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Keeping It Real Estate

News and Trends in UK Real Estate, Disputes and Planning Law

Posted in Real Estate News

What’s happening with the Retail Prices Index and why?

Speedread: Alongside Wednesday’s Spending Review, the government and the UK Statistics Authority (UKSA) have published their response to the recent consultation on reform to the RPI. The outcome to the consultation states that “it is UKSA policy to address the shortcomings of the RPI in full at the earliest practical time”.  The earliest the proposed changes can legally and practically be made by UKSA will be February 2030.

The RPI is described as the oldest measure of consumer prices in the UK and is used widely across the economy and in financial contracts. However, for some time the government has perceived that the RPI has a number of shortcomings which, more often than not, overestimate the rate of inflation.

What is changing and when?

As an official measure of inflation, the RPI is used for a variety of purposes including the calculation of interest and redemption payments under index-linked government bonds.  If the RPI is recalibrated then this could mean lower returns for funds which have invested heavily in those assets.  In view of this the Chancellor has now confirmed that he will not consent to a change to the methodology of the RPI before the current proposed date of February 2030, which is when the last of the RPI-linked gilts mature.

The change, when it happens, will bring the methods and data sources of the Consumer Prices Index (including owner occupiers’ housing costs (CPIH)) into the RPI.

What is the practical impact for real estate?

In real estate transactions, many rent adjustment clauses (and service charge caps) are index-linked by reference to the RPI.  This method of rent review is particularly popular in sale and leasebacks and other fixed income deals.

When the formulae used to calculate the RPI are altered to bring the index more in line with the CPI, the likely practical effect of such a change will be to reduce the increases in rent where they are linked to increases in the RPI. Parties who have negotiated clauses in the expectation that the RPI would give a greater return will not welcome this change, whilst others may well argue that index-linking is supposed to reflect inflation and the formulae used to calculate the RPI do not accurately do so.

Additionally, in some contracts, drafting will have been agreed which effectively seeks to preserve the original method of computation even after a material change in the RPI methodology, although how straightforward and/or contentious this might be to implement will remain to be seen.

In the meantime, for those contemplating entering into new index-linked deals, now is a time to give pause for thought about the choice of index if a contract’s duration will extend beyond  February 2030, at which point it now seems certain the change will be made.  Index-linking is unlikely to die out as an appropriate method of rental uplift, but the choice of index and, perhaps, the use of caps and collars will now come into sharper focus.

 

 

Posted in Real Estate News

A Conclusive Conclusion for Service Charge Certificates?

In a case that will be welcomed by landlords, the Court of Appeal has ruled that a service charge statement was conclusive both as to the landlord’s costs and the scope of the services.

Background

The case concerned Blacks, the outdoor retailer, who was the tenant under a commercial lease. Under the service charge clause:

  • the landlord was obliged to calculate “the total reasonable and proper cost” it incurred in providing various services;
  • Blacks was obliged to pay a “fair and reasonable proportion” of the total cost; and
  • the landlord was obliged to provide a service charge certificate detailing the total cost it incurred and the sum payable by Blacks and that “such certificate shall be conclusive”.

In January 2019, the landlord issued a service charge certificate for a much larger sum than it had in previous years. Blacks challenged the certificate on various grounds including that it contained unnecessary works and matters outside the scope of the relevant repairing obligations. The landlord subsequently issued proceedings to recover the unpaid service charge.

The High Court held that the certificate was conclusive as to the total cost incurred by the landlord in providing various services, but it was not conclusive as to whether those services fell within the scope of the service charge clause.

The decision

The Court of Appeal overturned the decision of the High Court. It held that the certificate was conclusive on both points. To be otherwise would require clear and express wording to that effect.

Lessons learned

Clauses which seek to make a service charge certificate conclusive are common in commercial leases.
This judgment will be welcomed by landlords, as (whilst each case will need to be determined on its facts) this decision should avoid opening the floodgates on challenges by tenants on historic service charges. It will also give landlords certainty to be able to operate service charge provisions without fear of challenge by tenants although we have yet to learn whether the case will be appealed.

The case is a reminder to all parties to pay close attention to the detail of the wording and the mechanics of service charges. As the Court commented, it is not the job of the courts to save the parties from an imprudent term which they have agreed.

