Covid-19 arrears – The likely direction of travel

After many commercial tenants were forced to cease in-person trading in March 2020, the status, enforceability and ultimate recovery of commercial rents became a significant matter of debate. In response, the Government relatively quickly protected commercial tenants in the form of moratoria and other restrictions on most forms of enforcement. As a result, this left only rent arrears actions by Court proceedings as a remedy where agreement could not be reached between landlord and tenants. Despite much legal debate being advanced in this context, a considerable amount of time passed before cases were heard and judgments handed down on.

'This article first appeared in issue 390 of the Property Law Journal, published by Legalease Ltd.'

The first reported case was Commerz Real Investmentgesellschaft mbh v TFS Stores Ltd [2021] EWHC 863 (Ch) (“TFS Stores”), with judgment being handed down in favour of the landlords by Chief Master Marsh on 16 April 2021. Given the substantial overlap and comparative brevity of the judgment in relation to subsequent cases, this initial decision does not form the focus of this article.  

On 22 April 2021, just six days after the judgment in TFS Stores, Master Dagnall handed down his decision in Bank of New York Mellon (International) Ltd and others v Cine-UK Ltd and others [2021] EWHC 1013 (QB) (“BNY Melon”). This case was in fact an amalgamation of a number of cases heard together, as the Court had rightly identified that similar issues would be raised in each one. Given this approach and the associated breadth of legal resources and representation, the judgment dealt with the most common – if not all – meaningful defences to COVID-19 debt claims available to commercial tenants. The commensurate detail with which the Judge approached the case makes it challenging to argue that any stones were left unturned. Master Dagnall’s reasoning and engagement with the submissions was forensic, with the judgment running to over 100 pages.

As with the TFS Stores case, the Landlords were making an application for Summary Judgment against the Tenants for rent – without the need for a full trial. In the usual way, the Tenants did not therefore need to prevail on every issue in order to defeat the application – they simply needed to show that they had a real prospect of defending the claims, or that there were other compelling reasons for there to be a full trial.

The Tenants sought to argue that the fact that these arguments were being rehearsed between landlords and tenants up and down the country meant that full consideration of the issues at a full trial was needed. The Judge bore this in mind, but nevertheless proceeded to award summary judgment in favour of the Landlords in any event.

Five principle grounds of defence were collectively raised by the Tenants, each forming a key issue to be decided. Whilst none of the grounds ultimately withstood scrutiny, they provide a clear reminder of the prevailing legal analyses; something which may previously have been purposefully overlooked by tenants given the increasingly political nature of the wider debate.

In summary the unsuccessful defences and issues were as follows:

• Whether the Government Backed "Code of Practice" for COVID-19 rent arrears in some way restricts claims by landlords for rent arears amassed by tenants during the pandemic.

In an opening remark, the judgment notes that the Code “strongly encouraged landlords and tenants to communicate and negotiate ameliorative measures for tenants including rent-free periods and moratoria." However, recognising (i) the Court’s discretion to order a stay (pending negotiations); (ii) the expressly voluntary nature of the Code and (iii) its clear stance on not interfering with a tenant’s obligations under a lease absent successful (voluntary) negotiations, the arguments under this head were quickly dismissed. The Code was regarded as being “outside the litigation process and not applicable to these Tenants who are not said to be unable to pay.”

• Whether rent cesser provisions in the various leases have effect during the national lockdowns.

As in the TFS Stores case, the rent cesser provisions all operated to suspend a Tenant’s obligation to pay rent if the premises were “destroyed or damaged by any of the Insured Risks so as to render the Property unfit for occupation or use”. However, unlike the lease in TFS Stores – which also contained a ‘keep open’ covenant – there was no such obligation to consider here. Noting Chief Master Marsh’s ruling in TFS Stores, Master Dagnall also came to a conclusion in favour of the Landlords that the rent cesser provisions cannot, on a literal interpretation, be read to incorporate the national lockdowns within the meaning of “damage or destruction”. It should be noted that the Judge came to this conclusion notwithstanding in these cases the absence of the word ‘physical’ in respect of the “damage or destruction” specified in the relevant rent cesser provisions. The Judge did nevertheless agree with the Landlords that the ordinary meaning of the words “damage or destruction”, both in the context of the rent cessar provisions and/or otherwise, necessarily relate to some form of ‘physical’ trigger of damage or destruction.

