Legal development

Binding arbitration to resolve COVID19 rent arrears what might we learn from other jurisdictions

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     Summary
    Key issues to watch out for in the UK Government's new scheme
    Why is this relevant?
    Is the plan to introduce arbitration, or other more flexible forms of alternative dispute resolution, such as mediation?
    Arbitration can be just as costly as full blown litigation – the UK Government might consider giving parties the opportunity to consider mediation and other methods too (much like the Australian model)
    Will the scheme apply to all companies, regardless of size?The Australian scheme only applies to companies with a net worth of $50 million or less. It remains to be seen if the UK scheme will apply to all companies, regardless of size.
    If the UK Government intends to allow leases to be automatically extended for up to 24 months to give tenants more time to pay, how will this interact with the Landlord and Tenant Act 1954?This could stall landlord redevelopment plans, for example, and parties will need to be careful to serve statutory notices under the 1954 Act with sufficient notice, in light of revised contractual termination dates.
     How will arbitrators ensure consistency of approach given arbitration is typically a confidential process? Cases with similar fact patterns could end up with different results, which could in turn cause confusion in the market. This could also make consensual negotiations more difficult, as parties will be unable to gauge where they stand.
     How will decisions stemming from the arbitration scheme interact with and affect current and future litigation in the courts? The UK government may prevent landlords from issuing or pursuing debt actions to recover rent arrears through the courts, until the arbitration process has either concluded or any time limit for arbitration has been passed. It is currently unclear what will happen to claims already underway (they may, for example, be stayed), or claims with multiple causes of action.
     Is it fair to continue to prevent landlords from enforcing repayment of rent arrears? Landlords may argue that their leases were agreed between sophisticated commercial entities, and despite the unprecedented nature of COVID, it would be unfair to continue to prevent them from enforcing their contractual rights.
     Will the UK Government's new plans be able to withstand potential challenges from landlords under the Human Rights Act and ECHR? As the legislation will retrospectively alter contracts between sophisticated commercial entities, the UK Government will need to ensure the drafting of its new scheme does not breach wider obligations under the HRA and ECHR.
     Might the UK Government consider offering incentives to parties to bring them to the negotiating table? Other jurisdictions have been more content to leave negotiations to the parties, and have enticed them to negotiate by offering incentives, such as tax breaks for landlords. The UK Government might consider following a similar tack.

    On 4 August 2021 the UK Government confirmed it would be legislating to address the current backlog of rent arrears in the UK commercial real estate market (estimated in June 2021 to be at least £7.5 billion). It intends to ringfence COVID-related rent arrears, create a more robust Code of Practice to guide parties with negotiating repayment, and introduce a "binding arbitration" scheme to be used where parties are unable to reach consensual resolution. The Government hopes these measures will "trigger the start of a return to business as usual."

    The Government is yet to explain how these proposals will work in practice. It will be particularly interesting to see how they will affect existing rent arrears debt proceedings. This was illustrated by the recent High Court decision of London Trocadero (2015) LLP v Picturehouse Cinemas Ltd [2021] EWHC 2591 (Ch). The judge held that the landlord could recover approximately £2.9 million in rent arrears, but dismissed the tenant's earlier application to adjourn proceedings in anticipation of the Government's proposed legislation. Clarification will no doubt be welcomed by all parties.

    With lawmakers soon putting pen to paper our global team of Real Estate Dispute Resolution specialists have shared their experience of how other jurisdictions have dealt with COVID-related rent arrears, and in this article we explore how their approaches might inform landlords and tenants about what is to come.

    Australia

    The UK Government has suggested that its new scheme will likely be based on the "successful Australian model", so we can expect elements of this to be imported. The Australian Government introduced a mandatory National Code of Conduct early on in the pandemic for dealing with commercial tenancy related issues, much like the (non-binding) Code introduced in the UK. Various pieces of local legislation have also been enacted by the Governments of Victoria and New South Wales to regulate repayment of arrears.

    For example, due to rising cases NSW has recently introduced new measures allowing commercial tenants with a turnover of less than $50 million, and that are eligible for certain government grants (that usually require at least a 30% fall in revenue as a result of the pandemic), to require their landlord to renegotiate the rent in proportion to their decline in turnover. Of the rent relief provided, at least 50% must be in the form of a waiver, with the deferred balance to be repaid across the remainder of the lease term, or if necessary over a 24 month lease extension period. Landlords are prevented from enforcing lease provisions, or claiming on securities, from between 1 July 2021 to 31 December 2021 unless they can prove they have renegotiated rent (if requested) and, importantly, the matter has been referred to mediation.

    The requirement for (at least consideration of) mediation echoes the UK's plan to introduce "binding arbitration." However, mediation and arbitration are two very different processes, with arbitration being binding by its very nature and often being just as costly and time consuming as full blown litigation. It is unclear if the UK Government really intends to introduce arbitration, or rather a broader menu of alternative dispute resolution mechanisms for parties to choose from.

    It also remains to be seen if the UK Government will restrict its new scheme to commercial tenants with a certain level of turnover like the Australian regime, or whether it will apply to entities of all sizes. A one-size fits all approach would arguably have the benefit of creating less confusion in the market, and avoid criticism aimed at the Australian model that larger tenants have been left to fend for themselves.

