The question of whether and how "COVID clauses" can be introduced into lease renewals has been the subject of much debate since March 2020. In particular, whether there is a situation in which rent is to be suspended as a result of some kind of enforced closure of premises ("pandemic rent suspension clause").
In WH Smith Retail Holdings Ltd v Commerz Real Investmentgesellschaft mbH [2021] PLSCS 68 (25 March 2021) the parties had agreed the principle of a pandemic rent suspension but not when the rent suspension would apply. The court determined that a pandemic rent suspension clause could be triggered in favour of an essential retailer when other non-essential retailers had to close, even though the essential retailer was itself permitted to be open. Key to this decision was that the premises are in a large shopping centre where footfall during a lockdown would be extremely low. The court was asked to decide the rent payable under the new lease and the position on interim rent. The decision is interesting as the court awarded a rent free period and it took a slightly unusual approach to interim rent.
Background
The case concerned unopposed lease renewal proceedings in relation to WH Smith's retail unit located in Westfield, Shephard Bush. WH Smith continued to trade during the pandemic as the unit contained a post office, which was deemed as essential under the COVID regulations.
WH Smith occupied the unit under a lease with a term of 10 years with the contractual expiry being 1 October 2018. The passing rent was £930,000 per annum (reviewed in 2013).
WH Smith served a notice under s.26 of the Landlord and Tenant Act 1954 ("the Act") requesting a new lease to commence on 23 March 2018. Proceedings were issued to determine the issue of the trigger of the pandemic rent suspension clause, the rent payable under the new lease and the interim rent. The trial took place in November 2020 (during the second COVID lockdown).
The Act entitles a tenant to a new lease on the same terms of the current lease save for fair and reasonable modernisation. If a party wishes to introduce a new clause then the party making the request must convince a court the new term should be introduced. This is known as the O'May principle.
When should the rent suspension clause be triggered?
WH Smith argued that the trigger event was the closure of the other non-essential retailers. Whilst WH Smith was able to trade as an essential business, as the majority of units in the shopping centre were closed, the footfall was dramatically reduced (by about 90%) which led to a reduction in sales. The landlord argued that as WH Smith had been able to trade the rent suspension should not apply – and should only apply if this unit was required to be closed.
The court found in favour of WH Smith; the rent suspension clause was triggered from the date of closure of the other non-essential retailers. It is important to note the court held that it did not need to consider the O'May principle as the parties had agreed to the inclusion of a rent suspension clause and it was only the issue of the trigger that was in dispute. However, the court also expressed a view that even if O'May was triggered, the change would be determined as fair.
As regards the amount of the rent suspension, the court disagreed with the landlord's position that WH Smith gained an advantage over other tenants because it remained open for trading. Clearly, WH Smith relied on footfall from adjoining/other stores in the shopping centre, the majority of which were closed and there was very little benefit in WH Smith continuing to trade. The court decided the rent reduction would be 50% of the total rent.
Rent and interim rent
The Court then turned to the question of the rent to be paid under the new lease. Under the Act, this is to be determined with reference to the rent which would reasonably be expected to be obtained in the open market by a willing landlord and tenant. WH Smith sought a rent of £146,300 per annum whilst the landlord claimed a rent of £751,995 per annum. The new rent was set at £404,666 per annum
The landlord took the view that no rent free should be given in circumstances where WH Smith had no intention to fit out and there should also be a 10% uplift in rent to take account of the pandemic rent suspension clause. WH Smith opposed the position on both points.
Interestingly, the court found that there should be no uplift in the rent as a result of the inclusion of a pandemic rent suspension clause as this is "something that all tenants want, and that the market has now priced it in". The court also granted a 3 month rent free and held that comparable evidence should be adjusted to take into account the absence of a rent-free period. The landlord argued this was unfair as WH Smith would not be fitting out. However, the test under the Act requires the rent to be determined on the basis of a letting in the open market with a new tenant and this would more than likely include a rent free period.
In relation to the interim rent, the court did not follow the usual formula for interim rent, being the rent payable under the renewal lease. Instead, the court ordered a higher rent on the basis that the interim rent commencement date was October 2018 and the rent at that time was pre-COVID and would have been substantially different if it was agreed at that time.
Take away
On the one hand, this decision should be treated with caution as it is very fact specific and does not lay the basis for general principles. However, it is interesting that the courts are now having to consider the wider impact of the pandemic on the retail sector.
The court commented that pandemic rent suspension clauses will become the norm and this decision may assist parties in lease renewal negotiations. However, this comes with the caveat that in this case, the parties had already agreed a pandemic rent suspension clause and it was only the trigger that had not been agreed. Therefore, the principle of O'May was not triggered in this case. In time we may well see that pandemic rent suspension clauses will be deemed as reasonable modernisation, but this is more likely in shopping centre leases and compelling evidence will need to be produced if this principle is to also apply on the high street.
In relation to rent, the decision demonstrates the court is willing to take a view in considering the overall impact on the retail and leisure section when determining COVID clauses, rent and interim rent. However, it is important to ensure detailed valuation evidence is available, with relevant comparables, to support any movement away from the pre-COVID rent position.
We may well see that tenants are more willing to contest rent and if required, ask the court to make a determination. Equally, I expect landlords to scrutinise interim rents, particularly where the interim rent commencement date is pre-COVID.
Inevitably, the pandemic has triggered a change in the way both landlords and tenants negotiate lease terms and address the issue of rent. The market has seen rent levels fall and increasingly tenants are demanding and landlords are offering longer rent free periods and considering turnover rents. It remains to be seen as to whether this is a short term position or a sign of things to come.
Howard Kennedy is experienced in providing legal advice to landlords and tenants in relation to all day to day property management issues to enhance their business and operations. This includes all dilapidations matters, lease renewals (opposed and unopposed), applications for consent, service charge disputes and forfeiture matters. For more information, please contact Bhavini Patel.
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