caused by risks that are insured against. Most leases contain a predictable defined set of ‘insured risks’ with the right for the landlord to insure for additional risks if ‘normal commercial risks’. That prevents the landlord insuring against obscure risks at the tenant’s expense. Hence why pandemic cover is rare.

If the leased premises are now closed, it will be in the interests of both the landlord and tenant to check the building insurance policy terms and the insurer’s requirements for steps to be taken at the premises and any larger building of which they form part when the premises or the larger building are closed for an extended period, to ensure that that benefit of property insurance is not lost.

Many commercial leases do now include provision for ‘uninsured risks’ due to concerns by tenants that landlords may have not have, for whatever reason, insured all the risks that they should have or because insurance cover may not be available or ceases to be available. It is worth checking your lease to see what, if anything, is provided for in relation to ‘uninsured risks’.

Business interruption insurance

Although most small and medium sized businesses do not have comprehensive business interruption insurance, it may nonetheless be worth checking to see whether you have business interruption cover and whether a claim could be made on it, for loses or expenses incurred from the Covid-19 response, particularly now that premises have been compelled to close.

It should, however, be noted that there has been clarification recently that even where policies contain disease cover, they will not usually cover Covid-19. It would be best to check the precise terms of any policy you have in case there is a general class of notifiable disease (Covid 19 having been listed in Scotland as a notifiable disease).

It is probably true to say that most business interruption policies will cover damage to property and therefore any possible claim for Covid 19 will then fail at this hurdle as there has been no damage or destruction to the property directly on account of the pandemic.

I am concerned about cashflow. I think I will be able to continue to pay rent to my landlord for another few months but I might not be able to pay on time. What penalties are there for paying rent late?

Unless payment of penalty interest on rent or other sums is specifically provided for in the lease, there is unlikely to be a right to payment of interest at common law.

Most commercial leases do however provide for penalty interest to be payable (usually at 4% above base rate of one of the clearing banks) from the due date until paid (in the case of rent) and from the due date, or if later, from the date of demand (for other sums such as service charge and insurance premiums). Most tenants will revise in a period of grace during which no interest will apply and the normal concession is that no interest will be payable if the amount is paid within 14 days of the due date, but if it is not paid within that time then interest will run from the due date.

If the landlord raises a court action against a tenant for payment of the late rent or other sums, the court can also be asked to award judicial interest on the sum due – but that would be from the date the court action started as opposed to the date when the rent/other sum was due.

If I become unable to pay the rent at all, what might the landlord do?

Practically, there is currently very little a Landlord can do to recover rent arrears. The Courts in Scotland are effectively closed for anything except urgent business. Sheriff Officers who assist in enforcing payment are not currently carrying out field work. The Landlord is therefore unable to raise a Court action, or carry out diligence for recovery of sums due. However, the rent will remain due and these are the steps that the landlord could take once matters return to normal.

Failure to pay rent (or other sums) when due will entitle the landlord to seek to recover the sum contractually due (including interest as noted above) by way of civil court action.

The amount due would determine which Court the debt recovery action could be raised in and the applicable procedure. In all cases, however, the landlord would need to write to the tenant demanding the outstanding balance under threat of litigation.

Should the landlord raise legal proceedings, it could, when doing so, seek ‘diligence’ – by instructing Sheriff Officers (i.e. bailiffs) to take any of a number of steps to secure the debtor’s assets to cover the debt pending the Court determining the outcome of the debt recovery action. Those steps could include ‘arresting’ (i.e. freezing) bank accounts, such that any balance in an account on at the time of the arrestment is frozen, or ‘poinding’ (i.e. seizing) assets (e.g. plant) such that they cannot be moved – in each case until the Court says otherwise (which could be until the debt recovery action is resolved). In each case, these are designed to force a debtor to settle or otherwise provide ‘caution’ (security) to the Court for the debt.

The landlord could instruct summary diligence against the tenant to enforce payment (of e.g. rent) without raising a Court action. The landlord can only do this if the lease contains a provision which allows it to be registered ‘for preservation and execution’. Most leases contain this provision. This means that the Landlord would not need to go to court to get a decree for rent due but could immediately take steps to serve what’s called a Charge for Payment and attempt to arrest monies.

Separately, if the tenant is a company, the landlord could issue a statutory demand for payment – leading to liquidation if not paid in 21 days.

Could the landlord terminate my lease on account of non-payment of rent or on account of some other breach given that I am not in occupation?

Irritancy is a right available to a landlord to terminate a lease due to breach by a tenant. The effect of exercising this right is that the lease is terminated and the lease becomes void, as if it had never existed.

There are two types of irritancy:

• Legal Irritancy is implied by law and can be utilised if the lease does not contain an irritancy clause. This provides the landlord with a limited right (at common law) to terminate the lease but this only applies if the tenant has failed to pay the rent for two years and is a qualified right.

• Conventional irritancy relies on a contractual basis. It will apply to most modern commercial leases as they will contain an irritancy clause which will set out the grounds of irritancy. This is much more common than legal irritancy as in respect of the ground of non-payment of rent, this enables a much shorter period (than two years) to be specified in the irritancy clause in the lease. In addition, the other events and grounds which would entitle the landlord to irritate the lease will be set out.

