WHN - Lease renewals during the pandemic – is it a tenants’ market

The pandemic has had a wide-sweeping impact on most areas within the property sector and lease renewals are no exception. There have been several emerging trends with one key theme being both landlords and tenants seeking to negotiate lease renewal terms that will protect their commercial interests should further government-imposed lockdowns arise.

Daniel Long, a director at WHN specialising in commercial property dispute resolution, outlines how several recent disputes regarding the renewal of commercial leases have been considered in court and what landlords and tenants need to bear in mind when negotiating lease renewals going forward.

Disputes frequently arise during lease negotiations where the landlord and tenant agree that the tenant should be entitled to a renewal lease, but the parties do not agree on all the renewal terms. The main terms that prove to be sticking points are the level of rent, length of term and tenant break options, as these can have a significant impact on valuation and overall liabilities for which the tenant is responsible.

Even before Covid-19, it is fair to say that in some sectors (retail being a prime example) there has been a slow general shift in favour of tenants with the market pointing towards greater tenant flexibility and reduced commercial rents.

The pandemic has ‘shaken things up’ even further with many tenants seeking to protect themselves from the impact of Covid-19 and against the risk of future lockdowns which may force them to close retail outlets or commercial offices.

How the courts have managed recent pandemic clauses

Since the start of the pandemic, many tenants have been pushing for the inclusion of pandemic/Covid-19 clauses as part of their renewal lease agreements. Landlords have, in the main, been resisting such clauses.

In the recent Poundland Ltd v Toplain Ltd case, Poundland argued that a renewal lease under the Landlord and Tenant Act 1954 should incorporate a so-called ‘pandemic clause’. The County Court ultimately rejected the tenant’s arguments and held that allowing such clauses on renewal would create a shift in the parties’ relationship and would not be fair and reasonable in all the circumstances.

In a slightly different scenario, in the WH Smith Retail Holdings Limited v Commerz Real Investmentgesellshaft mbH, WH Smith sought a new lease of its premises at the Westfield Centre in Shepherd’s Bush, London. WH Smith remained open during the various lockdowns as it was an ‘essential’ retailer and not required to close.

Yet there was no advantage to WH Smith remaining open during the lockdowns; in fact, it claimed to be at a disadvantage compared to non-essential retailers. WH Smith had to cover staff costs and was unable to take advantage of the furlough scheme. This was compounded by the lack of footfall in the Westfield Centre during the lockdown.

This case was a little different because the parties had already agreed the principle of including a pandemic clause but had not agreed the specific terms of the clause or what would trigger it. Even so, the judge did indicate that he would have ordered the inclusion of a pandemic clause even if it had not been agreed by the parties. Further, the judge did not consider that it would have been appropriate for the inclusion of a pandemic clause to result in an automatic increase in the rent to compensate the landlord.

So already we can see that the courts have approached the issue in different ways. It is important to note that the above cases were both heard in the County Court and so are not binding authorities. However, they provide a useful insight into how the courts will approach the issue.

When deciding whether to amend the terms of a lease on renewal, the court will be guided by the usual legal principles laid down at common law. The burden of proof will be on the party proposing a variation to the existing terms and the court will look at the terms of the current lease, what is fair and reasonable in all the circumstances and the parties’ reasoning and justifications. The court will balance the advantage that one party may gain from such an amendment against the detriment that may be caused to the other party. The court has a wide discretion with such matters.

How court decisions may affect future commercial rent values

In the recent cases of Poundland and WH Smith and in the separate decision in S Franses Limited v The Cavendish Hotel (London) Limited, we have seen huge rent reductions imposed on the respective landlords.

On each occasion, the tenants were awarded a rent reduction on renewal of a staggering 50-60 percent. For some landlords and tenants, such a determination on renewal would represent a difference of hundreds of thousands of pounds per year in rent.

Reductions of this scale will have a massive impact on landlords and tenants and so we may, therefore, continue to see prolonged negotiations and a marked increase in litigation due to the sums at stake.

It does appear that the courts have not readily determined interim rent at the same level as the principal rent determined under the new leases. The courts have recognised that there has been a significant shift in the market over recent years. However, when interim rent liabilities could, again, be worth hundreds of thousands (particularly if there have been lengthy negotiations), it is another issue landlords and tenants will fight for.

The current outlook

There is clearly uncertainty over how the courts will decide on pandemic clauses going forward. Landlords are advised to resist such clauses in light of the Poundland reasoning but equally tenants may ‘fancy their chances’ based on the judge’s comments reported in the WH Smith case. Each case will turn on its own facts and reasoning.

In some property sectors, parties should be prepared for significant rent reductions. However, we may see something of a cushioning effect when interim rent is being considered.

Perhaps more than ever, evidence is going to be crucial to demonstrate justification for any amendments being proposed to the terms of the existing lease, to demonstrate any market trends and to bolster the case from a valuation perspective.

With so much at stake for landlords and tenants, there may be an increase in protracted negotiations and more parties willing to go the distance and obtain determinations.

For this reason, parties should be ever mindful of costs, both in terms of amount and proportionality. The majority of these renewal disputes will still settle at some stage and it is typical, in those circumstances, that each party will bear their own costs. Parties should look to protect themselves by making early Calderbank or Part 36 offers and should be ready to explore forms of alternative dispute resolution such as PACT.

Commercial property disputes often involve particularly complex areas of law, whether you are a landlord or a tenant. It is important that correct and commercial legal advice is sought at the earliest opportunity in the event of a dispute arising.

Daniel Long is a director based at WHN’s Bury office. Daniel heads up the commercial property dispute resolution team and helps clients with all areas of commercial landlord and tenant disputes. To contact Daniel, please call him on 0161 761 8063 or email daniel.long@whnsolicitors.co.uk.