Case: Sara and Hossein Asset Holdings Ltd v Blacks Outdoor Retail Ltd [2020]

Posted in Real Estate News

Challenging Times (continued) – The Use Classes Order and Permitted Development Rights

In our blog of 3 September 2020, we brought you news of the challenge to the recent changes to the Use Classes Order and the Permitted Development Rights (“PDR”) regime.

The action group bringing the claim sought to quash the statutory instruments which bring about the changes to the Use Classes Order (including the introduction of the much-vaunted new Class E) and PDR (in particular granting rights to provide new residential units in a variety of types of development).

The claim was heard in mid-October. This morning, just over a month on, the High Court handed down its judgment.

In what will be a relief to the government, the challenge failed. The High Court found that the adoption of the changes to the Use Classes Order and the reforms to PDR was legal, and the new rules remain in force.

Although the Court found that the government had failed to carry out consultation, which it had promised to do, this wasn’t considered to be fatal to the reforms. The particular circumstances of the COVID-19 pandemic were held to be adequate justification for this failure – even though the changes to the Use Classes Order and the PDR regime could remain in force long after the pandemic ends.

On the face of it, the High Court’s decision is positive news for a property industry navigating its way through some of the choppiest trading conditions in living memory.

However, the action group bringing the claim has said it will appeal the decision. In that context, those dealing with use clauses in leases may wish to see where any appeal goes before they commit to referencing the new use classes.

We’ll keep you abreast of developments and your usual Hogan Lovells contact will be able to advise on the best approaches in the meantime.

Posted in Case Updates

Tenant fails to satisfy break clause in latest VP ruling

The High Court has ruled in the recent case of Capitol Park Leeds PLC v Global Radio Services Limited [2020] that a tenant’s attempt to exercise the break in a lease, which was conditional on the tenant giving “vacant possession of the Premises” to the landlord, was not effective after the tenant had removed a substantial number of the landlord’s fixtures and fittings.

The facts

The case centred around a tenant’s break clause contained in a 24 year lease of a three storey modern commercial unit.

The tenant served written notice to the landlord to exercise the break in accordance with the clause.

The tenant returned the keys on the break date having stripped out around seventeen features and fixtures from the premises (such as suspended ceilings , M&E equipment and floor boxes) which were agreed by both parties to be landlord’s fixtures and fittings under the lease (the “Fixtures”).

The works to remove the Fixtures had been carried out by the tenant with the view to addressing the reinstatement provisions in the lease but the work had been unilaterally stopped without the items being replaced when the tenant decided to attempt to negotiate a financial settlement instead.

The issues

The landlord argued that, by removing the Fixtures the tenant had not satisfied the condition to provide “vacant possession of the Premises” but had returned substantially less than “the Premises”.  The definition of “Premises” included the words “but including all fixtures and fittings at the Premises whenever fixed, except those which are generally regarded as tenant’s or trade fixtures and fittings…”.

The tenant argued that, whilst it acknowledged that it may be in breach of covenant in respect of the repairing obligations and therefore liable for dilapidations, it gave vacant possession of “the Premises” and so complied with the condition in the break clause.  The tenant sought to rely on various authorities that applied a simple interpretation of vacant possession, that the premises must be returned free (or vacant) of people, chattels and legal interest.

The decision

The Court decided that:

• the outcomes caused by the removal of the Fixtures (e.g. business disruptions, damage to property, health and safety problems) were the sort of outcomes against which the landlord had been guarding when it adopted the definition of “Premises” in the lease by including the words “all fixtures and fittings at the Premises…(except Tenant’s fixtures)…and all additions and improvements made to the Premises.”;

• this was an “exceptional case” and (applying the second test for vacant possession identified in two leading authorities) the physical impediment caused by the tenant stripping out the Fixtures was such that there was a substantial impediment to the landlord’s use of the property.  Therefore the condition, to return the Premises to the landlord with vacant possession on the break date, had not been satisfied.