The usual grounds of conventional irritancy set out in most irritancy clauses are:

• A rent payment being 14 days late, whether or not demanded
• Any other payment being 14 days late after demand
• The tenant becoming insolvent (bankrupt/sequestrated or a receiver, administrator or liquidator being appointed)
• Any other breach of the tenant’s obligations

Tenants will normally seek to revise the irritancy clause in order to allow for a period of 14 days notice to be given by the landlord setting out the failure to pay and threatening to terminate unless payment is made by the expiry date of the notice, and to provide for a reasonable period of time to be allowed for making good any other breach.

Tenants will also normally require the landlord to allow a period of 6 months to one year for a receiver, administrator or liquidator to dispose of the lease. In agreeing to this, the landlord will usually provide that this will only apply if the receiver, administrator or liquidator, undertakes personal liability for all payments including arrears and for performance of all other obligations during this period.

Statutory protection for tenants

Sections 4 and 5 of the Law Reform (Miscellaneous Provisions) (Scotland) Act 1985 contain statutory provision relating to the irritancy of a lease for monetary and non-monetary breaches.

Therefore, where a tenant has not made revisals to the irritancy clause to provide for the normal tenant provisos and concessions in the manner outlined above, they will gain a measure of protection by virtue of these statutory provisions.

Section 4 of the Act provides, that in relation to a monetary breach, the landlord must give the tenant a warning notice allowing the tenant 14 days (or such longer period as may be specified in the lease) to pay the arrears and stating that the lease may be or will be terminated unless the sum is paid within the specified time. This notice is known as a ‘pre-irritancy notice’. If the tenant does not pay within the specified period, then the landlord can ask the court to grant an order irritating the lease. This pre-irritancy notice must be sent by recorded delivery.

Section 5 provides, in relation to non-monetary breaches, that a landlord may only exercise his right to irritate the lease, if, in all the circumstances, a ‘fair and reasonable landlord’ would do so, and there is no requirement here to serve any warning notice. In assessing what is fair and reasonable, consideration should be given to whether the tenant has been given a reasonable opportunity to remedy the breach.

It is not possible to contract out of the 1985 Act. Please see the answer to the next question for further irritancy protection measures now introduced in response to the panademic.

I thought I’d heard that the government had passed legislation to suspend landlords’ rights to terminate leases at the moment?

In Scotland as of 6th April 2020, the Coronavirus (Scotland) Act 2020, provides that any pre-irritancy notice served by a landlord must now give the tenant 14 weeks to pay and that that period may be extended by Scottish Ministers.

Any pre-irritancy notice served before 6th April 2020 is void if the notice period in the notice has not yet expired – i.e. this is to cancels 14 day notices (which are still within the 14 day period) which have just recently been served.

In summary effect, therefore, a Scottish commercial lease cannot be irritated for at least 3 months under these provisions and that period may be extended.

This gives a breathing space to tenants struggling from a cashflow perspective, however, in the absence of agreement to the contrary with the landlord, rent arrears will be mounting over the substantial 14 week period.

The measures do not prevent landlords from commencing irritancy proceedings (albeit that may be a slow process in the current circumstances). Landlords who have served pre-irritancy notices in the 14 days prior to the Act coming into force, may consider re-serving their notices now giving 14 weeks’ notice. There may nonetheless be practical issues with doing so depending on the notice provisions in the lease.

The Scottish position is now aligned with that in England and Wales, where almost all commercial tenants are now protected by law from having their leases forfeited due to rent arrears until 30 June 2020. That date may be extended more than once by statutory instrument. This measure is contained in the Coronavirus Act 2020 and is in force.

I would like to terminate my lease now. Can I do this?

At common law, a lease can end if its purpose cannot be served (the legal term for which being it is ‘frustrated’), for example if the premises are destroyed. This can also apply if there is no damage at all but the Lease cannot continue, such as when a property is requisitioned by the military during a war.

Whilst the Courts in Scotland are more receptive to arguments in respect of frustration, the possibility of leases being brought to an end by frustration will depend on the length and severity of any Covid-19 measures. Any short-term enforced closures would unlikely be sufficient given the relative length of leases.

Parties can contract out of the doctrine of frustration in the Lease. Some leases fully contract out of the rule; others partially contract out of it so that the lease continues but may be terminated if insured risk damage or destruction is not made good within a specified period of time.

The end date of my lease is coming up anyway. Do I have to do anything to bring it to an end?

In Scotland the expiry of the agreed term of a lease does not automatically bring it to an end. Notice to quit needs to be served by one of the parties in order to bring the lease to an end; otherwise the lease will continue by virtue of the principle of tacit relocation (silent renewal). This doctrine will still apply during these unprecedented times and you should contact a solicitor as soon as possible to take appropriate advice in relation to terminating your lease properly.

If the lease does not specify the period of notice to be given prior to the contractual termination date, then the period of notice required depends partly on the length of the lease in question and partly on the type of premises let. Where the lease does not provide for a longer period, the usual period of notice for commercial leases is 40 clear days (but different periods can apply in the case of large premises of more than two acres) and the notice provisions in the lease must be complied with. In the first instance, check the terms of your lease.

Notwithstanding the above, given the current ongoing issues, your landlord may be receptive to terminating your lease early. However, this is an entirely commercial discussion to be had between you and your landlord and may be subject to monetary payments (or other obligations) to the landlord in exchange for them agreeing to terminate the lease early. Again, you should take appropriate advice from your solicitor in order to ensure the proper legal provisions are in place and documented.

If you require any more specific or detailed advice please do not hesitate to contact Katrina Ashbolt or Corra Irwin in our commercial property team who will be happy to help.

Please note that this is an ever evolving and changing scenario and we will provide additional updates in due course. The advice and answers provided above are correct as at 8th April 2020.

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