6th April, 2020

Where does my commercial lease agreement stand under lockdown?

With many businesses forced to shut as a result of the coronavirus pandemic, some are beginning to wonder if they can afford to pay rent on commercial lease agreements they’re not seeing value from. So, we asked an expert.

Since the Christchurch earthquakes the Auckland District Law Society (ADLS) form of lease has contained ‘no access’ in emergency clauses whereby tenants who are unable to gain access to the leased premises can seek ‘fair’ rent and outgoings abatement for the period of the lockdown.

The key questions are:

  1. Do these emergency clauses apply while NZ is in at COVID-19 Alert Level 4 and possibly Alert Level 3?
  2. How much rent and outgoings are payable by tenants during the lockdown period?
  3. Will this be covered by the indemnity insurance cover for loss of rents and outgoings?

Does the ‘no access’ emergency clause apply?

The most common standard form of commercial property lease in New Zealand – the Auckland District Law Society (ADLS) deed of lease – includes a ‘no access in emergency’ clause added in 2012 in response to the Christchurch earthquakes.

In the aftermath of the quakes, many buildings were cordoned off and tenants were unable to access their premises or conduct business from them but were still legally required to pay rent.

The wording of the standard clause states:

‘27.5 If there is an emergency and the tenant is unable to gain access to the premises to fully conduct the tenant’s business from the premises because of reasons of safety of the public or the property or the need to prevent, reduce or overcome any hazard, harm or loss that may be associated with the emergency.’

“The term ‘emergency’ is defined in clause 47.1(d) and covers a range of different emergency scenarios including eruptions, tsunamis, floods as well as epidemics and contamination that may cause loss of life or illness and such an event is not due to the act or omission of the landlord or tenant. It can certainly be argued that COVID-19 fits into this definition,” said Bret Gower, commercial law specialist and solicitor at Smith and Partners.

“If activated, then ‘a fair proportion of the rent and outgoings shall cease to be payable’ for the period during which the tenant is unable to ‘gain access to the premises to fully conduct the tenant’s business’ and is effective from the commencement of the emergency,” he said.

What is ‘fair’ amount to not pay?

The million-dollar question is what is considered ‘fair’ rent and outgoings abatement.

It’s only natural that landlords and tenants will have differing views.

Landlords may also attempt to do their best by their tenant by cutting all non-essentials services to reduce the outgoings for insurance and rates and passing on any relief provided from third parties.

“Particular circumstances will also be relevant and should be carefully considered on each occasion, although either party’s individual financial circumstances should not be considered as relevant to the leasing contract,” said Gower.

“It may be up to the courts to give some guidance in the future, but in the meanwhile it is encouraged that any arrangements made should be done on a without prejudice basis to further negotiations.”

Termination due to standard ‘no access’ period

Under clause 27.6 of the current ADLS standard lease, either party can terminate the lease by notice if the tenant is unable to gain access to the leased premises for a certain period due to an emergency.

The standard no access period under the ADLS lease is nine months. Because the parties are free to negotiate the length of the no access period, it is important to check the previously agreed period under the relevant lease.

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Other forms of commercial lease

Earlier versions of the ADLS lease and many other forms of commercial leases do not contain the ‘no access period due to an emergency’ clause.

This means that tenants under such leases would likely be expected to continue to pay rent and outgoings in full during the lockdown period.

“Despite this, it’s not difficult to foresee tenants feeling the financial strain during this unprecedented period may nevertheless attempt to negotiate with landlords the amount payable under their respective leases, and it might be arguable that some relief is reasonable depending on the circumstances,” said Gower.

“Any change in the payable amount will require agreement of both parties.”

What happens if I can’t fulfil my lease obligations?

“A tenant wanting to avoid payment under the lease may attempt to argue frustration of the lease (as in, due to the lockdown),” said Gower.

This might be achievable when performing the lease has become impossible or radically different from what the parties previously agreed, but the lockdown may not quite qualify in this situation.

“The temporary nature of the lockdown likely means that this would not constitute a frustration event.

“Because of the high threshold required for arguing frustration, careful consideration should be given before making this assertion.”

Whether a tenant can rightfully avoid their lease obligations would also depend on the specific terms of the lease. An example of this is a ‘force majeure clause’.

A force majeure clause enables a party to be excused from performing certain obligations or enables the lease to be terminated if stated specific events were to arise.

“It’s therefore important to check whether the specific events (for example, acts by governmental authority or epidemics) described in a force majeure clause would enable a party to avoid certain lease obligations or terminate the lease,” Gower explained.

Am I at risk of eviction if I can’t afford rent?

If, despite their best efforts, tenants are unable to pay rent and outgoings and cannot come to a mutual agreement with their landlord, the landlord may choose to start eviction proceedings.

Once a notice is issued, the tenant normally has 10 working days to remedy the default. If the tenant doesn’t remedy the breach, the landlord has the power to evict them.

“However, in my view it’s not clear if the non-payment of rent in these circumstances, will be considered to be a breach of the lease,” said Gower.

“Landlords also need to weigh up the benefit of choosing eviction over abatement. They should take into consideration the value of the lease and period outstanding to determine if it’s worth pursuing in the courts as this isn’t a quick fix nor a guaranteed win.”

Can I consider using business interruption insurance?

A Business Interruption (BI) insurance policy works in conjunction with the primary Material Damage (MD) policy.

A BI policy is often referred to as a ‘Consequential Loss policy’ meaning it will activate after a loss has been paid (or covered) under the Material Damage policy.

The first prerequisite for a BI claim, is a claim under the MD policy for loss or damage to the assets insured (buildings, plant, equipment, stock and so on).

If, as a result of such damage, the business suffers a loss of revenue or increased costs, then the BI policy kicks in.

In the case of an infectious disease such as COVID-19, there has not been any damage to an insured item under the MD policy so, without this component, there is no trigger for the BI policy to respond to.

Where to from here?

Ultimately, the leases need to be carefully reviewed in each case in order to determine the extent of the obligation to pay and whether parties wanting to terminate their lease can in fact rightfully do so.

Obviously matters of goodwill and a tenant’s ability to pay are very relevant. At the same time, landlords would naturally be wary of tenants attempting to take commercial advantage during this lockdown period.

“The best place to start is referring to the terms of your lease agreement and then opening a dialogue with your landlord about the amount of the rent and outgoings payable in the coming months,” said Gower.

“It’s important that you do not simply refuse to pay the rent or you could be deemed to have repudiated the lease and the landlord may be entitled to claim damages that flow from that repudiation.”

If you have any questions or concerns relating to your lease obligations arising from the outbreak of COVID-19, please contact your legal advisor or reach out to Bret Gower and the team at Smith and Partners.