Under the Alert Level 4 lockdown, many businesses are prohibited from accessing their premises. Some leases suspend a “fair" proportion of rent and outgoings while the tenant is unable to gain access. But how do landlords and tenants calculate a fair amount?
Prevention of access under the ADLS lease
One of the common leases used for many commercial leasing arrangements in New Zealand is the Auckland District Law Society lease (ADLS lease). Following the Christchurch earthquakes, the lease was updated to deal with situations where a tenant cannot access the premises because of an emergency. The lease defines “emergency" as including an epidemic. Although the lease wasn't drafted with COVID-19 in mind, it clearly includes this epidemic.
In addition to an emergency, clause 27.5 also requires the tenant to be “unable to gain access to the premises to fully conduct the tenant's business" for a number of specified reasons, including a “restriction on occupation of the premises by any competent authority". In our view, this has been satisfied in respect of non-essential businesses by the order made by the Director-General of Health under section 70(1)(m) of the Health Act 1956. That order requires “all premises" to be closed, other than “premises necessary for the performance or delivery of essential businesses" as described on the government's essential services list.
What is a “fair" proportion?
As a consequence, clause 27.5 of the ADLS lease provides that “a fair proportion of the rent and outgoings shall cease to be payable" for non-essential businesses. While the ADLS lease also contains a standard provision stating that rent must be paid without set-off or deduction, this is not applicable in circumstances where clause 27.5 applies, as that clause operates in its own right to reduce the rent payable (without the need for a set-off or deduction).
But what is a “fair" proportion, and how is it calculated? There is no definition or guidance in the ADLS lease itself. There is also no case law on this clause, therefore there is no guidance from the courts to assist.
The ADLS has said that the reference to a “fair" proportion in clause 27.5 was taken from the partial damage and destruction provisions of clause 27.3. This clause applies if the premises are damaged but not untenantable and insurance money is available to repair the damage. It provides that a “fair" proportion of the rent and outgoings shall cease to be payable from the date of damage until the repairs are completed. But again, this clause gives little guidance to as to how to assess what is “fair".
Tenants are likely to argue that:
Fairness must be assessed by reference to the extent to which the tenant is unable to access the premises to fully conduct its business, on the basis that clause 27.5 (twice) refers to the inability of the tenant to access the premises to fully conduct its business, and
the ability of the tenant to operate its business remotely is irrelevant.
However, landlords may respond that:
A “fair" proportion should be assessed by reference to the extent to which the tenant can still conduct its business without access to the premises (such as by working from home). This focuses on the effect of the government order on the tenant's business, rather than the effect of the order on access to the premises. A tenant may question whether that was the intention of the clause.
The word “fair" means that the parties must take into account, not only the effect on the tenant, but also the effect on the landlord. For example, if the landlord does not have loss of rent insurance (as is likely here, given the standard notifiable disease exclusion), a landlord could argue that this should be taken into account. This argument places a significant amount of emphasis on the word “fair", and less on the remaining terms of the clause.
In addition, other relevant considerations might include the extent to which the premises are still required by the tenant for the operation of its business (for instance because the business' network server is in the offices or its merchandise is being stored in the warehouse) or the necessity for certain building services to keep operating, such as a need for air conditioning to operate at certain times of the day even during Alert Level 4.
For essential businesses the position is more complicated. The business may only need to operate from some of its premises (in order to deliver or perform the particular service) or may only be using part of particular premises because of reduced numbers of staff working.
A landlord may argue that clause 27.5 of the ADLS lease does not apply to an essential business, because it is not prohibited from using the premises. However a tenant would argue that it is entitled to a rent and outgoings reduction for the premises that it is not operating from (or is only partially operating from) because it is only permitted to use premises to the extent necessary to deliver or perform an essential service.
In the absence of any existing guidance from the courts, we recommend that landlords and tenants seek to reach a commercial resolution as to a fair reduction in rent and outgoings. We are seeing many of our clients do exactly that, given the risks associated with coming out of the lockdown embroiled in a dispute as to how to assess what is “fair", as well as the associated impact on relationships.
Parties who cannot reach an agreement should consider facilitated negotiations or expedited mediations in order to resolve any dispute promptly and quickly. Arbitration and court proceedings remain as options, but these are likely to involve greater time and cost, as well as a degree of risk for both parties.
If you would like any advice on these issues, or assistance with resolving any dispute, please get in touch with the contacts listed, or your usual Bell Gully adviser.
To view our other COVID-19 related publications, click here.
To receive all Bell Gully's updates on COVID-19 you can subscribe here.
This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.