    If the UK Government intends to follow the Australian model and introduce an ability for tenants to repay arrears over a 24 month lease extension period it is unclear how this would interplay with the Landlord and Tenant Act 1954. For example, under the 1954 Act a tenant benefiting from security of tenure is entitled to remain in occupation of the premises after the contractual termination date, on the same terms as the lease, until one of the parties serves at least 6 months' statutory notice of termination. If a lease term is automatically extended by the new legislation, a landlord that was hoping to recover possession of its premises at the end of the tenancy (for example, to carry out redevelopment works) would have those plans delayed for up to two years. It would also need to ensure that it served a valid section 25 notice 12-18 months in to that 24 month extension period, so as to give at least 6 months' but not more than 12 months' notice of termination. Although a government mandated extension to lease terms would give tenants extra breathing space to repay arrears, and in turn make it more likely that landlords would actually recover those sums, such a mechanism would arguably impose an unfair additional burden on landlords whose development plans may be scuppered by a tenant's repayment plan, and that might happen at a late stage in the landlord's plans. Those drafting the legislation will hopefully take these nuances into account.

    Spain and Germany

    In Spain commercial tenants temporarily had the ability to apply for moratoriums or temporary rent reductions, but this scheme was scrapped on 31 January 2021. Interestingly, though, in October 2020 the Autonomous Government of Catalonia adopted a decree which established an obligation for commercial landlords in the region to offer rent discounts for leases signed on or before 1 January 1995 where the tenant's business had been affected by measures that restrict the use of the property or activity for which it is leased. Tenants can require their landlords to make a reasonable and equitable amendment' to the terms of their leases and, if the parties do not reach an agreement within one month, the landlord will automatically be subject to discounts in rent. Arrears can be reduced by 50% for as long as the tenant's activity is suspended.

    This scheme has strong parallels to the one currently in force in Germany. Laws there not only prevent landlords from terminating leases due to rent arrears accrued between 1 April 2020 to 30 June 2021, but also entitle tenants to ask that the terms of the lease are amended, on the basis that the core contract has been 'disturbed' by the pandemic. The concept of amending a contract due to disturbance is not a new one in German law, but a regulation passed in December 2020 introduced a legal presumption that COVID-19 related restrictions affecting the use of commercial rented space have disrupted the basis of the contract. The concept being that the parties would not have entered into the lease on the same terms if they could reasonably have foreseen the position that they now find themselves in.

    Unlike in Australia and Catalonia, in Germany the lease will not automatically be amended should the parties be unable to come to an agreement. Whether and to what extent tenants can demand an adjustment, for example a lower rent or a deferment of payment, remains a matter of comprehensive consideration of the circumstances of each case by the courts. This consideration by the courts can differ widely, which arguably could lead to uncertainty in the market. The UK Government will have to consider a similar issue if binding arbitration is introduced, in particular how decisions of one arbitrator will marry with another to ensure consistency of approach, and to avoid unfair decisions being imposed without any real mechanism for appeal. As arbitration and mediation are typically confidential processes, it may be that the UK Government intends to make decisions public. If so, consideration will in turn need to be given to how those decisions will sit alongside and affect judgments handed down by the courts regarding repayment of COVID-related arrears. A lack of coordination and cohesion could potentially lead to different decisions being made in cases with similar fact patterns, and ultimately, make it harder for those negotiating consensually to understand their bargaining positions. We anticipate that the UK government may prevent landlords from issuing or pursuing debt actions to recover rent arrears through the courts, until the arbitration process has either concluded or any time limit for arbitration has been passed. Again, this is not straightforward – many claims include more than one cause of action (e.g. a claim for rent arrears, and a counterclaim relating to the provision of services). In such cases, how would any stay on the rent arrears part impact the remaining aspects of a claim?

    The Catalonian and German approaches are arguably even more radical than the binding arbitration scheme proposed by the UK Government. Rather than requiring parties to enter into ADR, these laws give tenants the ability to strong arm landlords into amending fundamental terms of their leases should they have been affected by the pandemic. The schemes have no doubt added fuel to arguments by landlords that they have continued to bear the brunt of the financial effects of the pandemic. They too often have obligations further up the chain, to creditors and shareholders, which are difficult to satisfy with forced rent reductions.

    Belgium

    The Belgian Government has taken a comparatively more laissez-faire attitude to the rent arrears issue. Ancillary support measures were introduced to encourage landlords and tenants to the negotiating table. There are tax reductions available to landlords that agree to waive part, or all, of their tenants' rent arrears, and local governments have set up schemes to enable businesses to apply for loans to help them pay rents, subject to them meeting certain criteria evidencing hardship caused by pandemic. However, the Belgian Government has left the negotiation of repayment of rent arrears to the parties - no formal guidance (mandatory or otherwise) has been issued, and escalations will most likely be dealt with by lawyers and, ultimately, the judiciary.

    The Belgian Government may have taken account of concerns raised by some that the proposals announced by the UK Government go too far in retrospectively altering private contracts negotiated between sophisticated commercial entities. Those drafting the new legislation will need to carefully consider this, and ensure that provisions are sufficiently robust so as to withstand potential challenges from landlords under the Human Rights Act and the ECHR. This particularly if the proposal for binding arbitration is considered alongside existing and extended protections afforded to tenants, such as the ban against eviction for non-payment of rent and use of CRAR. To soften the blow the UK Government might consider coupling its new proposals with further incentives for landlords, such as the Belgian idea of offering tax breaks to those that voluntarily come to the negotiating table.

    With the UK Government expected to release further details of its proposals in the near future, it will certainly be interesting to understand the scope of the new legislation. Approaches taken in other jurisdictions may offer some inspiration and, in places, some pitfalls to avoid.

    Please look out for our Estates Gazette article on this topic published on 29 October 2021.

    With thanks to Joe Perry, Associate, for his contribution.

    The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to.
    Readers should take legal advice before applying it to specific issues or transactions.

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