In the third and final article in their
lease series, Jennifer Ayris and Guy Whitehead look at how Covid-19 has
affected the industrial sector.
Our previous two articles looked at the
impact Covid-19 may have on leases in the retail and office sectors, specifically
looking at the effect on rental provisions, service charges, tenant covenants
and lease duration. In this final article we look at the industrial leasing
sector.
Many manufacturing processes cannot be
carried out remotely, with employees being required to work in close proximity,
leaving manufacturers vulnerable to virus outbreaks. The economic downturn has
created less demand for products, and supply chain disruptions are causing
bottlenecks that mean it can be difficult for manufacturers to fulfil orders on
time.
Rent suspensions and deferrals: The issue for the manufacturing
sector will be how to determine the trigger point for the type of rent
suspension or deferral mentioned in our previous articles. For shops and
offices, there is a clear marker: an order to close or for all staff to work
remotely. For manufacturers, although employees were still allowed to work
during the lockdown, many had to close, reduce output or assist with the
national effort to produce ventilators and PPE. Across the sector, margins were
(and continue to be) severely affected, impacting on the manufacturer’s ability
to pay rent. Will we see the introduction of a royalty-based lease, with the
rent paid by the manufacturer calculated wholly, or partly, by production?
User clause: Occupiers will need more flexible user
ratios between office, industrial and storage and distribution space to allow
for changes in operating practices. There may be an increased storage
requirement for materials to safeguard against another supply chain disruption,
with landlords being asked not to enforce temporary planning breaches.
Opening hours: Occupiers will require flexible hours to
allow 24-hour shift work to catch up on lost time and manage social distancing.
Alterations: Manufacturers will need flexibility to
make emergency alterations, such as changes to the layout of a factory floor to
implement social distancing or to manufacture different products, without
landlord’s consent (which can be a slow and expensive process).
Term: There will have been delays to projects
owing to the lockdown. This will impact on property requirements if a unit has
been leased to deliver a particular project. We anticipate an increased
requirement for reversionary leases and call options so that if the rent has
been suspended for a certain period due to a pandemic, the tenant can call on
the landlord for a new lease for the corresponding period.
Quiet enjoyment: Landlords will wish to state that
closing any shared areas due to a pandemic event is not a derogation of grant
or a breach of quiet enjoyment to avoid any possible claim of a landlord’s
repudiatory breach by the tenant. In the event of recession, landlords may
request the flexibility to partially close common parts if large swathes of the
property are unoccupied or certain occupancy thresholds are not met.
Forfeiture and commercial rent arrears
recovery: Tenants may request that the temporary protection
provisions legislated for in response to Covid-19 – namely the suspension of
forfeiture, CRAR (unless an amount equal to not less than 189 days’ rent is
overdue) and the service of statutory demands and winding-up petitions – are
written into leases in case another pandemic event occurs. Tenants are
concerned about a perceived cliff edge when the current restrictions are lifted
on 30 September 2020 and may wish to agree the length of any future moratorium
to suit their own circumstances or allow the provisions to be implemented if
there is a local lockdown which is not accompanied by protective national
legislation.
Service of notices: Landlords may want to serve
notices for tenant breaches by email to avoid issues with the availability/delays
of postal services during future pandemics.
Distribution facilities have seen
exponential growth as a result of the pandemic. There is a huge demand for
warehousing space as online retailers respond to increased demand. Larger
online retailers will want to commit to shed space, and agreements for lease
will need to include pandemic safeguards, such as extensions to longstop dates
caused by delays in the planning or construction processes.
Our journey though the anticipated lease
amendments required for each sector demonstrates just how extensive the changes
to current leasing practice could be. If changes to leasing practice are far
reaching, we foresee difficulties for Landlord and Tenant Act 1954 renewals,
where the leading case of O’May v City of London Real
Property Co Ltd [1977] 1 EGLR 76 states that the new lease should be
on the same terms as the existing lease unless a party is able to demonstrate
that changes are fair and reasonable and are not required just to fit with
market practice. The courts will ultimately decide if pandemic-related clauses
are fair and reasonable in this context.
If there is no radical change, it will
be interesting to see the extent to which the government may step in. The Code
of Practice for commercial property arrangements during the Covid-19 pandemic
is limited in extent, voluntary and, with no sanctions for non-compliance,
there are already early signs it is being ignored. Other areas for government
legislation could include the abolition of upward-only rent reviews and/or the
implementation of the Law Commission’s 2006 recommendation to abolish
forfeiture and replace it with a new, fairer system for dealing with tenant
defaults. The fact that the report is still on the shelf after 14 years,
together with the still-voluntary nature of the Code for leasing business
premises, is indicative of successive governments’ unwillingness to interfere
with the landlord and tenant relationship.
Only time will tell what the leasing
legacy of Covid-19 will be.
Jennifer Ayris and Guy Whitehead are
both senior associates at Irwin Mitchell LLP
READ PART ONE: The future of leases: retail
READ PART TWO: The future of leases: offices