Permission for the tenant to appeal to the Court of Appeal has been granted, however (and whilst each case will need to be interpreted on its own facts) the case potentially puts tenants in a difficult position – they will need to ensure that they are removing chattels from the premises in order to give vacant possession but if they go too far and remove landlord’s fixtures they could nonetheless fail to satisfy the break.

Posted in Real Estate News

Supreme Court ruling in restrictive covenant case: ignore covenants at your own risk

The Supreme Court has handed down judgment today in an eagerly awaited case on restrictive covenants and affordable housing. It is the first time that the Supreme Court has considered a case on the modification of restrictive covenants. In today’s judgment, the Court has sent a warning message to developers who knowingly breach restrictive covenants where other viable options are available. The Court has refused the developer’s application to modify the covenants.

What are the facts?

Millgate was a developer that owned land subject to a restrictive covenant which prevented any use of the land other than as a car park. The Alexander Devine Children’s Cancer Trust owned a neighbouring property which benefitted from the covenant. It was building a hospice for terminally ill children on the site and planned to have a peaceful wheelchair path around the perimeter of its gardens. Millgate built 13 affordable housing units in order to meet planning obligations which would allow it to market a high-value development nearby. It built the homes close to the boundary with the Trust’s land, in deliberate breach of the covenant, and then applied to the Upper Tribunal to modify the covenant. The case was first heard by the Upper Tribunal in 2017. The Upper Tribunal found that the housing development had a significant impact on the hospice land and also noted that Millgate had not acted in good faith. However, it held that the public interest in making the affordable homes available immediately to people who had been waiting for social housing was sufficient to justify modifying the covenant.

The Supreme Court decision

The case has gone all the way to the Supreme Court. The Supreme Court disagreed with the Upper Tribunal’s decision. Although there was a strong argument that it was in the public interest to allow the much-needed social housing units to remain, ultimately this did not outweigh the public interest in protecting the Trust’s contractual rights. The Supreme Court noted that it would have been perfectly possible for the developer to build all of the housing units on land unaffected by the covenants, while still meeting its affordable housing requirement. Alternatively, it could have paid a contribution to provide social housing on an alternative site nearby, which could have been ready quickly. The arguments on both sides carried weight and, when exercising its discretion, the Supreme Court also considered the developer’s conduct. It had built the units knowing that the land was subject to the covenants and completely at its own risk. It should not be entitled to rely on its own unlawful conduct in having built the social housing in breach of covenant as a factor justifying the modification of the covenant. Ultimately, it could not be rewarded for providing the Upper Tribunal with a fait accompli.

What does this decision mean?

As the Supreme Court noted, the dilemma imposed by the facts of the case was particularly sharp. On the one hand, a covenant protecting the privacy of a children’s hospice and, on the other, the prospect of having to demolish 13 affordable housing units. Two competing uses of the land are pitted against each other. The Supreme Court’s decision in favour of the hospice feels like the right one but it was not a foregone conclusion. In particular, the developer’s conduct in knowingly building the affordable housing in breach of the covenant would not in itself have been enough to overturn the original decision in favour of the developer but for the fact that they could have chosen to build the affordable housing on land not subject to the covenant (albeit at less profit). Had the developer applied to modify the covenant before building the affordable housing that argument would have scuppered its claim and it was not right for the developer to have improved its position as a result of its own breach. It seems that the message is that poor conduct will not always be fatal but those who skate on thin ice should not complain when they fall in.

 

Posted in Real Estate News

Stand By for Action on EPCs!

Back in July 2018, the government launched a “Call for Evidence on Energy Performance Certificates”. To read our blog click here.

Over two years later the government has published an “Action Plan”, setting out what it is going to do in the light of the responses it received. However, if you are worried about the consequences of the government launching a radical overhaul of the system and massively expanding its reach while everyone is distracted by a global pandemic, don’t be. There are no immediate changes. Instead, the government has set out its current thinking and explained what it is going to consider in more detail. Timelines stretch, in many cases, to the end of 2021 providing helpful transparency on the speed of change.

The Action Plan identifies three key strands of policy that the government is looking to tie together. These are:

• ensuring that EPCs are accurate, reliable and trusted;
• enabling EPCs to engage consumers and support other government policies; and
• providing a data infrastructure that is fit for the future of EPCs.

