With the UK real estate industry in uproar over incredibly low rent collections, the coronavirus crisis is raising important questions about the distribution of risk within new lease contracts, say experts from Taylor Wessing.
Commentary
'As the world adjusts to the impact of coronavirus, the real estate sector is focusing on preventative measures that will protect their interests in the future, and from future pandemics.
Welcome to 'Covid clauses'! In the UK, the question remains, will these contractual provisions hold up?
Currently, commercial tenants rely on flexibility and understanding from their landlords to provide a break in their rental agreements if they've had to close their businesses due to Covid-19. This has resulted from the lack of legal provision in real estate contracts in the UK.
Understandably, landlords and tenants are looking to avoid situations like this in the future and 'Covid clauses' are being applied with the expectation that this is market standard. This is a huge risk. With no force majeure law applied in the UK, adding these clauses without proper legal guidance could still lead to massive rent debts, broken agreements and increase disputes.
Force majeure in England and Wales
In other countries, people can assume that Covid-19 can result in a break in their contract and their rent. This doesn't apply in the UK and can be explained through the traditional role of force majeure in contracts in England and Wales.
A global pandemic on the scale of Covid-19 is something that no one could have anticipated and is quite clearly outside of anyone's control. [Click here for the latest on UK rent collections]
But situations like this must still be expressly provided for in contractual drafting or parties aren't covered. In a global pandemic, or any other situation or event beyond our control, we can't take for granted that these are implied in contracts – they must be expressly outlined. Importantly, they must also be negotiated and agreed by both parties.
Covid clauses can't just be added in now. The contractual obligations contained in commercial leases (especially full repairing and insuring leases) and contracts for the sale and purchase of property (when the risk transfers on exchange) are rarely relieved in such circumstances.
It is true generally that contracts without an express force majeure provision may be able to fall back on the principle of frustration. This concept grew as far back as nineteenth century case law. But its assault on the sanctity of contract, so fundamental to the legal system of England and Wales, has actually been quite limited.
Frustration terminates a contract at the point of an event that is no party's fault, for example, if a situation occurs after the formation of the contract and was not foreseen. Any situation must render contract fulfilment physically, commercially or legally impossible or make obligations radically different from those undertaken at the moment of entry into the contract.
It is also generally accepted that the principle is applicable to leases or land contracts. However, there is no reported case law and no precedent of a lease ever having actually been frustrated. Even Brexit could not frustrate the European Medical Agency's 25-year lease and rental obligations at Canary Wharf in London.
Indeed, the House of Lords had already gone on record stating that, for frustration, what is required is ‘some vast convulsion of nature’ to swallow up a leasehold property or submerge it beneath the sea. Of course, never say never, but this doesn't bode well for the business interruption of a pandemic constituting both a legal and a literal frustration.
Contrasts with continental codes
This situation in England and Wales is in stark contrast to that in some other European countries. Many civil codes provide for various situations of hardship or force majeure in which contractual liability may be exempted, or the compensatory requirements of breaches waived. Some countries anticipate the difficulties by enabling counterparties to be brought to the table for negotiations on amending existing contracts, in certain situations.
Conditions for classification of a force majeure event are usually strict, but even in circumstances where parties are able to amend or completely contract out civil code provisions, they still create a contracting environment whereby the principle of release might be acceptable in unprecedented conditions. In Austria, for example, the Austrian Civil Code provides for a rent reduction in the event of an epidemic, albeit there is no confirmatory case law to rely upon yet.
The Ukrainian government has meanwhile amended specific regulations defining ongoing quarantine restrictions as force majeure. However, contract parties must still apply for a respective certificate to justify each instance of default.
Rebalancing the risk
The question in the UK now focuses on how the risk of future pandemic disruption is distributed in the real estate contract. While it is still far too early to claim an emerging market standard for these covid clauses, some key themes are emerging.
Like previous slow-moving shifts to accepting provisions for uninsured damage in lease insurance and reinstatement clauses, they could foreseeably form part of drafting lexicon in the future.
Depending on the experience of the sector involved, tenants and landlords might be starting to agree variations on a theme of reduced or suspended rents in the event of future pandemics. Amendments should seek to make these suspensions conditional on the application of government guidance, or new pandemic-related laws, on turnover impact, or even the disruption of a retail supply chain from overseas.
There are clear difficulties in fairly judging the measurable impact of these hypothetical pandemics. Societal lockdowns vary in their severity and some insurance might plug some gaps. However, these clauses do largely adopt features common to other commercial force majeure drafting.
Thus, the affected party will have notification and/or evidential hurdles and a duty to take reasonable steps to mitigate their losses. For many tenant companies, the price of these amendments could be the commitment to a longer lease term for example, but of course the terms of this trade-off is not standard either.
Landlords need to be well advised on seeking other opportunities in lease amendments, and to address other issues. This includes ESG policies to ensure better sustainability benchmarking, for example, or future-proof building alterations to guarantee compliance with the changing requirements for minimum energy efficiency standards in England and Wales.
In any case, drawing these dots needs a comprehensive portfolio review, and expert legal advice, and as this unprecedented pandemic has taught us all, forewarned is forearmed.'
Christopher Turley heads the Real Estate & Construction Group at London-based law firm Taylor Wessing. Clare Harman Clark is a senior professional support lawyer at the firm.
