COVID-19 – Crunch Time for UK Restaurants
by Scott Keown, partner Commercial Real Estate, JMW Solicitors
Large parts of the UK hospitality sector have been battered in recent years, with changes in consumer behaviour, extreme pressure on margins driven by spiralling costs and labour supply challenges combining to create a toxic cocktail for restaurateurs.
As if the macro situation wasn’t already sufficiently tough, the unfolding COVID-19 crisis has plunged virtually all restaurateurs into an even more perilous state of uncertainty and existential threat.
The sector is characterised by restaurateurs operating on relatively traditional commercial lease agreements with third party landlords and as the impact of COVID-19 on the UK economy becomes clear, restaurateurs and landlords alike are keen to understand what steps they can take, whether unilaterally or in cooperation with other stakeholders, to help them weather the unfolding COVID-19 storm.
Each case must of course be considered on its own merits, and specific legal advice must be taken on a case-by-case basis, but we see the following key points arising repeatedly in the case of restaurateurs on traditional commercial lease agreements:
Many landlords and restaurateurs are asking about the doctrine of frustration. In the present context, this is where a restaurateur-tenant would argue that the lease is “frustrated” by an event rendering it physically or commercially impossible to fulfil the terms of the lease or where the obligations have been made radically different by the frustrating event and radically different from that contemplated at the time of the lease. This doctrine has always been construed narrowly and the Supreme Court in the 2019 Canary Wharf v European Medicines Agency (“the EMA”) case held that neither the UK’s departure from the EU nor the EMA’s head office move were frustrating events. As the effect of frustration would be to end the lease entirely (and so end the restaurateur’s own rights and obligations under it), even if the particular circumstances of the case meant that frustration could be successfully argued, it might not be an appropriate remedy for many restaurateurs. Many restaurateurs will simply have temporary cash flow difficulties, and will therefore be looking for a temporary relaxation of payment obligations, as opposed to a complete end to the lease. Restaurateurs looking for a temporary relaxation of payment obligations may be well advised to explore a company voluntary arrangement instead but this would of course impact on the landlord’s investment values and so would be resisted where possible;
The contractual principle of force majeure is being talked about a lot, which in the present context is where one or both parties might not have to perform the lease obligations due to the occurrence of certain events outside of the control of one or both parties. This might be argued to include the COVID-19 virus response. The party in question would not be liable for its failure to perform its obligations, such as payment of rent for example. The difficulty for a restaurateur is that commercial leases rarely include such a provision and so this will not be available and in the absence of such provisions, a restaurateur cannot argue for it;
Compliance with legislation
A restaurateur is usually required by its lease to comply with all legislation passed which concerns the use and occupation of the premises. If the COVID-19 virus response was for a complete “shut down” of the premises and this was, as it would need to be enforceable, passed into law, then the restaurateurs would not be able to use the premises at all, but this would not of itself entitle the restaurateur to stop complying with its payment obligations in the lease, although it might provide a basis for commercial negotiations with the landlord, who will need to consider carefully its response to what may be seen to be quite a unique situation;
The landlord will usually have insured the premises for what are defined as “insured risks” and the landlord is given wide discretion in what to insure over and above the usual risks. A quick review of the policy coverage, whether acting for either party, will likely show that all risks covered entitling withholding of rent will be limited to those situations where the premises are rendered unusable as a result of physical damage or destruction. Further, apart from the ability of a restaurateur to avoid paying rent under such a rent suspension clause, the general rent payment clause will prevent any withholding of rent for any reason, even if the restaurateur had its own claim to make again the landlord for any reason. A check of the restaurateur’s own business interruption insurance cover, if acting for them, should also be undertaken to see if there is anything in that policy which might be of help, depending on the particular circumstances in which its own insurer might pay rent;
In the EMA case the court noted that the EMA was able and had agreed to assign the unexpired remaining term in its lease to a third party as a way to avoid ongoing liability to its landlord. The alienation provisions of the lease should be carefully scrutinised in the context of the restaurateur’s appetite or operational feasibility of giving up the whole or only part of the leased premises and whether, for example, it might wish to assign the lease or share occupation with a third party for a short period of time and thereby share its payment liabilities and whether a landlord would be able to let any part of the premises to a different restaurateur entirely and on better terms;
Rent review provisions
If a rent review is pending or in ongoing negotiation, the restaurateur could seek to agree a rent holiday or reduction for a certain period along with a corresponding agreement as to how and in what circumstances it might be terminated and perhaps with an agreement in relation to the future treatment of rent review provisions. For example, in exchange for a temporary relaxation of its leasehold payment obligations, a restaurateur and a landlord may pre-agree a fixed uplift of rent on a future date, by which time the effects of COVID-19 may hopefully have passed;
If there is tenant break clause available then its terms should be scrutinised carefully. Often where a restaurateur does not exercise a break clause it will be entitled to a corresponding reduced rent (or rent free) period in which case it may be possible to renegotiate the break date and/or the reduced rent period with a view to bringing forward the benefit of the reduced rent period so that it can be enjoyed now during the current crisis. Alternatively, a landlord may be persuaded to agree a temporary relaxation on lease costs in exchange for the restaurateur agreeing to “drop” or reset a future break date, or to extend the remaining lease term if it is quite short. There are a number of ways in which an existing break clause could be restructured via negotiation between landlord and restaurateur in ways that could be mutually beneficial in the longer term, particularly if doing so might improve the chances of there still being a solvent and rent-paying restaurateur once the immediate COVID-19 crisis had passed.
In some cases restaurateurs will have paid a “rent deposit”, being funds paid by the restaurateur and held by the landlord as security for performance by the restaurateur of its obligations in the lease. The quantum of these rent deposits can often be in the region of 6 months’ rent plus VAT (and sometimes even more). We are working with some landlords and restaurateur who are together looking at ways to “unlock” these funds to help the parties through the immediate COVID-19 cash flow crisis. In unprecedented times like these, landlords and restaurateur alike are willing to consider relatively extreme measures like these.
We are working with our clients and their other advisors such as accountants and surveyors to negotiate sensible solutions to the challenges posed by COVID-19.
Ideally, negotiations are conducted without prejudice to the lease’s existing terms and, depending on the parties’ wishes, would either be formally concluded by a deed of variation to the lease or a less formal “side letter” setting out the temporary or permanent solution agreed.
Landlords may prefer to deal with these solutions by way of side letter as those are often expressed to be personal to the parties and would not be subject to registration at the Land Registry, and could therefore be more easily kept confidential between the landlord and the particular restaurateur involved.
A restaurateur should expect to be asked to provide financial information evidencing how the COVID-19 crisis is adversely affecting its business, including bookings and cancellations data, and its proposals to the landlord in terms of lease payment restructuring should be aimed at addressing those adverse effects.
This could include the effect on its turnover, ability to run the business if staff and suppliers are not present or able to travel to work and whether, and to what extent, it would be able to make other savings across the business for example in relation to taking advantage of support/loans offered by central and local government (including relaxation of business rates) or reduction in staff numbers or management costs.
We encourage landlords and restaurateurs alike to engage early in focussed and constructive dialogue exploring solutions designed to achieve the best possible outcomes for key stakeholders, not just for their own good but for the good of the hospitality sector as a whole.