All three of these are welcome and to be encouraged, especially with the asset rating on an EPC likely to remain a critical metric for Minimum Energy Efficiency Standards and the government’s commitment to achieving net zero greenhouse gas emissions by 2050.

The government is committed to:

  1.  A post-Brexit consultation on the law underpinning EPCs. The “EPB Regulations”, as they are known, derive from an EU Directive and the most recent set of Regulations dates from 2012. The government wants to see how a post Brexit environment can offer new opportunities for legislative flexibility and improvement.
  2. A renewed focus on enforcement of the Regulations, which the Action Plan recognises is a current weakness, over the course of 2021. This is likely to comprise both increased enforcement and also greater sanctions for breach. The Action Plan suggests that other parties might be brought into the scope of this as well, such as mortgage lenders, although it does not explain how.
  3. A move towards EPC ratings that are more reflective of actual energy use, as opposed to hypothetical energy efficiency. The real estate industry has long argued that for an EPC to be meaningful it has to reflect how a building is actually occupied and used, and it seems that the government has listened, although we must see first see the detailed proposals in the 2021 consultation.
  4.  An increase in the use of EPCs, including more or updated trigger points for EPCs, which the government will consider by the end of 2021. The Action Plan suggests that a lot of the inconsistencies and areas of confusion over the current law were highlighted in responses to the Call for Evidence including: Houses in Multiple Occupation; the effect of having a smart meter; the effect of alterations to buildings; and what can and cannot be done with heritage buildings. The implication is that the government will be looking to resolve these issues. What they will propose is, of course, as yet unknown.
  5. A focus on increasing compliance with MEES, on which we may hear some news shortly as the Action Plan states that this will be done by the end of 2020. This will include “a consultation on the merits of setting requirements for lenders to help households improve energy performance of homes they lend to”, which sounds intriguing!
  6.  A new EPC register by the end of 2020, with improved functionality including the ability to interact with other government owned databases (presumably the Land Registry, although it isn’t clear) but also incorporating Open Data access to real-time EPC datasets. The Action Plan acknowledges that there are complexities here that will need to be worked through, in particular around data protection and what happens if an individual opts out of having their data stored in the EPC database.

Inevitably, the detail of all of this remains to be worked through as the government carries on its thinking and launches its consultations, but it is promising to see that feedback given in 2018 has been heard and is being acted upon. Let’s hope it has also been understood. Only time will tell!

Posted in Real Estate News

The Sun Also Rises on Pre-pack Administration Reform

In 2015, responding to mounting concerns about pre-pack administration sales, a set of voluntary industry measures were introduced to address the perceived lack of transparency and trust in the process – especially when the sale was to a connected party, like a director or shareholder of the company in administration.

To encourage compliance, the government inserted a “sunset clause” into the Insolvency Act 1986 giving it the power to ban or regulate pre-pack sales to connected parties within the next five years. When that power expired in May 2020 many thought it was the end for pre-pack reform.

However, it was revived by this year’s Corporate Insolvency and Governance Act and extended to June 2021. In a report published today, the Insolvency Service has announced that the power should be exercised to require an independent opinion to be provided on any pre-pack sale in administration to a connected person.

Why has the government now decided to regulate pre-packs?

Following a review, the government has concluded that connected party pre-packs remain a cause for concern for those affected by them and there is still the perception that they are not always in the best interests of creditors. There is, in the government’s words, “still room for further transparency”.

It was also recognised that more companies may become insolvent as a result of the COVID-19 pandemic. Indeed, since the start of the pandemic, we have seen pre-pack sales by several major brands in both the retail and leisure sectors. This gives rise to concerns about the need to protect the interests of creditors as well as promote company rescue, and the Insolvency Service has concluded that further regulation is justified to ensure that pre-pack sales are subject to a measure of independent scrutiny.

What is a pre-pack sale?

A pre-pack sale takes place when the sale of all or a substantial part of a company’s business is arranged prior to the company entering administration, and then completed by the administrator after they are appointed, usually on day one of the administration.

