Built Environment: Outlook for 2022 – Real Estate Dispute Resolution

Chloe:
Hello, and welcome to the second in As hurst series of three podcasts on the built environment outlook for 2022. Yesterday, we heard from Richard Vernon and Allison Murn on the real estate industry. And today we'll be focusing on real estate dispute resolution. My name's Chloe Meredith. I'm a senior associate in the real estate disputes team here at As hurst. And I'm joined today by my colleagues, Alison Hardy and Kim Clifford.

Alison:
Hi.

Kim:
Hi there.

Chloe:
Alison heads APAR real estate disputes team, and has a broad practice covering all aspects of commercial real estate. Kim is a senior associate in our team and is noted in Jameson partners for her strong experience and insolvency related real estate matters. Alison, I know that at the end of each year, you'd like to get your crystal ball out and forecast what the following year has in store for the property disputes world. Give me the headlines, what should we be looking at for in 2022?

Alison:
Well, first and foremost, Chloe, I think addressing the backlog of COVID rent arrears, and then flowing from that, I think we may see more activity in the tenant insolvency and restructuring space. We've also seen lots of dilapidation claims as tenants have sought to reshape their property portfolios post COVID. And I think that's going to continue to.

Chloe:
So you think there'll be a lot for us to do in terms of addressing the impact of COVID then?

Alison:
Yes, but there is of course a world beyond COVID too, well we certainly hope so. The real estate industry's role in tackling climate change continues to be a big talking point. And I think we could see disputes arising as to who should bear the costs of making buildings more energy efficient. We've also seen a number of cases this year, concerning and restrictive covenants, and as property owners continue to repurpose their real estate to meet the needs of today, I think it's highly likely that we will see more cases concerning the removal of restrictive covenants in 2022.

Chloe:
Well, it sounds like we could be in for another interesting year. Kim taking Alison's first point first, I remember it seeing in the headlines over the summer that landlords were owed up to 7 billion pounds by their tenants. How is that backlog of arrears going to be addressed in 2022?

Kim:
Yes. Well, we don't actually know how accurate that figure of 7 billion pounds is, a lot of our landlord clients have worked hard with their tenants to agree payment plans and concessions and ways forward. And a number of clients I've spoken to have said that they either no longer have tenants with significant arrears, or their tenants have actually paid their arrears, which relate to the period of COVID lockdowns, and have they then built up arrears subsequently to that. But regardless of what the overall figure is, the government is hoping to have its arbitration scheme in place by the end of March 2022. Now this is a scheme which will allow both landlords and tenants to refer their renter arrears disputes to arbitration in the event that they are unable to agree the position between themselves. Now, the arbitrator is likely to be an accountant rather than a lawyer, and could decide to reduce the arrears payable by the tenant or extend the amount of time the tenant has to pay the arrears and their decision will be binding on the parties.

Chloe:
Do you think there's likely to be a large uptake?

Kim:
Well, it's hard to say, landlords are unlikely to be keen on a scheme, which could reduce their contractual rent entitlement. However, the scheme may actually prove to be a helpful tool for those landlords who are dealing with tenants, they consider are able to pay with who are taking advantage of the situation in order to avoid payment.

Chloe:
And what about tenants, do you think it'll be popular with them?

Kim:
The scheme might actually be less popular with tenants than you might think. In theory, the idea of submitting to an arbitration scheme where the arbitrator may reduce your rental liability, sounds like a great win for tenants. However, tenants will only be eligible for the scheme if the arbitrator considers that their business is viable. That's one of the reasons the arbitrators are going to have accounting rather than legal backgrounds. So we may find that tenants in weaker financial positions try and avoid the scheme for a fear that the arbitrator may decide that their business is enviable.

Chloe:
Interesting. I imagine that fear could result in a wave of CVAs and restructuring plan proposals in advance of the introduction of the scheme as the current draft of the legislation provides that tenants will be ineligible for the scheme, if they've entered into insolvency or restructuring processes, but we'll come onto tenant insolvency shortly. What doesn't the scheme cover?

Kim:
Yes, as you say the scheme's currently in draft form, but as it's currently drafted, it will only apply to COVID arrears. There is more to it, but broadly speaking, that means that if you are disputing arrears that predate 21st of March 2020, or post date, 18th of July 2021, you're not eligible for the arbitration scheme in respect of those arrears. And even if a tenant is arrears in relation to that period of time, they will only be eligible for the scheme if their tenancy was adversely affected by the pandemic. So in order to be adversely affected by coronavirus, the draft legislation requires that the premises or the business must have been subject to a closure requirement. So that means that office tenants for example, are highly unlikely to be able to rely on the scheme.

