Are turnover rents the answer to accommodate the interests of both business tenants and landlords?

Guest blog by Simon Dawes, Angela Bhaseen and David Jones – Kennedys Law

It is difficult to imagine where many business tenants will find the necessary funds to pay rent in addition to utility bills and other business outgoings when they may not have traded for months.

Ordinarily where business tenants fail to pay rent, landlords have the right to forfeit leases and to take possession of premises. However, Section 82 of the Coronavirus Act 2020 prevents landlords from enforcing their rights of re-entry or forfeiture (by proceedings or by peaceful re-entry) against business tenants for non-payment of rent. The moratorium was initially set by the government for the period 26 March 2020 to 30 June 2020 but this has recently been extended to the end of September 2020. Whilst the purpose of the Act is to ensure adequate protection for businesses, the suspension on forfeiture means that landlords will not be able to bring a lease to an end for failure to pay rent for the period up until the 30 September 2020. However, once the moratorium period ends, a landlord will be able to claim for forfeiture for both the March and June quarters rent payments and for all rent becoming due but unpaid thereafter.

In the current economic climate it could prove difficult for landlords to find new tenants and they should consider if forfeiting leases would be in their best interests. Landlords, on taking possession of premises, could find themselves potentially liable for payment of business rates following the expiry of any available empty business rates relief and all other outgoings, including building insurance premiums, as well as being responsible for the repair, maintenance and security of premises. Allowing tenants to remain in possession of premises could provide them with the breathing space to build up their businesses again and would lead to landlords avoiding these payments and responsibilities.

The Code of Practice for Commercial Properties (the Code) during the COVID-19 pandemic

The objective of the Code/government is to provide the right support to those in the chain of commercial property payments – from customers to tenant businesses to commercial landlords and lenders so that the economy can recover swiftly. The government’s aim is to support businesses to come together to negotiate affordable rental agreements. It builds upon any discussions already taking place by giving those tenants and landlords affected by the crisis the tools to come to a mutually beneficial agreement; ensuring that best practice becomes common practice.

For those landlords and tenants who have yet to come to a mutually beneficial agreement, a possible solution could be to vary the terms of business leases to provide for the method and type of rental payment arrangement to be changed for a temporary or permanent period. For example: to change terms from quarterly rental payments in advance to a turnover rental payment arrangement with payments being made monthly or quarterly in arrears for up to a year to allow business tenants time to build up their businesses.

It has been reported that The Crown Estate have apparently offered turnover-based rent arrangements in an attempt to help some operators trade through the pandemic. Historically, turnover rents have been used for retail premises but there is no reason why they should not be applied to the likes of serviced offices and possibly hotels.

There are a number of ways in which rents with a turnover element can be structured. The most frequently used are:

• Pure turnover rent: x % of This normally has a headline rent to allow for regular invoicing and an adjustment is made at year end accordingly.
• The open market rent plus turnover rent top Here, the agreed open market rental value is applied to the premises with an additional agreed percentage of the turnover to be charged quarterly or yearly in arrears should the turnover exceed a stated cap.
• Base Rent (% of open market rent) plus turnover rent (flat percentage or stepped percentage). A base rent is agreed on the premises and is paid quarterly or monthly in advance and is topped up by an agreed percentage of the turnover quarterly or yearly in arrears. The base rent can either be a fixed figure or a percentage of the agreed open market rent on the

All of the above can be exclusive or inclusive of other costs payable under the terms of the lease which may be included in the rent. The vast majority of turnover percentages are exclusive of VAT.

The pros and cons of turnover rent

The advantages of turnover rents include:

• Shared success: where the business tenant performs well, landlords will reap the rewards of an increased level of turnover rent
• Monitoring: Landlords can monitor tenants’ performance and plan for the future accordingly
• Attract new business tenants: Business tenants who are start-ups or who are unsure about entering into a lease of new premises may be willing to take a chance if rents are linked to turnover.

The disadvantages of turnover rents include:

• Tenant’s point of view: Turnover rents will create more administration for business tenants as additional documentation needs to be is provided including a requirement for regular reporting to landlords (providing trading accounts etc.)
• Landlord’s point of view:There is a lack of certainty over the level of turnover rent payable and landlords will have to rely on production of accurate turnover information by tenants. Accordingly, a landlord’s funders may not approve of this uncertain structure

Comment

 Turnover rents could provide tenants with the opportunity to rebuild their businesses which in turn could deliver landlords with rental payments in excess of what they would have received under a quarterly rental payment arrangement.

Varying the method of rental payment to a turnover rent arrangement for a temporary or permanent period could be dealt with by way of variations to the tenants lease. In this way, landlords and business tenants can work together during these difficult times to kick start the economy and move towards a brighter and better future for all.