An independent review led by the now Dame Teresa Graham CBE in 2014 highlighted the lack of transparency around pre-pack sales for unsecured creditors, leaving them feeling aggrieved. One of its key recommendations was the establishment of a group of experienced business people which could be approached, on a voluntary basis, to offer an opinion on any pre-pack sale to a connected party. The Pre-Pack Pool (the Pool) was formed to provide such an opinion.

What were the government’s findings?

Despite the number of connected party pre-packs increasing since 2016, there has not been a corresponding rise in the number of referrals to the Pool. The number of pre-pack sales to connected parties increased year on year from 163 in 2016 to 260 in 2019. Remarkably, however, the number of referrals fell in the same period from 36 (22%) in 2016 to just 23 (9%) in 2019.

The reason given for this poor take up rate was that the purchaser saw no benefit in making a referral. Administrators have no ability to request an independent opinion from the Pool, so referrals are entirely dependent on the willingness of potential purchasers to make one. Further, administrators are only required to make connected party purchasers aware of their ability to approach the Pool; they are not required to recommend that the Pool be approached.

In light of this, stakeholders including insolvency industry trade body R3 and the British Property Federation supported the establishment of a statutory mechanism for making referral to the Pool mandatory.

What has the government decided?

The government does not propose banning connected party pre-pack sales altogether. In many circumstances it was felt that a pre-pack sale provides the best outcome for creditors.

Instead, the government will bring regulations into force before June 2021 preventing an administrator from disposing of company property to a connected party within the first eight weeks of the administration without either the approval of the creditors or an independent written opinion. The opinion provider, who must meet certain eligibility requirements, will provide a written report to state that either the case is made for the disposal or not made. Whilst the administrator can proceed with the disposal if the case is not made, the administrator will be required to provide a statement setting out the reasons for doing so. The administrator must in all cases provide a copy of the opinion to the creditors and Companies House.

Today’s announcement on pre-packs will be no doubt be welcome news for landlords, who may feel that the government’s response so far to COVID-19 has been decidedly debtor friendly and undermined their interests as creditors. Whilst the Insolvency Service does not mandate that written opinions must be sought from the Pool, as the established operator in the market it does appear likely that referrals to the Pool will increase dramatically from their current low levels.

A copy of the report can be found here

Posted in Real Estate News

Higher MEES for residential properties? Have your say

On 30 September 2020 the government published its consultation on amending the Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015 (the “Regulations”), raising minimum energy efficiency standards for the domestic private rented sector in England and Wales.

What is behind this consultation? The government’s aim is to have as many private rented sector homes as possible achieve an EPC band C by 2030. As a reminder, since 1 April 2020 there is a minimum EPC band of E for domestic private rented property (subject to a limited number of exemptions).

The consultation outlines four key proposals to achieve this goal:

  • Raising the minimum energy performance standard…

The government’s preferred policy is for all domestic private rented property to meet the single target of an EPC band C. To be clear, this is the “energy efficiency rating” (“EER“) rather than the “environmental impact rating” (“EIR“). The EER measures a building’s performance based on the total energy costs to heat and light the building, whilst the EIR measures carbon emissions from a building.

  • …via a phased introduction

The requirement to meet the minimum EPC band C would be introduced in phases. Under the proposals, the new minimum standard would apply from:

    • 1 April 2025 for new tenancies of domestic private rented property (including renewals); and
    • 1 April 2028 for all domestic private rented property tenancies.

Alternative approaches include: a single compliance date (i.e. all properties must achieve the EPC band C rating by 1 April 2028); earlier compliance dates in a phased approach; or more interim targets in a phased approach.

  • Changes to the costs cap

At present, where a landlord has substandard domestic private rented property its spending requirements in improving energy performance are capped at £3,500 (VAT inclusive).

Achieving a higher minimum EPC band will require more investment, and the government wants to increase the cap to £10,000 (VAT inclusive).

The government sees the increased cap as the best way to ensure the majority of properties are improved whilst limiting landlords’ costs. Its modelling indicates that landlords would spend £4,700 per property to reach EPC band C if the £10,000 cap was set.

  • A “fabric first” approach

This broadly means improving the energy efficiency of the fabric of a building as a priority, ahead of other improvements. EPC recommendation reports currently adopt the fabric first approach, but landlords are free to implement recommendations in any order they wish.

