Covid-19 commercial rent arrears: new legislation

The Act applies to business tenants under a business tenancy (defined by Part II of the Landlord and Tenant Act 1954) who were mandated to close their premises or businesses in whole or in part under Government regulations made under the Public Health (Control of Disease) Act 1984 during the Covid-19 pandemic during the pandemic. A list of the businesses forced to close and the duration of such closures are set out in Annex A of the new Code of Practice that was  published alongside the Bill back in November 2021. The focus of the Act is therefore rent debt accrued during the pandemic by businesses operating in the retail, leisure and hospitality sectors.

The Act does not apply to licences or tenancies at will since they do not fall within the definition of "business tenancy." This definition also raises a question mark over certain other arrangements which appear to fall outside of the Act’s remit. These arrangements include headleases (where the head lessee is not in occupation) and circumstances in which business tenancies have ended prior to commencement of the Act (the tenant no longer being in occupation) or where business tenancies have been assigned since 21 March 2020.

The Act applies to tenants under a business tenancy and also extends to guarantors and former tenants who are liable for payment of rent (for example under an Authorised Guarantee Agreement (AGA) and persons (other than the tenant) who are liable on an indemnity basis for payment of rent. However, such "guarantor" parties are only liable in respect of payments required under the arbitrator’s award (a clarification made as the Bill passed through Parliament). Guarantor parties are therefore offered protection by the Act although they do not seem to be able to make a referral to arbitration directly – instead having to rely on other parties to do so.

Landlords or tenants who have been unable to reach agreement as to the treatment of rent arrears accumulated during the pandemic will have the right to unilaterally apply for arbitration during the six month period following the date on which the Act is passed. However, the government has the power to make regulations extending this six month period. The power for the Act to apply to any future periods of coronavirus control is also reserved.
The statutory dispute resolution process will be administered by private arbitrators who will have undertaken a pre-approval process through which their competence will be confirmed and a list of approved bodies will be published by BEIS. Given the relatively short window of time within which parties can submit an application for arbitration there will be a practical requirement for a sufficient number of arbitrators to be available with the capacity to deal with such applications. In a debate held on 9 March 2022 Lord Grimstone explained that 12 arbitration bodies had applied for approval and a sift was underway, he also offered reassurance that the approvals process "specifically asked arbitration bodies to evidence their capacity."

On 23 February 2022, BEIS issued draft statutory guidelines for arbitrators which will accompany the arbitration process under Part 2 of the Act (the Arbitration Guidelines). The government has promised that further guidance as to the operation and mechanics of the process will be issued by BEIS and DLUHC.

It might be the case that there will be an initial "rush" of applications at the end of March 2022 from parties who have failed to reach a satisfactory arrangement since March 2020. However, this risk is mitigated by the fact that the six month period is subject to extension by the Secretary of State under clause 9 of the Act. The government has also adjusted its estimate of the expected number of arbitration cases down to 2,500 arbitration cases in England and Wales from 7,500 cases (as at 8 March 2022).

Other forms of alternative dispute resolution, such as mediation, remain available should parties prefer to proceed with a different method.

For the purposes of arbitration, arrears will include not only principal rent. It will also comprise any amount payable by the tenant to its landlord or managing agent for the possession and use of the premises including VAT (whether or not described as rent), service charge and interest. Service charge is defined as a fixed amount or an amount that varies or may vary according to the relevant costs (or a combination of the two). It includes insurance costs incurred by a landlord (or paid by a landlord to a superior landlord) in connection with insuring  against  loss  of  rent and relating to the insurance of  the whole or any part of the premises comprised in the tenancy and any common parts of a property which includes those premises.  

For those landlords who have opted to make a withdrawal under a rent deposit the amount drawn-down to meet rent debt will be treated as unpaid rent due - although it will be treated as being paid where the tenant makes good any shortfall in the deposit.

Parties should note that the arbitration process will not apply to debt that has accrued outside of certain time parameters. The process will apply only to "protected rent debt" attributable to such time period as the tenant’s business was "adversely affected by coronavirus" during a "protected period".

In practice this means the ringfencing of rent arrears which accrued as a result of mandatory closure of certain business premises (fully or partially) by coronavirus regulations during the period from 21 March 2020 until the date on which restrictions were lifted for that tenant’s particular sector (and ending in any event on 18 July 2021 for premises in England). Where coronavirus regulations permitted specific limited activities to be conducted at the tenant’s premises despite mandated closure this will be disregarded for the purposes of determining whether or not the tenancy was "adversely affected by coronavirus."

Normal periods of operation will not be within scope of the binding arbitration and so tenants are encouraged to meet their rent payments for these periods.

The applicant for arbitration must notify the other party of their intention to refer the matter to an approved arbitration body ("initial notice"). The other party will then have 14 days in which to respond. A reference to arbitration can be made at the end of the period of 14 days following receipt of the response. Alternatively, if no response is received, a reference to arbitration can be made at the end of the period of 28 days following service of the initial notice.