Chloe:
Okay. So in theory, there could be a lot of disputes that fall outside of the scheme?

Kim:
Yes, there definitely could. In relation to non COVID arrears, we understand that it's still the government's intention to lift the restrictions on landlord remedies by the end of March.

Chloe:
So that means by the end of March, it's likely forfeiture for rent arrears, commercial rent arrears recovery, statutory demands and requiring subtenants to pay rent directly will all come back into play?

Kim:
Yes, that's absolutely right. And at the moment, landlords can still big debt claims in respect of non COVID arrears, and also pursue former tenants and guarantors. So in respect of non COVID arrears, by the end of March, landlords should be back to business as usual in terms of this recovery. We spent a fair amount of time this year, talking with our clients about tenants insolvency, and how the lifting of limitations on landlords, and the introduction of the scheme will feed into that. So, Alison, what do you think the key points are here?

Alison:
A key point to mention is that in 2021, really has been a quiet year for tenant CVAs when compared with 2020. So in 2020 in that last six months of 2020, we had more CVAs than we could really expect. There were well over 30, mainly in that retail restaurant and hospitality sectors, and a number of those CVAs then resulted in administrations, including household names like Debenhams, Carluccios, Monsoon. This year on the other hand, in the whole year, we've seen just over 10 CVAs and restructuring plans. And to date I'm aware that of only one that has resulted in administration.

Kim:
So why do you think that is Alison?

Alison:
There are numerous factors, but from a landlord and tenant perspective, the restrictions on landlords remedies have played a key role. Also the governments support measures have kept some businesses propped up, and the government indicated its intention to introduce an arbitration scheme quite early in 2021. And tenants might well have been holding out to see what that scheme looked like.

Kim:
So now that we have the draft scheme and know that it's the government's intention to lift the protections in respective non COVID arrears in March, what do you think the impact on tenant solvency will be?

Alison:
Chloe has already mentioned that we may well see a wave of CVAs and restructuring plan proposals in the first quarter of 2021, sorry 2022, as we run up to the introduction of the arbitration scheme, because weaker tenants will want to avoid having a third party arbitrator to declare their business unviable. And tenants won't want to be forced into such an arbitration scheme by their landlords. So they may want to get in first and make a CVA or restructuring proposal, and that certainly is a possibility. It's also likely that some tenants will have built up significant arrears after July 2021. These arrears will be non COVID arrears, of course, so then fall within the scheme, and they won't be eligible to be compromised by the arbitration scheme.

Alison:
That means that at the end of March, landlords should have their usual arsenal remedies. The outcome could be a heightened number of winding up petitions and tenants enter into administration. But tenants are managing to fall out of COVID in lots of different ways. And as I mentioned earlier, something we've seen this year is an increase in the number of tenants choosing not to renew leases upon expiring. And we may well see that trend continue in 2022. So Chloe, I know you've been working on a number of dilapidation claims recently, what's your take on that?

Chloe:
Completely agree with you, Allison. I think they'll continue to be a high number of dilapidation claims in 2022, as tenants continue to reshape their property portfolio or right size their property holdings following COVID.

Alison:
This reason that due to economic factors, some tenants can no longer afford their rent. Why do you think tenants are choosing not to renew or enter into new leases?

Chloe:
Well, tenants property needs are changing, and that change in needs has been accelerated by COVID and the way in which it's altered consumer behavior and forced us all to adopt different working practices. For over a decade, we've seen more and more retail go online and COVID spread that process up for smaller businesses who perhaps didn't have a formal online presence in March 2020. One of the effects of that transition is that, certain tenants need less retail stores and more warehousing space, for example. But as I say, that shift has been going on for a long time and COVID has simply accelerated a preexisting trend. The real shift has been in relation to office space.

Chloe:
We were banished from the office, the large parts of 2020 and 2021. And a number of surveys have indicated that the vast majority of people want to adopt a hybrid approach to working going forward, spending some time in the office and some time at home. We've seen that shift here at Ashurst where we now have our fantastic 60-40 office-home working policy, an effect of this shift is that some commercial tenants may not need as much office space anymore. In fact, it's been estimated that the demand in Europe could drop by 17% over the next decade.

Alison:
And that point links in neatly with one of our other headlines for 22, that there may be an increase in claims concerning restrictive covenants and applications to remove those restrictive covenants. Kim, why do you think that's going to be a feature of 2022?