The government is open to views on how to incentivise fabric first measures – making it mandatory via legislation is up for consideration.

Whilst the above is the government’s preferred policy, it is not the only option on the table. The grading of substandard EPCs is currently done on the EER rather than the EIR. Confusingly, the EIR is also on an A to G scale but is included in EPCs for information purposes only. The government is considering an alternative “dual metric” approach whereby landlords would need to ensure their properties achieved an EER band C and an EIR band C. The cost cap would also be increased to £15,000, rather than £10,000. Whilst this is more ambitious and would lead to more significant emissions savings, the cost to landlords is potentially higher. The government has welcomed views on this alternative.

Finally, the government wants responses on how to encourage compliance. This could include the creation of a new property compliance and exemptions database, operated by a third party provider with a registration fee of £30 per property. The government accepts that there may need to be a maximum registration fee for landlords with significant domestic private rented property portfolios.

The government is also considering changes to enforcement powers, mainly for local authorities. Local authorities have some powers to enter domestic private rented property under the Housing Act 2004 (for health and safety purposes), but the government’s view is that using these powers for enforcing the Regulations is disproportionate to their intended purpose. Instead, local authorities may be given alternative powers to serve notices on landlords and any tenants to carry out inspections at agreed times. In the future, the Housing Health and Safety Rating System that local authorities use may be amended to align with the Regulations. Fines for breaching the Regulations could also be increased to £30,000 per property and per breach to act as a greater deterrent.

You can find a copy of the consultation here. Responses must be submitted by 30 December 2020, and we strongly encourage all interested parties to respond.

Posted in Real Estate News

Prejudice to landowner is too high to impose Code rights on its land

The Electronic Communications Code gives powers to telecoms operators to acquire rights over private land to install their apparatus for the purpose of providing their network. In order to impose rights against a reluctant landowner, the operator must establish that the prejudice caused to the landowner by the imposition of those rights can be adequately compensated in money and that the public benefit of imposing the rights outweighs that prejudice.

In a recent decision, Cornerstone asked the Tribunal to impose an agreement conferring permanent Code rights to install and operate their apparatus on the roof of a building in Elephant and Castle, which was owned and occupied by the University of Arts London. Cornerstone needed a new site in the area having recently been ordered by the Tribunal to leave two other roof-top sites nearby for redevelopment.

The University had already entered into an agreement with a developer to construct a new building for them. Once the new building was completed, the University would sell its existing building to the developer but would remain in occupation under a three-year leaseback to give it time to fit out the new building before moving in. The first 18 months of this leaseback were rent-free, but then the annual rent would increase to £3,000,000. The University had the benefit of a break clause in the leaseback which enabled them to terminate it at any time. However, the break was conditional on the University delivering vacant possession of the existing building to the developer, specifically, free of telecoms apparatus. The significant hike in rent after 18 months created a strong incentive for the University to complete its fitting out works of the new building and exercise the break clause in the leaseback within that first 18 months.

The price of prejudice

It was accepted by both parties that if Code rights were imposed, the University would need to terminate those rights and successfully remove Cornerstone’s apparatus before it could deliver vacant possession. Since Cornerstone would have security of tenure under the Code, and hadn’t left its previous buildings voluntarily without a court order, the University argued it would probably have to litigate to obtain possession. It argued that it would have to follow the 18 month notice procedure in the Code and obtain an order from the Tribunal to terminate the Code rights on one of the statutory grounds and then separately secure an order for removal. There was no guarantee how long that would take and it was likely that the University would be unable to exercise the break in the leaseback at 18 months, which would have significant financial repercussions.

The University also argued that the consequences of litigation would be unpredictable and damaging to their reputation. In the worst case scenario, if the University was not able to deliver vacant possession at the end of the three year term of the leaseback, it argued that the developer could seek an injunction against them. The University’s position was that their prejudice was unquantifiable and could not be compensated by money. Further, the public benefit of imposing the Code rights did not outweigh that prejudice.

Cornerstone argued that that there was a chance the development of the new building would be delayed and in any event, the University would be able to obtain the various orders under the Code to require them to remove their apparatus. Any prejudice suffered could be compensated and would not outweigh the public benefit.