• Whether terms should be implied into the Leases to allow the rent cesser provisions to apply during national lockdowns.

The Tenants then argued that, even in the absence of “physical” damage or destruction, a full rent cesser should be implied in favour of the Tenants not paying rent in these circumstances, because (i) COVID and the COVID Regulations are unprecedented and unforeseen, and had forced the closure of the Premises and (ii) the Landlords had in fact chosen to insure their losses caused by a pandemic so that the Insured Risks did extend to Landlord losses, and had done so at the expense of the Tenants. In the context where the Leases (and the Insurance) provide for cover to include loss of Rent then the Tenant’s liability to pay rent should be suspended.

Focusing for a moment on the first limb of this argument, Master Dagnall disagreed; COVID and COVID regulations were not entirely unforeseen and unforeseeable, citing examples such as SARS and noting the availability to Tenants of business interruption insurance to cover notifiable diseases and their rental liabilities during such periods. Following a comprehensive review of “clear and consistent” legal principles, extending the scope of the rent cesser clause was considered to be neither obvious nor necessary on account of business efficacy. Master Dagnall stressed that it is simply not clear that the response from a hypothetical landlord and tenant (to the officious bystanders’ question) would be that the implied term sought would “go without saying”. Likewise, it could not be argued that the Leases do not ‘work’ without the term being implied. The issue was therefore resolved in favour of the Landlords.

• Whether tenants should be entitled to rely on insurance taken out by landlords for loss of rent as a reason not to pay rent.

Dealing more substantially with the second limb of the third issue (above) Master Dagnall highlighted that mitigation and management of risk is something which each party should consider for itself.  Whilst the Landlords’ policies included cover for loss of rent caused by the pandemic regardless of any physical damage, it still was not clear in what sense (if any) rent was “lost” under the Leases. By reference to what the Judge found to be the ‘ordinary meaning’ of the rent cesser clauses, physical damage or destruction was ultimately required to suspend the Tenants’ rent obligations; without it they could not argue that the Landlords should claim under insurance for rents they squarely owe.

The Tenants raised a further argument by implication: that by contributing to the insurance obtained by the Landlords, the Landlords had to ensure that the Tenants could rely on cover for losses suffered upon closure of the Premises because of COVID – the very risk the Landlords had elected to obtain extra insurance for. Again, the Court was not convinced that the Tenants could show either (or both) obviousness or necessity for business efficacy for such a term to be implied, and the arguments failed.

• Finally, whether the national lockdowns temporarily frustrated the Leases, so as to treat them as suspended or terminated.

Whilst none of the Tenants contended that the leases had been (entirely) frustrated by COVID and the COVID regulations, an argument was raised that there had been a ‘temporary frustration’ during the national lockdowns, resulting in rents not being payable during this time. Whilst somewhat novel in comparison to the arguments advanced in the TFS Stores case, Master Dagnall found that there was no such thing as a ‘temporary frustration’ in law which could lead to a suspension of contractual obligations for a period of time only.

Whilst authorities were cited and recognised to support a contention that a contract may in effect be frustrated altogether if an obligation is suspended for long enough (for example due to illegality), the Judge distinguished the instant case on the basis of the practical effects of the closure: the Leases all had in excess of a year left to run, with security of tenure under the 1954 Act. Accordingly, both frustration and suspension arguments therefore failed.

Both Master Marsh and Master Dagnall therefore made it very clear that, legally, COVID-19 rents are due and owing (period).

