Time to Redress the Shopping Centre Leasing Power Imbalance
There is no doubt that many small businesses in major shopping centres are currently in a difficult financial position.
Flat or declining sales, serious margin compression and, according to a recent report by the UBS Evidence Lab, a 15 per cent drop in shopping centre visitor numbers combine with the pressures of increased rent, wages (notably penalty wages), utility costs and overheads to squeeze small business profitability.
In already difficult circumstances, shopping centre landlords often make the situation worse, with excessive rental increases and abuse of market power, in particular, causing substantial financial hardship for franchisees and franchisors.
By mandating excessive rental increases, particularly at the end of term when the tenant is at its most vulnerable, landlords can take advantage of the substantial information imbalance and the vulnerability of the tenant to extract an unreasonable rental increase that has no regard for the viability of the business at the location.
The abuse of market power to continually add new competitors to the shopping centre consistently and negatively impacts the revenue of existing tenants with no offer of rental abatement.
The essence of the problem is the captive nature of the business relationship, which enables landlords to require vulnerable small businesses to commit to contractual arrangements that are open to abuse.
Tenants are required to commit to high rentals with relatively short lease terms (five years is common), often with automatic annual rent increases (five per cent is standard, and usually above CPI), yet landlords retain the right to add new competitors that reduce business revenue without compensation. Landlords can exploit their superior bargaining power, armed with detailed information collected from tenants (and competitors) that enables them to know precisely how much rent the tenant can afford to pay. On the other hand, tenants have little or no access to market information and no bargaining power.
This dynamic is particularly harmful in circumstances where a tenant is renewing their lease, and the alternative to accepting a landlord’s rent offer is to walk away and sacrifice the significant sunk costs involved in establishing the business. Despite this harsh paradigm, franchisors have a limited capacity to influence landlord behaviour. Ultimately, landlords are not regulated to the same extent as franchisors, nor scrutinised as closely by the media, so are less accountable for hard-nosed business practices.
Given the severe pressure our retailers are facing in the current environment, now is the time to look at reforming the regulatory regime for shopping centre leases, to recalibrate a broken system and protect vulnerable retail tenants.
Against this backdrop, it was no surprise that when the FCA recently surveyed members about their current economic and business issues, leasing was highlighted as one of the top business challenges members are currently facing.
The case for a Retail Leasing Code
The FCA is concerned about the critical level of pressure unfair commercial leasing arrangements and exorbitant rental increases are having on small businesses operating in the retail sector. While traditionally a state government issue, the power imbalance has created a competition issue that the FCA believes needs to be remedied by a sector-wide code of conducted implemented at a federal level
To that end, the FCA proposes the development of a voluntary Retail Leasing Code that applies to landlords and tenants or representative organisations that are signatories to the code under the legislative framework provided by the Competition and Consumer Act (CCA).
Industry-specific regulation can be achieved very effectively and efficiently under the industry code framework overseen by the Australian Competition and Consumer Commission (ACCC). The ACCC is well placed to oversee the operation of a shopping centre leasing code and has previously expressed its concerns about unconscionable conduct and unfair contract terms in retail leasing.
The content of the code would be developed as part of the consultative process involving all key stakeholders. However, it would need to address the key identified concerns, including:
- The significant and unfair financial impact on sitting tenants if competitive offerings are added. One proposal is for tenants in major shopping centres to be allowed to exit their lease without penalty by giving three months’ notice in the event that the landlord introduces a new tenant that materially competes with the existing tenant.
- End of term arrangements that result in substantial rental increases for sitting tenants, in circumstances where the tenant has no real option but to continue, need to be addressed. Similarly, some form of hardship relief needs to be offered to sitting tenants whose business is no longer viable.
- Measures to address the massive information imbalance between landlords and tenants, possibly by prohibiting landlords of major shopping centres from collecting, acquiring or distributing information on turnover and profitability of tenants.
- The introduction of a dispute resolution procedure similar to the Franchising Code of Conduct would be a welcome tool in allowing tenants to openly discuss their concerns with landlords without the expense and inefficiency of litigation.
The proposed code would also aim to increase transparency and reduce compliance costs for landlords and tenants by using consistent national disclosure and occupancy documents.
The code would intend to overlay additional protections on the existing state regimes, which would apply only to the specific sub-market of major shopping centres. The code would compliment and enhance existing state laws by adding a higher benchmark for the major shopping centre landlords and addressing some of the unique issues in that field. The application of the code could be limited to shopping centres, or landlords, of a certain scale.
What can the franchise sector do?
The introduction of new regulation to address the power imbalance within major shopping centres will be a difficult task and is unlikely to be achieved without a considerable commitment from all stakeholders and Government. Any move towards higher regulation within the sector is likely to face resistance from the major landlords and their lobby groups, as it will undermine a protective business model which embeds profitability.
However, the current system is broken, and the status quo needs to be disrupted. Franchisors can support initiatives to change the rules by engaging with the Franchise Council of Australia in their work advocating for reform in this field.
In the meantime, both franchisors and franchisees should consider more closely scrutinising the proposed lease terms offered by shopping centre landlords and avoid short-term benefits offered by landlords (such as fit-out contributions) at the expense of long-term viability. Landlords should be asked to provide assurances as to tenancy mixes and exclusivity, or an option to terminate without consequence in circumstances where the landlord introduces competitor businesses. In addition, caps on rent increases for renewal terms ought to be contemplated.
Ultimately, if reasonable lease terms cannot be reached with the landlord, franchisors should reconsider whether the risk of placing a franchisee into a shopping centre lease is too high to bear.