The Tribunal found in favour of the University: there was a real risk of litigation (both under the Code to remove Cornerstone and from injunctive proceedings by the developer), which would create stress, uncertainty, reputational damage and could harm the University’s relationship with the developer and its students. The Tribunal acknowledged that the prejudice must be “very high indeed” to outweigh the competing public benefit, “but there comes a point when it is too much to ask”. In this case, impeding the University’s ability to perform its pre-existing contractual obligations would reach that threshold. As such, the Code rights were not imposed.

Cornerstone Telecommunications Infrastructure Ltd v University of The Arts London [2020] UKUT 248 (LC), The Upper Tribunal (Lands Chamber)

Posted in Real Estate News

UK COVID-19 – The FCA Business Interruption Test Case ruling – the end of the ‘Covid clause’ in leases?

This week the High Court has delivered its eagerly anticipated ruling in the FCA Business Interruption Test Case. The case was brought by the Financial Conduct Authority on behalf of business interruption policyholders, with the aim of determining issues of principle on coverage and causation under a series of sample policy wordings.

Whilst of broad significance for all those whose businesses have been affected or interrupted by COVID-19, the judgment does not specifically address the question which many owners of real estate have been asking in the context of their leases:

  • Can landlords make any recovery under ‘loss of rent’ insurance policies, where tenants have failed to pay rent but this is not linked to physical damage/destruction of their premises?

The judgment does, however, have the potential to influence some of the negotiations which have been occurring between landlords and tenants in recent months, particularly around requests for so-called ‘Covid clauses’. With the spectre of further lockdowns (whether local or national) continuing to loom, such clauses are still being sought by tenants keen to secure either suspensions or reductions in rent in the event of an inability to trade or work from their premises. The negotiation of these clauses is fraught with difficulty: Should they cover only COVID-19 or also any future pandemic? Should they be triggered by government-issued guidance or only by legislation? The test case ruling doesn’t help to answer those questions directly, but in providing more certainty around the scope for successful insurance claims – and therefore the risk profile for each party – it does potentially alter the landscape going forward.

For occupiers of real estate, the key question has been:

  • Can tenants make any recovery under business interruption policies, to cover rent which they have had to keep paying even while they have been unable to occupy or trade from their premises due to lockdown restrictions?

In this regard, the judgment is complex, addressing cover for COVID-19 related claims under 21 different sample policy wordings, and does not lend itself to easy conclusions. Our insurance team have reviewed the judgment in detail and their headline analysis can be read here.  Although there were ‘wins’ for each side on the case, it is clear that at least some business interruption policies -depending on the specific wording – would be construed widely enough:

  • To cover not only the effects of local occurrences of notifiable diseases but also a wider ‘national’ peril
  • To be triggered not only where government action has the force of law but also, in some cases, by government ‘advice’
  • To pay out in respect of ‘hindrance of use’ even where complete prevention of access does not occur.

The critical upshot is that the outcome in each case turns on the effect of specific words and phrases within the various clauses considered by the court. Also (for certain clauses) it turns on the nature of the business conducted by the policyholder and how it was affected by COVID-19 and the various government measures. But in summary, it is fair to say that there is at least a gateway to insurance cover under a broad range of wordings. Whether landlords and tenants will have the capacity and inclination to investigate their particular policies in detail when negotiating Covid clauses, and whether the balance of negotiating strength will tilt in favour of landlords as a result of this ruling, are matters which remain to be seen.

 

 

Our interactive tracker is a single point of reference for you on COVID-19 real estate specific matters across our global practice. It lets you view relevant guidance and changes to legislation for each country and it also allows you to compare information across different jurisdictions:

 

COVID-19 Global Real Estate Interactive Map:
Government Response Tracker

https://www.engage.hoganlovells.com/knowledgeservices/covid-19-real-estate-developments

 

For material that will help you run your business, as well as details of our business continuity planning, our COVID-19 Topic Centre houses all  of our resources on the topic – from crisis leadership to supply chain.

Key real estate contacts

Daniel Norris, Global Head of Real Estate

Mathew Ditchburn, Head of Real Estate Disputes

Hannah Quarterman, Head of Real Estate Planning