Kim:
Yes. So as Chloe mentioned, there have been some really big shifts in the ways that we as a society use real estate in recent years, we are seeing buildings be repurposed for different uses, and we're also seeing certain types of buildings being developed in non-traditional locations. So for example, the shift towards online retail has put increasing pressure on the logistics sector, not only because of the increasing online orders, but because of the push towards next day delivery fueled by the likes of Amazon Prime. So the level of demand can no longer be met by logistics centers based in [nor 00:11:39] traditional locations, such as next to motorways or on urban boundaries. So to be able to fulfill the orders and meet customer expectations on delivery times more warehouses will need to be closer to city centers.

Alison:
And so how do restrictive covenants fit into that picture?

Kim:
Well, restrictive covenants can be quite a thorn in the side of developers or property owners looking to repurpose their assets. If a piece of land or a building is encumbered by restricted covenant, it basically means that at some point, an owner of the land has agreed to restrict the use of the land for the benefit of someone else. This could mean, in theory that the land may only be used for agricultural purposes or a former owner may have agreed not to build on the land. As buildings are developed in these non-traditional locations and buildings are repurpose developers definitely therefore need to be alive to...

Alison:
And what should developers be thinking about if they want to develop land burden by a restrictive covenant?

Kim:
Well, the first thing is they shouldn't ignore the issue. That much is clear from the last year's Alexander Devine case, where the Supreme court refused to modify a restrictive covenant and that was despite the fact the developer had already built out part of its development, but it's not all without hope for developers. As I mentioned, restrictive covenants are entered into for the benefit of the land owned by another party. Therefore they can agree and express release or variation of the covenant with the beneficiary of it. If agreement couldn't be reached for whatever reason, developers can also apply to the land's tribunal to modify or remove the covenant. In order for the tribunal to do that, the developer must satisfy one of a number of grounds. One of the grounds that is most likely to be relevant in here is that the covenant impedes some reasonable use of the land.

Alison:
Thanks Kim. And of course, there's plenty of case law concerning those grounds for modification or removal too. For any tennis fans listening, I saw on the news recently that the all England lawn tennis club wants to expand their Wimbledon tennis club by up to 39 new grass courts, in time for Wimbledon 2028, so that they can bring their qualifying rounds in house. I think those qualifiers are currently held in Roehampton, sounds great, right? Well objectors have claimed that this will be a breach of the restrictive covenant against building on the adjoining Wimbledon park site. I'll definitely be looking out to see how that dispute develops in 2022.

Kim:
Yes, definitely. That sounds interesting. And I think that brings us on to our final observation for 2022. This being that there will be disputes between landlords and tenants concerning who should bear the cost of reaching net zero. Chloe, I think you've been dealing with a case that touches on this point recently?

Chloe:
That's right, Kim yes. Although the building of the matter I'm working on is far from achieving net zero, the context in which I've seen this issue arise is where a tenant client of ours was occupying a building with an EPC rating of an F. They exercised a break right in their lease and on termination of the lease, the landlord issued its schedule of dilapidation. Now the minimum energy efficiency standards currently prevent landlords from granting a new tenancy of commercial properties with an EPC rating of F or G. And in this case it was necessary for the landlord to carry out certain works to the premises in order to bring the premises back to standards so that they could be re-let. Our client surveyor went through the schedule of dilapidation and identified a number of items that would effectively be superseded by the energy efficiency works that the landlord was required to undertake. And the parties are currently negotiating to what extent the dilapidation sum should be reduced to reflect the required efficiency works.

Kim:
And so why do you think there's likely to be more cases in this area in 2022?

Chloe:
Well, the ME standards are changing, from the 1st of April 2023, a landlord will be in breach of MEs for continuing a lease of commercial properties with an EPC rating of F or G. That is to continue an existing lease, which is a change from the current position of granting a new lease. So we could see landlords trying to pass the cost of upgrading buildings down to tenants, through service charges, using Jarvison Harris clauses, or those clauses in the lease which require tenants to ensure that the premises complies with statute.

Kim:
Interesting. And I suppose, therefore there'll be tenants who'll want to challenge any attempt to pass down such costs?

Chloe:
Definitely. The government's also made it clear in its white paper that the aim is for all commercial properties to have an EPC rating of a B by 2030. So I anticipate, we'll see more tenants questioning schedules of dilapidation on the basis that the landlord intends to or is even required to carry out energy efficiency works, which would render the works that the tenant is obliged to carry out under the lease completely valueless. And that concludes our disputes overview for 2022. Thank you to Alison and Kim for chatting with me today. And thanks to you for listening, do look out for the third podcast in our series, which will be released tomorrow and focuses on the construction sector outlook for 2022. Goodbye.

Speaker 4:
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