Government unveils scheme for binding arbitration in relation to COVID related rent arrears

Summary of the new legislation

The proposed legislation introduces a new arbitration system binding on landlords and tenants. Where the scheme applies, it will enable either landlords or tenants to apply to an arbitrator to settle disputes relating to arrears that have accumulated during the Covid pandemic (as defined by the legislation). The arbitrator will have discretion to write off arrears owed by tenants and/or to defer payment.

The legislation also further curtails remedies that would traditionally be available to landlords to enforce debts owed by tenants which are caught by the scheme.

The key points are as follows:

• When does the scheme come into force?

The legislation will come into force as soon as it is passed. The government has indicated that this is likely to happen by 25 March 2022. However, some provisions will be retrospective.

• Who does the scheme apply to?

The legislation, and therefore the arbitration process, only applies to those businesses which were forced to shut during the Covid pandemic by government order. These are:

• Hospitality & nightclubs

• Non-essential retail

• Garden centres

• Personal care including hairdressers

• Hotels and tourist accommodation

• Sport & leisure

• Theatres, cinemas & large event venues

Other sectors, including those businesses operating out of offices, are not caught (and therefore do not have the protection of the legislation), even where Covid has had a material impact on those businesses forcing them to shut temporarily.

Furthermore, the government has also made it clear that the scheme only applies to those businesses who are unable to pay the ring-fenced debts. For those businesses who are, prima facie, eligible for the scheme but are in a position to pay – they will be expected to pay the arrears to their landlord in full. The scheme has not been designed as a shield for well-funded tenants to hide behind. Equally, the scheme only applies to businesses that are “viable” (or would be viable if they received relief from COVID arrears). Whilst the Code of Practice does not set a definition of viability, where a tenant has been unable to pay its rent since the restrictions were lifted, this is likely to be used as evidence by the landlord that it is not a viable business and it may therefore find itself ineligible for the scheme. A tenant that is or is about to become insolvent will not be eligible.

• Which periods are caught be the scheme?

The scheme is limited to arrears accrued during a “protected period”. A protected period is the period during which a tenant’s business was forced to shut as a result of the government restrictions commencing on 21 March 2020 and terminating at different times for the various sectors, the latest date being the earlier of 18 July 2021 and the last day on which the tenant’s business was subject to restrictions. The arrears accrued during this period are referred to as the “ring-fenced debt”.

• Does the scheme just apply to arrears of rent?

The scheme does not just apply to arrears of rent, but also includes service charge, insurance, and interest together with any other sums due under the tenant’s lease during the protected period.

• How does the arbitration work?

Landlords and tenants caught by the scheme are encouraged to try and reach a negotiated settlement in relation to the ring-fenced debt between themselves. If they are unable to reach an agreement, then either party can refer the dispute to arbitration. To do so they must apply within six months of the legislation being enacted. It appears that the six-month window is intended to be a strict cut off date.

The arbitrator will be chosen from a register of arbitrators which the government is compiling. Both the landlord and tenant will then be given the choice of a public hearing or, if neither party asks for a hearing, the arbitrator will make their decision based on the documentation provided by the parties.

In terms of the arbitrator’s powers:

• The arbitrator will be able to write off or defer payment of arrears (for up to 24 months) which relate to a protected period.

• In making their decision the arbitrator is to be guided by the principles set out in the Code of Practice – with the overarching aim being to preserve the viability of the tenant’s business albeit this should not be “at the expense of the solvency of the landlord”.

• The arbitrator must accept whichever of the claims made by the landlord and tenant is, in their view, most appropriate. However, any relief granted to the tenant “should be no greater than necessary for the tenant business to afford the payment”.

• What is the position where the parties have already reached an agreement?

Until the legislation comes into force landlords and tenants are encouraged to continue negotiations in accordance with the principles set out in the Code of Practice. Where a settlement or rent concession has already been reached and/or is concluded prior to the legislation being enacted, such agreements will remain binding on the parties. The scheme cannot be used to re-open concluded settlements.

• Can landlords still issue court proceedings in relation to arrears?

Landlords who have issued court proceedings in relation to ring-fenced debt before 10 November 2021 are entitled to continue with those proceedings in the usual way. Any proceedings issued on or after 10 November 2021 will be stayed until the later of six months from the date this legislation is enacted and the date any arbitration proceedings are concluded. If the legislation is enacted in March 2022 as proposed, the moratorium on court proceedings for ring-fenced debt will therefore effectively be extended to August 2022 at the earliest.

Landlords will, however, be able to issue proceedings in relation to debts not falling within the protected period.

There are similar restrictions on landlord’s initiating forfeiture, Commercial Rent arrears Recovery and insolvency proceedings in relation to ring-fenced debt.

• What is the position in relation to rent deposits and guarantors?

The draft legislation refers only to “landlord” and “tenant” – and it is the financial standing of the parties that the legislation appears to be concerned with, not the status of any parent companies or guarantors. It therefore appears that guarantors will also benefit from any arbitration award made in favour of the tenant as, once rents are reduced or deferred by an arbitrator, the guarantor will only be liable for the reduced/deferred rent.

Landlords will also be prevented from drawing down on tenancy deposits to cover outstanding ring-fenced rental arrears. If a landlord has already drawn down on a deposit and used it to cover ring-fenced debt, the contractual requirement for the tenant to top-up the deposit is to be suspended.

Takeaway

Where the scheme applies, the legislation removes the final remedies that had been left available to landlords – namely issuing a debt claim and drawing down on any rent deposit. Allied with the fact that landlords will also be unable to pursue third party guarantors in relation to the ring-fenced debts, landlords will have little option but to negotiate with their tenants in a meaningful way. Where a tenant is able to show that its business is still viable but that it is not in a position to pay some or all of the ring-fenced arrears, landlords will be expected to make a concession. If an agreement is not reached with the tenant, then the landlord’s hand will ultimately be forced by an arbitrator.

Where the scheme does not apply, the current moratorium on forfeiture will remain in place until 25 March 2022, but after this, and subject to the government enacting additional legislation, tenants will be liable to have their leases forfeited. In the interim, landlords are at liberty to enforce their other remedies including issuing debt claims.