The reference to arbitration must include a formal proposal for resolving the matter and must be accompanied by supporting evidence. Following submission of the initial proposal the other party will have 14 days in which to put forward a formal proposal in response. The parties can submit revised proposals within 28 days of submitting their formal proposals. The Bill is not prescriptive as to what this evidence might comprise however it may include written statements, and if so, such statements must be verified by a statement of truth. The updated Code of Practice (referred to in section 3 of this note) provides an example list of evidence that arbitrators might consider at Annex B. The parties will also have an opportunity to make final proposals – if a final proposal is made solely by the party who has made the referral to arbitration, the arbitrator will make the award set out in that proposal. On that basis parties will be mindful of responding within the statutory timeframes with their revised and final proposals.

As a general rule, parties will each be responsible for their own costs. The intention is to incentivise efficient negotiation since neither party will wish to escalate costs to a level that exceeds or is disproportionate to the arrears that are the subject matter of the process. Fees will be payable in advance by the applicant to ensure that “parties know in advance how much arbitration will cost to avoid deterring them from using the scheme.” To prevent exclusion of SMEs, arbitration bodies will be able to set fees that differ depending on the size of the parties involved. Additionally, there will be no fee-cap on the basis that "complexity is subjective and difficult to define and measure" and the fact that the scheme is intended to be "fast and low cost."[1] Legal or other costs incurred in connection with arbitration (including arbitration fees) will not be recoverable by virtue of any term of the business tenancy concerned.

[1] Commercial Rent (Coronavirus) Bill - Hansard - UK Parliament

The arbitration process will not be available where the protected rent debt is subject to a CVA approved under s.4 Insolvency Act 1986, an IVA approved under s.258 Insolvency Act 1986 or a compromise/arrangement sanctioned under s.899 or 901F Companies Act 2006. It will also be open to the arbitrator to dismiss a reference to arbitration if:

• the parties have already reached agreement prior to the reference being made;
• the tenancy is not a business tenancy or there is no protected rent debt; or
• the arbitrator assesses the tenant’s business and determines that it is not viable and would not be viable even if relief from payment was awarded.

An insolvency arrangement that has been proposed, is pending or has been approved will therefore have priority over the statutory arbitration process. It is only at the pre-proposal stage that the Act will have effect.

A referral must be dismissed by an arbitrator where there is no ringfenced debt (where it is unclear as to whether or not rent debt is "protected rent debt" for the purposes of the Act this may be a method of obtaining clarity). Other conditions for dismissal include where the tenancy is not a business tenancy or where the parties have reached agreement prior to the referral being made (parties should be clear in their negotiations to avoid this). 

If a reference to arbitration is dismissed, a landlord may be able to instigate enforcement action to recover the rent arrears. Tenants will therefore be encouraged to think carefully about wider circumstances before making a referral to arbitration in addition to accurately reflect the impact of the pandemic on their business or risk facing formal insolvency steps and/or immediate action from landlords.

The Act provides that the following "reliefs from payment" could be applied by the arbitrator in relation to ringfenced arrears:

• writing off the debt in whole or in part;
• allowing additional time for payment of the debt, including provision for payment in instalments; and
• reducing any interest on the debt in part or in its entirety.

It will be within the arbitrator’s remit to make an award stating that the tenant is to be given no relief from payment of the debt. For those parties who do go through the arbitration process, the award made by the arbitrator will be legally binding on both landlord and tenant and there will be a maximum repayment period of 24 months. Before making the award the arbitrator will consider any final proposals put forward by the parties and will measure these against the principles set out at clause 15 of the Act – the proposals most closely aligned with the principles will be favoured. For this reason, it is suggested that parties consult clause 15 when collating their proposals. If only one party submits a final proposal the arbitrator will make the award in accordance with that proposal provided that it is consistent with the principles in clause 15, if it is not, the arbitrator can make such award as they consider appropriate.

The principles in clause 15 are a balancing act based on (i) preserving or restoring the viability of the tenant’s business insofar as that is consistent with preserving the landlord’s solvency and (ii) ensuring that the tenant is required to meet its obligations regarding payment of the protected rent in full and without delay.

The threshold for landlord’s solvency is low. The landlord will be considered to be solvent unless it is or likely to become unable to pay its debts as they fall due. In assessing the landlord’s solvency the arbitrator will consider the landlord’s assets and liabilities and the landlord’s financial position generally.

The Arbitration Guidelines include details of how the concept of "viability of a tenant’s business" is envisaged.  It is acknowledged that "viability is deliberately not specifically defined, in order to take into account the vast array of different business models both within and between sectors" and the Arbitration Guidelines caution that "that profit margins can vary significantly between industries and sectors." The tenant’s viability and solvency will be assessed having regard to previous rental payments made, the tenant’s assets and liabilities (including other tenancies), the final position of the tenant and the impact of coronavirus on the tenant’s business. The tenant will be responsible for proving its proposal and must provide evidence that will allow the arbitrator to determine the viability of its business. The prospect of business restructuring or borrowing money will be excluded by the arbitrator in considering the solvency of both parties.

