The current pandemic has brought about several economic impacts to the businesses and operations of both tenants and landlords.
With corporations, whether operational or not, bearing the brunt of continuing to payout salaries and benefits to its workers, it is only understandable that financial relief will be sought where possible.
There are different strategies that a landlord may take, in order to provide a mutually beneficial concession for all parties involved.
In this article, we go in-depth at the proposed measures and analyze the Pros and Cons for each.
Possible Rental Concessions:
I. Early Application of Advance Rent
In a typical office lease contract, advance rent is usually paid upon execution of contract and applied to the last few months of the lease term. If a tenant is cash-strapped and conserving liquidity for more immediate expenses, landlords may offer to use this amount instead to cover for the months under lockdown.
Colliers recommends this option since it is the most equitable for both parties. However, this option needs to be reviewed vis-à-vis the current lease contract since the application of Advance rent is unique per company.
If the option is not possible (utilize earlier the Advance Rent) because the contract applies it to the first few months of the term, then another option is to use the Security Deposit instead. This solution offers the same pros and cons, but with this being a security deposit, an agreement to replenish or reinstate the amount at a later date is necessary.
It is also worth noting that the replenishment/reinstatement provision can be used for Advance Rent and will substantially reduce the Cons for this option.
II. Rental Deferment
The Philippine government, via Department of Trade and Industry Memorandum Circular (DTI MC) 20-12, provided the guidelines for rental concessions via rental deferment. However, this relief was only offered to companies belonging to the Medium, Small, Micro enterprises (MSME) classification. For these MSMEs, all rental amounts due and payable during the Enhanced Community Quarantine (ECQ) period – March 16 to May 15, 2020, can be paid in six (6) equal monthly payments starting at the end of the ECQ period.
Although not applicable for all tenants, unless under MSME classification, the Landlord has this option, and can offer this as a rental concession.
Because this is solely based on the magnanimity of the Landlord, rental deferment should still be equitable and applied only to the specific days when tenants are unable to utilize the leased premises. For tenants who continue to operate at full or reduced capacity, a tiering system may be used to compute for the deferred amounts.
Note that deferment only covers the rental amount and does not include Common Area or Common Utility Service Area (CUSA) and other charges.
In our previous advisory, we mentioned that it is better for Landlords to use this concession as an incentive against non-performance. Any violation therefore of contractual provisions will make the deferred rent due and demandable immediately.
III. Rental Discount / Abatement
The DTI MC 20-12 does not compel landlords to grant rental discounts nor abate rent during the ECQ period for office tenants belonging to the MSME classification. However, it also does not prevent Landlord from offering concessions beyond the MC.
Rental discount /abatement has the most adverse effect on the landlord. Depriving the landlord of its rental income puts it also at a precarious position to look for ways to sustain operations despite paying for operational expenses including employees’ salaries and benefits.
Like how deferment can be made fair for both parties, rental discount or abatement must be computed based on the actual number of days tenant was at reduced or closed operations. Full abatement or 100% discount on rent is not equitable if tenants were operational in the leased premises.
However, the goodwill generated by this concession may prove beneficial to the landlord upon rental renewal. Tenants will, more than likely, look back and consider this generous offer and use it as a key deciding factor to renew for another term.
Since abatement and or rental reduction is temporary and only cover the ECQ period, Rental should revert or can be renegotiated upon lifting of the lockdown. This will be based on the conditions set forth by the landlord in the awarding of the abatement or rental rate reduction.
What Happens Next?
Whichever rental concession is agreed upon by both parties, the commercial terms and financial obligations in the lease contract should resume upon lifting of the current lockdown. Additionally, upon the awarding of the rental concessions, legal provisions on default must be made integral in the concessions agreement to safeguard the landlord’s business.
Rental concessions must be bespoke per tenant. It cannot be all encompassing since the impact of ECQ is different per company. Tenants must be willing to substantiate claims of financial duress by providing Landlord with relevant documentation to serve as proof prior to any concession award.
A strict confidentiality agreement must also be in place to prevent such disclosure of rental concessions provided by the landlord to the different tenants.
The goal of both parties is to survive the pandemic. In so doing, they must maintain a deep understanding and empathy for the other side. Concession cannot be one-sided but must also be leveraged on to foster a better tenant-landlord partnership. Each option discussed has Pros and Cons, but ultimately, any of it should accomplish economic viability for both tenant and landlord post COVID-19.