The broader issue is, of course, more nuanced. Whilst the BNY Melon judgment is a rigorous reminder of the current state of the law as concerns the validity of rent debts, it would be inattentive not to place it within its appropriate context; the main issue being the continued lack of a viable means of enforcement.

The “relevant period” in the Coronavirus Act 2020 – containing various provisions restricting the ability of landlords with commercial tenants to forfeit a lease – has been extended multiple times. It was originally due to end on 30 June 2020, with regulations stretching the period to 30 September 2020 in England & Wales, then to 31 December 2020, then to 31 March 2021, then to 30 June 2021 and most recently to 25 March 2022 in England and until 30 September 2021 in Wales.

During this time, rights of re-entry or forfeiture for non-payment of rent may not be utilised, by action or otherwise. Similarly, use of Commercial Rent Arrears Recovery (“CRAR”) measures are also restricted, with a minimum of 554 days’ net unpaid rent having to be outstanding before CRAR can be invoked.

But how to resolve what is said to be £3billion of unpaid rent? On 4 May 2021, the Ministry of Housing, Communities & Local Government (“MHCLG”) opened a call for evidence as part of its consultation on the best way to withdraw or replace the moratorium on commercial lease evictions and the restrictions on the use of CRAR, paving the way for legislative reform.

A subsequent Government press release on 16 June 2021 confirmed that, in addition to extending the end of the “Relevant Period” until 25 March 2022, primary legislation will be introduced that will ringfence rent arrears that have built up in specific periods in which a business has had to remain closed during the pandemic.

Next on 4 August 2021, the MHCLG published the outcome of its consultation, including a summary of responses and analysis, and a policy statement entitled ‘Supporting businesses with commercial rent debts: policy statement’ (the “Policy Paper”). The Policy Paper outlines the plan to legislate to ringfence rent debt accrued from March 2020 for commercial tenants who have been affected by COVID-19 business closures and introduce a system of binding arbitration in respect of such rent debt.

In the meantime, however, it nonetheless seems a novel argument to be made – on the basis of anticipated legislative change – that these arrears cannot be recovered until the parties have properly “engaged” with one another, and failing which the matter must instead be referred to binding arbitration. The BNY Melon decision certainly highlighted the lack of judicial appetite for such a contention pending concrete legislative input.

The Commercial Tenant’s Association have called for an Australian style model with landlords writing off at least 50% of COVID-19 arrears. This would be their starting point with leisure and hospitality tenants receiving up to 100% write offs from their landlords. Clearly the respective positions are somewhat partisan.

Turning to alternative avenues of enforcement within the insolvency regime is likely to be equally fruitless. The restrictions on presenting winding up petitions, for instance, remain in force until at least 30 September 2021. Before then, a creditor is precluded from presenting a winding up petition unless the Court is satisfied that the company would be unable to pay its debts regardless of COVID-19, and/or from using a statutory demand as a basis for such a petition. In turn, without the threat of winding up, a statutory demand offers little benefit to landlords – albeit with liquidated debts – other than potentially triggering defaults in the debtor’s facilities or other contractual agreements.

Ultimately, it seems that encouraging and achieving just and equitable compromise between pandemic-hit tenants and out of pocket landlords remains to be no easy task. On the one hand, it is said that tenants who can afford to pay must always do so. On the other, significant evidence is being seen of some tenants taking advantage of the moratoria and COVID restrictions as an opportunity to store cash and negotiate turnover rents and/or downwards rent reviews with their landlords; sometimes under the threat of reorganisations and where appropriate Company Voluntary Arrangements. This is despite having good liquidity and at times even improved trade. Both landlords and tenants appear at times to have become overly aggressive and may have lost sight of the fact that each need the other successfully to trade in the longer term. For now, however eventually defined or determined, outstanding COVID rents will not result in a lease being forfeited. Whilst proceedings and a judgment might be achieved, will the Court now be prepared to stay those proceedings and/or enforcement, pending greater clarity of the options yet to be announced by Government, in order to ringfence COVID-19 arrears?