COVID-19 and commercial lease obligations: are there now greater risks for Scottish tenants than their English counterparts?

When lockdown began on 23 March 2020 many businesses closed and only now, some 12 weeks later, are we beginning to see what the path to reopening fully might look like.

The loss of revenue during that period has inevitably had a significant impact. While the Job Retention Scheme (i.e. the ability to furlough employees) has helped support employers with their wage bills, there is currently no legislation in force which extinguishes or suspends a tenant’s obligations to pay sums due under a commercial lease such as rent, insurance and service charge. Such sums continue to be due and payable.

While we have seen landlords offer tenants rent free periods under commercial leases since lockdown began, those have been commercial, not legal, decisions (in recognition that a landlord’s medium to long term interests will often lie in assisting a tenant trade out of the current crisis). Nevertheless, a tenant cannot legally insist that their landlord offers a rent free period or waives a rental or other payment.

That said, measures have been implemented during lockdown at both the Scottish and UK levels to delay or suspend the normal enforcement remedies available to a commercial landlord when faced with a non paying tenant. They include significantly extending the period of time that must elapse before a landlord can exercise a right of irritancy (early termination of the lease) from 14 days to 14 weeks. For further information on this, see our previous blog.

The Corporate Insolvency and Governance Act 2020, which is due to come into force in late June 2020 and have retrospective effect, will also severely curtail the service of statutory demands and the right to petition for a tenant’s winding up order. Although not yet in force, its mere existence in bill form has already persuaded an English court to exercise its discretion to restrain a winding up petition (see A Company (Injunction to Restrain Presentation of Petition) 2020 EWHC 1406 (Ch)).

The message from government seems clear enough: during lockdown, landlords should act responsibly towards their tenants. Aggressive enforcement of lease obligations is discouraged.

And yet, in Scotland at least, a lacuna has emerged in recent days which, if not addressed quickly, could see some commercial tenants exposed to enforcement action by their landlords. The lacuna concerns a landlord’s right to execute summary diligence.

Summary Diligence

Scottish commercial leases are typically registered in the Books of Council and Session.  Effectively this gives the lease the status of a court decree in respect of the payment obligations (usually covering rent, insurance and service charge, the sums for which are ascertainable from the lease itself).

This enables the Landlord to enforce the payment obligations quickly by way of ‘summary diligence’. It can result in freezing of monies in bank accounts and the seizing (and ultimate sale) of assets, amongst other things. Landlords are not obliged to provide tenants with notice of their intention to take such steps. Summary diligence is carried out by Sheriff Officers.  

In the period from lockdown in March 2020 until now (i.e. mid June 2020), there was some comfort for tenants to be taken from the fact that Sheriff Officers, as a result of social distancing measures, were unable to carry out summary diligence and other non-urgent services. However, in conjunction with the Scottish Government’s phased approach to the lifting of lockdown, Sheriff Officers are now able to resume certain services, which includes summary diligence.

The traditional remedy for a party who wishes to suspend diligence (whether or tenant or debtor) is to make an urgent (summary) application to the court. But the court will normally only grant such an order if there is an arguable defence and the debtor provides security for the creditor’s claim (in the event the application is eventually found to be without merit).

As noted above, nothing in the Coronavirus legislation enacted so far extinguishes a tenant’s obligation to pay rent under a commercial lease, and thus any application to suspend diligence is likely to fail at the first hurdle. With many commercial tenants in Scotland being due a substantial payment of rent on 28th May 2020 (being the relevant Scottish quarter day), there is accordingly now a real risk of prejudice for commercial tenants in Scotland - at least, until the Scottish Government takes action to protect them against summary diligence.