The impact of the arbitrator’s award is to change the terms of the tenancy between the parties in respect of the ringfenced debt – for example any amount payable pursuant to the award is to be treated as rent payable under the tenancy. Furthermore, the tenant is not to be regarded as in breach of covenant by virtue of non-payment of an amount written off by the award, or failure to pay an amount payable under the terms of the award before it falls due under those terms. Presumably, however, this would mean that a landlord’s right to forfeit would attach to non-payment of the amount repayable by the tenant under the award as it falls due (although this is unclear).

During the "moratorium period" a landlord will not be able to use the following remedies in relation to or on the basis of the protected rent debt:

• a debt claim;
• CRAR;
• forfeiture or exercising a right of re-entry; and
• draw-down on a tenant’s deposit.

Where arbitration under the Act is initiated the "moratorium period" starts on the day the Act is passed and finishes on the date that the arbitration concludes. Where a reference is not made to arbitration within the time period prescribed by the Act the moratorium period begins on the day the Act is passed and ends on the date that is the last day that a reference to arbitration could have been made under the Act.

Where a debt claim has been commenced by a landlord against a tenant in respect of debts including or relating to the protected rent debt on or after 10 November 2021 but prior to the date of commencement of the Act it will be possible to apply for a stay of such proceedings to allow for resolution of the matter relating to payment of the protected debt rent by arbitration or otherwise. The Act also addresses the circumstances where judgment is given on a debt claim during this period. These provisions will be of key interest to landlords – particularly given that recent County Court cases have resulted in judgement in favour of landlords in debt claims.

The protected debt rent will be disregarded in calculating net unpaid rent for the purposes of CRAR. It is only the protected rent debt in respect of which CRAR cannot be exercised during the moratorium period.

Certain provisions, equivalent to those under s.82 Coronavirus Act 2020, apply to the moratorium on forfeiture. For example, the landlord will not waive its right to forfeiture or re-entry during the moratorium period through its own conduct, or conduct on its behalf, during the moratorium period - only an express waiver in writing will waive the right. Additionally, the failure of the tenant to pay the protected rent debt cannot be used by the landlord to establish ground 30(1)(b) Landlord and Tenant Act 1954 (persistent non-payment of rent) in resisting a statutory lease renewal.  

The Act also addresses the appropriation of rent. For example, where payment of rent is made by a tenant during the moratorium period in respect of rent arrears which are not ringfenced by the Act and the tenant has not exercised its right to appropriate the payment to any specific rent debt that it owes to the landlord then the landlord must apply the payment to the non-ringfenced element before applying such payment to the ringfenced protected rent debt. This prevents the landlord from extending the debt in respect of which it is able to take enforcement action.

Where reference has been made to arbitration under the Act, no proposal can be made (relating to the whole or part of the protected rent debt) for a CVA under s.1 of the Insolvency Act 1986 or an IVA or interim order under s.256A or s.253 of the Insolvency Act. Nor can an application be made for a compromise or arrangement under s.896 or 901C Companies Act 2006. These restrictions apply during the "relevant period" beginning on the date that the arbitrator is appointed and ending on:

• the date that an award is made (or if appealed the date on which the decision is made);
• the date that the reference is dismissed by the arbitrator (if it is dismissed); or
• the date of abandonment or withdrawal (in the event the arbitration is abandoned or withdrawn).

It is not clear what effect these provisions might have on extant insolvency proposals or arbitration proceedings – the Act specifically prohibits the initiation of these arrangements.

Landlords and tenants of business tenancies will be prohibited from initiating arbitration proceedings (other than those provided for in the Act) during the "moratorium period" unless the other party agrees. The arbitration scheme under the Act will therefore take precedence over a contractual dispute resolution clause which provides for referral to arbitration. For this purpose, the "moratorium period" is the same as that applicable to the temporary moratorium on enforcement. It is not clear what effect these provisions might have on extant arbitration proceedings – the Act specifically prohibits the initiation of these arrangements.

The provisions in schedule 3 of the Act prohibit the presenting of:

• a winding up petition under section 124 Insolvency Act 1986 solely in relation to a protected rent debt; and
• a bankruptcy order petition under section 286(1) of the Insolvency Act 1986 in relation to a protected rent debt.

The provisions relating to winding up petitions come into force on 1 April 2022. The prohibition on presenting winding-up petitions will apply during the "moratorium period" which is the same as that applicable to the temporary moratorium on enforcement.

For bankruptcy orders, the prohibition applies during the "relevant period" which runs from 10 November 2021 and ends on the same date as the "moratorium period" ends. The provision relating to this prohibition is intended to come into force as of 10 November 2021.

Where a bankruptcy order is made (on petition of the landlord) on or after 10 November 2021 but before the date on which schedule 3 of the Act comes into force and the order is one that the court would not have made if schedule 3 was in force, the order will be void.