The final piece in the jigsaw – the new binding arbitration process for landlords and tenants

Hogan Lovells
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Hogan Lovells

[co-author: Alex Snell]

As foreshadowed in its announcement on 16 June 2021, the UK Government has issued the Commercial Rent (Coronavirus) Bill establishing a binding arbitration procedure to resolve disputes relating to certain commercial rent arrears. The new process is designed to provide a backstop in the event that landlords and tenants under commercial leases cannot agree the repayment of rent arrears accrued during the various lockdowns in the period from 21 March 2020 to 18 July 2021 (in England – 7 August 2021 for Wales). Once in force, the legislation (which is intended to come into effect in March 2022) will round out a package of measures introduced by the Government to provide support to commercial tenants and to help mitigate the impact of multiple lockdowns during the course of the pandemic.

Click here and here for our previous updates in relation to these measures and here for the Bill.

The Bill – how does the arbitration process work?

  • Who does it apply to?
    • The Bill applies to “protected rent debt” which is defined as rent plus service charge plus interest due on unpaid amounts.
    • Rent is “protected rent” if the tenancy was adversely affected by the pandemic (meaning for any period between 21 March 2020 and 18 July 2021 the whole or part of the business carried on at the premises or the premises themselves was subject to a closure requirement ) and the rent is attributable to a period of occupation by the tenant within the protected period applying to the tenancy.
    • The “protected period” for a tenancy starts on 21 March 2020 and ends on the earlier of 18 July 2021 or the last day that a closure requirement or specific coronavirus requirement applied to the business or premises.
    • No attempt is made to split the protected period into different lockdowns, or regionally (remember the tier system?). All periods start on 21 March 2020 and end when the closure restrictions for that business were finally lifted. It also doesn’t seem to matter if a business was able to operate partially from the premises notwithstanding a closure.
  • Who are the arbitrators? The Secretary of State (SoS) can approve one or more bodies as approved arbitration bodies. The arbitration body(ies) will appoint an arbitrator or panel of arbitrators to deal with any arbitration between landlords and tenants. Apart from that there are no real requirements set out in the Bill as to what qualifications or qualities an arbitrator has to have.
  • Set timetable:
    • The process can be started by either the landlord or the tenant. Any application has to be made within the period of six months from when the Act is passed (although the SoS can extend that period).
    • The party intending to apply (the applicant) has to notify the other (the respondent) – the respondent has 14 days to submit a response.
    • Either 14 days after the response is received, or 28 days after the day the notification is served if there is no response, the matter can be referred to arbitration.
    • The applicant has to include a formal proposal with the application and the respondent can put forward a counter-proposal within 14 days of receiving the proposal from the applicant.
    • All proposals have to be accompanied by supporting evidence (such as why the tenant cannot afford to pay the protected rent debt in full or why the landlord cannot afford to accept the tenant’s proposal).
    • Each party then has 28 days from receipt of the proposal or counter-proposal (as appropriate) to put forward a revised proposal.
    • The award has to be made as soon as possible after the last day on which a proposal or counter-proposal could be lodged, unless there has been an oral hearing (which either party can request, although hearings are public) in which case the award has to be made within 14 days of the conclusion of the hearing.
    • The award then has to be published, together with the reasons for making the award, but confidential information can be omitted.
  • Fees: Although the applicant pays the fees for the arbitration up-front, the respondent has to pay half unless the arbitrator considers a different amount should be paid by the respondent. There is a suggestion that arbitration fees maybe capped and all fees have to be published on the arbitration body’s website. Each party has to meet their own legal and other fees.
  • The awards:
    • All awards are binding on both parties.
    • The arbitrator has to dismiss the application if it feels that either an agreement has already been reached between the landlord and the tenant, the rent is not a protected rent debt, the tenancy is not a business tenancy or if the arbitrator concludes that the tenant’s business is not viable (and would not become viable if the protected rent debt were reduced or time were given to pay).
    • If the application isn’t dismissed then the arbitrator can grant time to pay (up to 24 months) or reduce the debt (including writing it off completely). However, the arbitrator has to go with the proposal that it feels is the most consistent with “the principles”. The principles are that the award should be aimed at restoring and/or preserving the viability of the tenant’s business as long as that also preserves the landlord’s solvency, and, so far as is consistent with that first aim, at requiring the tenant to meet its obligations to pay the protected rent debt in full without delay. In other words, the tenant should only be given such relief as it needs to ensure continued viability of the business, but the relief should not jeopardise the landlords own solvency.
  • Interplay with CVAs and other debt compromises: The Bill provides a restriction on the use of restructuring mechanisms in respect of protected rent debt:
    • A protected rent debt cannot be referred to arbitration if it is already subject to a CVA, scheme or restructuring plan.
    • Once a referral to arbitration has been made, an arbitrator cannot be appointed if the protected rent debt is subject to a CVA proposal or an application for a scheme or restructuring plan (i.e. a tenant cannot refer a matter to arbitration and then apply to have the same debt compromised under a CVA, scheme or plan).
    • Once an arbitrator has been appointed, no CVA can be proposed and no scheme or plan applied for which seeks to compromise the protected rent debt. This restriction lasts for a varying period of time as follows:
      • If the arbitrator dismisses the application or proceedings are abandoned or withdrawn, the restriction lasts until the day the application is dismissed, abandoned or withdrawn;
      • If the arbitrator makes an award (and that can either be relief or an award which says no relief will be granted) the restriction will last for a period of 12 months from the date on which the award is made.
      • If an award is made and then set aside on appeal, the restriction lasts until the day of that appeal decision.