The position for English tenants is not currently as stark. There is no equivalent of summary diligence in England. Therefore a landlord would require to follow formal procedures to enforce the payment obligations under the lease. Rent arrears are typically pursued using the Commercial Rent Arrears Recovery Process (“CRAR”). This allows a landlord to instruct an enforcement agent to take control of the tenant’s goods and sell them in order to recover an equivalent value to the rent arrears. CRAR requires various notices to be served on the tenant by the enforcement agent at each stage of the process. An enforcement agent can only exercise CRAR if the tenant has been given notice (seven clear days) before CRAR is exercised.

However, regulations that came into force on 25 April 2020 prevent landlords using CRAR unless they are owed 90 days of unpaid rent (rather than the usual seven). English tenants are therefore currently protected (at least in respect of the March 2020 quarterly payment).

On the other hand, with the English June quarterly rent payment fast approaching – 24th June 2020 (as opposed to 28th May in Scotland) - English tenants could, like their Scottish counterparts, shortly be facing cliff edge.

Draft Covid-19 Code of Practice for Commercial Property: is this the answer?

With the English June quarter date in mind, the UK Government has just issued a draft code of practice that is intended to apply ‘to all commercial tenancies held by businesses which have been impacted by the COVID-19 crisis, whether in the hospitality, retail, leisure, hotel, offices, industrial and logistics sectors, ports, or agricultural sectors – but it is expected that the hospitality, leisure and retail sectors, especially those based in high streets and town centres, will have most need of it.’

The code can be found here.

This Code does not represent government policy and has no legislative effect but it ‘is designed to set out principles of behaviour and responses to difficulties experienced by businesses in order to share the property-related costs and business risks of the COVID-19 crisis in a proportionate and measured way. It is a voluntary Code which seeks to set out principles and good practice in how to balance the interests of landlords and tenants reasonably and responsibly, through as swift and efficient means as possible.’

The Code reflects two fundamental principles:

• Tenants who are in a position to pay in full should do so, and tenants who are unable to pay in full (taking into account alternative financial resources that may be available to them, where applicable) should pay what they can.
• Landlords who can provide support to businesses who need it should do so (taking into account their own financial commitments and fiduciary duties, where applicable), so that viable businesses affected by the current circumstances are able to continue.

Where a tenant is unable to meet all of payment obligations under a lease, the code encourages it to prioritise service charge and insurance premiums (to ensure that the building is insured and safely maintained) with discussions about payment windows, deferments or discounts focussing on rental payments.

The code strongly encourages communication and co-operation between landlords and tenants and we expect many landlord and tenants will ultimately do so. Aside from the commercial rationale for co-operating, the code is expected to contain a schedule listing various landlord, tenant and trade bodies who will sign up to it.

Although no names are currently listed in the draft schedule, the press release that accompanied the code contained favourable comment from the British Retail Consortium, the Scottish Property Federation and UK Hospitality. In light of the June quarter day, we expect the code to be in force (whatever precisely that means in this context) in the next week or so. Once implemented, it is due to apply until June 2021.

The code does not currently spell out the consequences for landlord or tenant if it is not adhered to. Where negotiation fails, the code encourages mediation but only where the parties ‘feel that a negotiated outcome could still be achieved’ and where the cost of engaging a third party mediator is ‘proportionate’.

As is currently the case for a number of voluntary and mandatory pre court action protocols (not just in the commercial leasing sector), will the courts be entitled to take non compliance with the code into account should a dispute later be litigated, whether in relation to the legal remedies available to a landlord or the legal expenses/costs of the case? Could a court, for example, order landlord and tenant to mediate if it has yet to take place or sist/stay the case until the parties have mediated?

The answers are not clear at present (although, from a Scottish perspective at least, we doubt a Scottish court would be prepared to restrict remedies, order mediation or impose legal expense penalties without clear instruction or regulation to that effect which is presently not the case).

What is apparent from the wording of the code is that the UK government would prefer to avoid interfering with substantive rights under commercial leases (which might attract criticism that it is unlawfully or unfairly interfering with the operation of the market) and would rather encourage landlord and tenants to find reasonable, market based solutions.

