Arbitration of Covid arrears: How will it work?

First principles

There are two fundamental tenets to the scheme:

1. The arbitrator must seek to preserve (or, if necessary, restore and preserve) the viability of the tenant’s business, so far as that is consistent with preserving the landlord’s solvency.
2. The tenant should be required to meet its rent payment obligations in full and without delay, but only if this is consistent with the first principle.

Tenant’s viability

In view of the almost-infinite number of relevant businesses, sectors, and profit models, the draft legislation sensibly refrains from venturing a definition of “viability”.  Whilst some assistance can be drawn from the updated Code of Practice published by the Government in November, which suggested looking at whether the tenant’s business “has, or will in the foreseeable future have, the means and ability to meet its obligations and to continue trading”, the latest guidance leaves the matter very much in the hands of the arbitrator.

The latest guidance suggests that the arbitrator should have regard to the following factors when assessing a particular tenant’s viability:

1. The tenant’s assets and liabilities, including any other tenancies held.
2. Previous rental payments made under the immediate tenancy.
3. The impact of the Covid-19 pandemic on the tenant’s business.
4. Any other appropriate information relating to the tenant’s financial position.

The arbitrator may consider (and may request from the tenant) a broad range of supporting information as part of this exercise. For instance, conclusions may be drawn from:

• Bank statements
• Financial and management accounts
• Profit margins
• Dividend records
• Credit applications (and particularly refusals)
• Tax demands
• Money judgments
• Financial grants and loans.

The arbitrator must disregard the possibility of the tenant borrowing money or restructuring their business and should also specifically ignore the pandemic arrears themselves from the assessment.

Landlord’s solvency

Under the draft Bill, a landlord is considered “solvent” unless it is – or is likely to become – unable to pay its debts as they fall due. This entails an assessment by the arbitrator of the landlord’s assets and liabilities – including any other tenancies to which the landlord is a party – and any other information relevant to the landlord’s financial position.

Presumably, the inclusion here of “other tenancies to which the landlord is a party” is to consider whether the landlord has the benefit of other income streams that would off-set any arrears written off by the arbitrator. However, if a landlord has many tenants in its portfolio who would all individually qualify for relief via the scheme, that collective write-off could have a serious effect on the landlord’s solvency. It is unclear from the current guidance whether this can, or will, be taken into account by the arbitrator as part of his or her assessment.

Again, the arbitrator must disregard any possibility of the landlord borrowing money or restructuring its business to improve its solvency prospects.

Perhaps unsurprisingly, the arbitrator must also disregard anything that either party has done to manipulate their financial affairs to put themselves in a better position for the purposes of the arbitrator’s assessment.

What can the arbitrator award?

“Relief from payment” under the draft legislation includes:

1. Writing off all or part of the debt.
2. Giving the tenant time to pay, including by way of instalments.
3. Reducing or writing off any interest payable on the arrears under the terms of the lease.

These options are not mutually exclusive. For example, the arbitrator can write off half of the protected debt and allow the tenant to pay the remaining half by way of instalments. Where the tenant is given time to pay, this cannot be more than 24 months from when the arbitrator’s award is made.

The arbitrator cannot revisit agreements already concluded between the landlord and the tenant in relation to protected rent. They will, however, have jurisdiction over (i) money claims issued by landlords after 10 November 2021, and (ii) money judgments obtained by landlords from that date. If an arbitrator awards relief in those circumstances, the judgment debt will be reduced accordingly.

Comment

There is plainly an imbalance between the interests considered by the arbitrator when examining protected rents. The tenant’s “viability” requires only that the tenant can continue trading and will vary enormously from sector to sector. Arbitrators will therefore be required to make value judgments when assessing the tenant’s financial position, and it would be reasonable to assume (given the purpose of the legislation) that tenants will likely receive the benefit of any doubt. By contrast, a landlord’s solvency will be called into question only if it can no longer pay its debts as they fall due – a far stricter, and more binary, financial test, and one that may make it difficult to resist a tenant’s proposals for relief.

Further notes will be published in due course on the many other legal and practical aspects of the new scheme.

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