The Bill also provides for continued restrictions on landlords during the moratorium period

  • Moratorium on enforcement of protected rent debt: A landlord cannot bring civil proceedings to recover the protected rent debt as a debt claim. This also has retrospective effect, in that any civil proceedings started after 10 November 2021 but before the Act is passed must be stayed on the application of either party. Any judgment given on a debt claim started in that period cannot be enforced or relied on by the landlord before the end of the moratorium period and if an arbitrator makes an award, the judgment is taken to be altered in accordance with the award.
  • Restriction on use of CRAR: The landlord cannot use CRAR to recover all or any part of the protected rent debt.
  • Restrictions on re-entry or forfeiture: The landlord cannot enforce by action or otherwise a right of re-entry or forfeiture for non-payment of the protected rent debt. The right to forfeit is merely suspended, not waived.
  • Right to appropriate rent: Any payment of rent has to be allocated to the unprotected part of the debt, unless the tenant specifically says otherwise.
  • Winding up petitions: No winding up petition can be presented by a landlord based on non-payment of the protected rent debt.

The moratorium period starts on the day the Act is passed and ends on (a) where the matter isn’t referred to arbitration, the date when applications can no longer be made (so 6 months after the Act is passed, unless that period is extended by the SoS) or (b) where the matter is referred to arbitration, the day on which the arbitration is abandoned or withdrawn, or when the appeal period for any award expires without an appeal being brought, or when any appeal is finally determined, abandoned or withdrawn.

New Code of Practice

In addition, the Government has published a new Code of Practice which replaces the existing Code of Practice initially issued on 19 June 2020, and updated on 6 April 2021.

The Code has immediate effect and applies to all commercial leases under which rent arrears have built up due to an inability to pay as a result of the impact of the pandemic (relevant arrears). It states that the policy aim is to ensure that relevant arrears should not force an otherwise viable business to stop operating. It makes it clear that landlords and tenants should try to reach agreement on payment of relevant arrears through negotiations before the Bill becomes law and that the expectation is that those tenants who can pay, should pay and that includes relevant arrears. However, tenants who genuinely cannot pay the relevant arrears should negotiate with landlords in the expectation that the landlord will share the burden where they are able to do so.

The Code also sets out certain expected behaviours (such as acting reasonably, transparently, and collaboratively), certain principles (which will also apply to any arbitrator) and what should be considered when assessing viability and affordability.

