24 March 2020

Given the significant economic uncertainty, there is a natural pressure on tenants to preserve cash to help get them through the short term future. One of the obvious ways to “preserve” that cash is to withhold all or part of the rent due on the Quarter Day falling this Wednesday. This has an obvious knock-on effect for borrowers, particularly those who service their loans from commercial property rents. What should borrowers and lenders be thinking about and prepare for?

Rent obligations for lenders, borrowers and tenants 

In the tri-partite relationship between lenders, borrowers and tenants, there are three key obligations:

  • an obligation on the tenant to pay rent on the Quarter Day;
  • an obligation on the borrower to collect the rent; and
  • a prohibition on the borrower altering the terms of a lease without the consent of the lender. 

Therefore, in ordinary times, tenants should pay the rent, borrowers should collect it and borrowers should not agree to any deal or forbearance with a tenant without the lender’s consent. 

Possible flexibility for rent due on the March Quarter Day

Given that the UK economic shutdown only really took effect in the last week, it is likely that many tenants will have the necessary cash to pay the rent due on the Quarter Day. That said, they will have more than half an eye to the future uncertainty in their business over the next three months and, moreover, their ability to pay rent on the June Quarter Day. 

What we expect to see is a dialogue initiated by tenants (but ultimately involving borrowers and lenders) requesting a more flexible payment structure for rent falling after the March Quarter Day.

Arcadia Group have already requested a significant rent reduction (on top of the reduction already imposed on landlords under last year’s CVA), and B&Q and Superdry are reported to have made similar requests. Also in the retail sector Debenhams, H&M and Sports Direct have instead requested up to 5-month rent free periods and, in the already hard hit casual dining sector, Carluccios are seeking a 3-month “rent holiday”.

Other options tenants may propose include moving from quarterly rent payments to monthly rent payments to better manage cash flow, suspending any element of turnover rent payable (while current turnover will be significantly reduced, many leases will look at turnover over several months’ trading and may even have deemed turnover provisions where the premises are not trading), and seeking to defer or waive upcoming rent reviews.

While all of these options may make commercial sense, they are all likely to be caught by a prohibition on varying the terms of the lease.

In addition, it is important to highlight the draft COVID-19 legislation which proposes prohibiting the eviction of commercial tenants in the next 3-months for non-payment of rent.

Lenders’ approach

Ultimately, lenders are interested in long term relationships and avoiding defaults under their facilities. That said, they do expect rent to be collected so that the debt can be serviced. Moreover, various alternative lenders have transparent reporting relationships with their investors and need to be mindful of the expectation of their investors and their best interests. 

If lenders are to be asked to agree to a rent reduction, then they will want full transparency as to the commercial discussions behind it, including its duration and the nature of the tenant’s balance sheet and current trading. Moreover, they could well require some kind of increase in pricing on the related loan so as to compensate for the higher risk. The most fundamental points are the need both for:

  • full engagement between tenants, borrowers and lenders from the earliest possible moment rather than waiting until the eleventh hour; and
  • any change in payment or other terms to be formally documented (for example, by side letter), rather than orally or by email, so that all parties are clear on what has been agreed and over what time period.

As such, whilst we expect the rents due on the March Quarter Day, generally, to be paid in full (unless the business has ceased trading or is on the retail or hospitality sector), we envisage a lot of discussions between parties from now onwards, with a view to coming to some kind of reduced/flexible rent arrangements for the June Quarter Day and possibly also for the following two Quarter Days. Lenders will need understand the impact of that on covenant compliance, security, cashflow and, where applicable, their relationship with investors.

What should lenders, borrowers and tenants be doing?

As with our previous notes, the conclusion is simple: there should be ongoing and active communication, and anything agreed should be clearly recorded. These are very challenging times and lenders accept the pressures which tenants are under, however arrangements to assist borrowers and tenants in the short term can only come about by proactive and open communication between all concerned.

For more information, please contact Richard Leeming or James Sutherland.

Key contact

Richard Leeming

Richard Leeming Partner

  • Banking and Trade Finance
  • Derivatives, Debt Capital Markets and Securitisations
  • Real Estate Finance

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