However, the Code states that is ‘not the only government intervention in the commercial rental industry that either has been implemented or may be necessary going forward to support the financial health of the sector.’ The carrot has been offered but the threat of the stick remains. Landlords should bear that in mind.

Nevertheless, as it stands, the code is neither mandatory nor in force and, worryingly for Scottish tenants, there is precious little comment in the Code regarding the different situation that currently prevails north of the border (with respect to the May quarter day having passed and the business decision taken by Sheriff Officers in the last few days to recommence summary diligence).

The press release accompanying the Code stated that ‘We [the UK Government] will engage with Devolved Administrations to ensure the code applies across the UK.’ At the time of writing, and as far as we are aware, the Scottish Government has yet to publicly comment on the Code.

On the basis that the UK Government does not appear to have any intention to implement further statutory measures to restrict or prevent the landlord taking action under the CRAR, we would expect the Scottish Government to follow suit – that is to say, adopt the Code, encourage Scottish landlord and tenant bodies to sign up to it and then to review how it is operating in the weeks ahead. Enacting formal legislation to prevent a landlord exercising summary diligence is likely to be a measure of last resort.

In the short term, this light touch approach will undoubtedly create risks for some Scottish tenants (since the code itself is equivocal on when a landlord can legitimately take formal action to enforce lease payment obligations). It does seem at odds with the Scottish government’s commitment to support retail, hospitality and leisure business during lockdown that summary diligence is freely available, when irritancy and winding up are not.

On the other hand, a bank arrestment (which is likely to be the diligence of choice for a landlord at this time) merely freezes funds in a bank account. It does not result in the automatic transmission of the funds to the landlord. Most landlords will not know if any funds have been arrested until 3 weeks after service of the arrestment by Sheriff Officers (this being the statutory period in which a bank must report to the landlord) and, unless the tenant otherwise consents, no funds will be released from the bank until the expiry of 14 weeks. This should give a tenant the opportunity to negotiate with its landlord (with or without the benefit of the code) albeit the existence of the arrestment may serve to weaken the tenant’s negotiating position particularly for those tenants who have significant arrears under the lease, a cash flow problem or both (assuming the arrestment has in fact frozen funds which it will not have done if the bank account is overdrawn when the arrestment is served).

What does this mean for your commercial property business?

Given the unprecedented demands that have been placed on the Scottish Government since lockdown began in March 2020, it is perhaps not surprising that something as innocuous as a business decision by Sheriff Officers to resume summary diligence with little or no prior notice has exposed a lacuna in what otherwise might be seen as a reasonably coherent set of protections for debtors generally and commercial tenants in particular.

On the other hand, as we move out of lockdown and try to return to some form of business normality, both the Scottish and UK Governments will increasingly come under pressure to lift or ease the legislative restrictions it has imposed during lockdown. In that context, it is perhaps not surprising that the UK Government’s preferred approach in the commercial property sector now appears to be a voluntary code rather than further legislation or regulation. We would expect the Scottish Government to follow suit.

Up until now, the approach of many commercial tenants during lockdown has been to suspend lease payments (even for those tenants who continue to trade in some capacity). The code is relatively clear: non-paying tenants are now going to have to engage meaningfully with their landlords and justify the approach they have taken. If that approach cannot be objectively justified, there are likely to be consequences (since the code does not ban future execution of summary diligence or the CRAR).

On the other hand, unreasonable or aggressive landlord conduct is unlikely to be tolerated for long. While it may take time for the code to bed in, which will open a window of opportunity for some landlords in the short term, we would anticipate that the Scottish and UK Governments will act quickly to implement more formal protections in favour of tenants should it become apparent that the code is not being operated as intended.

The message from the code is clear: “fair and transparent discussion between landlords and tenants over rental payments during the coronavirus pandemic….will enable collaboration and cooperation within the sector and help ensure that no one part of the chain shoulders the full burden of payment.”