Some key takeaways

  • Option of last resort: The Code of Practice and the Bill continue to place priority on parties to a commercial tenancy reaching their own agreement through bilateral negotiations or the use of other alternative dispute resolution procedures such as mediation. It is clear that the proposed arbitration procedure is designed to supplement, rather than replace, those negotiations – and perhaps even be seen as something of a last resort.
  • “Can pay – won’t pay!”: In line with all communications from the Government on the subject of rent arrears, the message both in the Code and the Bill is very clear – tenants who can pay, should pay. Some landlords may argue this has fallen on deaf ears but may now take some comfort from the fact that the scheme says that if a tenant is unable to show that it is unable to pay the rent that accrued in the lockdown periods, the arbitrator can direct the tenant to pay the outstanding amounts in full.
  • A “viable business”: Tenants are only able to avail themselves of the arbitration procedure in circumstances where they have a viable business and where they can prove to an arbitrator that the business is viable (or would be viable if the arbitration award were made). When assessing viability or solvency, the arbitrator has to disregard anything done by the relevant party to manipulate its financial affairs so as to improve their position in relation to an award (for example, reducing cash by making excessive dividend payments). The arbitrator must also disregard the possibility of the tenant borrowing money or restructuring their business when assessing whether the tenant’s business is viable which may reduce the number and type of tenant businesses which might be deemed viable. It will be something of a balancing act for a tenant both to show that the business is viable (or would be viable if a rent agreement is reached) whilst at the same time showing that it needs relief from paying outstanding protected rent in full. Painting too gloomy a picture risks the arbitrator determining tenant is unviable … which could have other consequences.
  • Protections for landlords: Landlords can also provide evidence to show the impact of any proposal by the tenant on their own business. A landlord does not have to agree to a compromise if it would affect its own solvency. It is perhaps unlikely that one lease is going to tip the scales for a landlord but if the landlord wants to take the point it is one which will require a level of disclosure of financial information by the landlord.
  • Position of the arbitrator: This isn’t going to be easy for the arbitrator! Complex determinations about the financial condition and affordability of payments for tenants and the potential impact on the solvency of the landlord will need to be made. The process requires relatively quick turnarounds from the arbitrators, the reasons for their decisions have to be made public and fees are likely to be capped. It will be interesting to see who steps forward (and which bodies put themselves forward) to act as arbitrators.
  • Will the process be used?

Since last summer the number of new CVAs and landlord restructuring plans has dropped significantly. The restructuring market has been quiet generally during this period so this is not surprising but the extension to the tenant moratorium until March 2022 and promise of a binding arbitration process is likely to have been a factor as well. Now the detail of the arbitration process is out, will tenants be willing to take their chances in an arbitration process or will they be dusting off CVA plans?

Time will tell but whilst the arbitration scheme is certainly novel, it may not be the panacea some had hoped. It will entail significant disclosure of financial information and may leave the tenant in a worse place than when they started. For example, the tenant cannot propose another form of compromise for 12 months once an arbitrator has been appointed - it is all eggs in one basket for the tenant. Well advised tenants will want a degree of comfort around a positive outcome heading into the process. Also, the decisions the arbitrator is going to have to make are going be complex and in many cases finely balanced and so an element of uncertainty of outcome is unavoidable. Landlords and tenants may actually now be more incentivised to come to a consensual agreement and from a tenant perspective this would preserve the CVA or restructuring plan option (as a bilateral agreement is a block on using the arbitration process).

It would also be possible for a tenant to hold off making an arbitration application until late in the initial 6 month moratorium period to buy further breathing space as the moratorium period is then extended until the arbitration is determined. Landlords may also consider using the process as defensive tactic. Given that a dispute can be referred to arbitration by either the tenant or the landlord, a landlord could can pre-empt the use of a different formal compromise process such as a CVA, or hasten the end of the period during which they’re prevented from using other procedures such as forfeiture by actively moving negotiations towards arbitration. If tenants are concerned about tactical use of the process by landlords, that might bring forward CVA or landlord restructuring plans for Q1.

[View source.]

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