The effect of COVID-19 on commercial leases

24 Mar

Introduction

In the fight against COVID-19, the Government escalated the alert level to 3 on 23 March 2020. 24 hours later, at 11.59 pm on 25 March, the alert level was escalated to level 4, forcing educational facilities and ‘non-essential’ businesses to shut their doors.

This article considers the effect of COVID-19 on commercial leases, with specific reference to the Auckland District Law Society form of deed of lease (ADLS Lease).

No access in emergency

Clause 27.5[1] was inserted into the ADLS Lease in 2012 (after the Christchurch earthquakes), and states:

“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 property or the need to prevent reduce or overcome any hazard, harm or loss that may be associated with the emergency including[2]:
(a) a prohibited or restricted access cordon applying to the premises; or
(b) prohibition on the use of the premises pending the completion of structural engineering or other reports and appropriate certifications required by any competent authority that the premises are fit for use; or
(c) restriction on occupation of the premises by any competent authority,
then a fair proportion of the rent and outgoings shall cease to be payable for the period commencing on the date when the Tenant became unable to gain access to the premises to fully conduct the Tenant’s business from the premises until the inability ceases.”

In summary, for clause 27.5 to apply there are three elements that must be satisfied:

there must be an emergency;
the tenant must be unable to gain access to the premises to fully conduct the tenant’s business from the premises; and
that inability must be because of reasons of safety of the public or property or the need to prevent, reduce or overcome any hazard, harm or loss.

We consider each of those elements below.

Element 1: Is COVID-19 an emergency?

The term ‘emergency’ is defined in clause 47.1(d), as follows:

“emergency for the purposes of subclause 27.5 means a situation that:
(1) is a result of any event, whether natural or otherwise, including an explosion, earthquake, eruption, tsunami, land movement, flood, storm, tornado, cyclone, serious fire, leakage or spillage of any dangerous gas or substance, infestation, plague, epidemic, failure of or disruption to an emergency service; and
(2) causes or may cause loss of life or serious injury, illness or in any way seriously endangers the safety of the public or property; and
(3) the event is not caused by any act or omission of the Landlord or Tenant.”

Our view is that COVID-19 meets this definition of ‘emergency’ given that it:

is an epidemic[3];
has caused loss of life and serious injury; and
was not caused by any landlord or tenant.

Element 2: Is the tenant unable to gain access to the premises to fully conduct the tenant’s business from the premises?

The measures which apply for alert level 4 are:

people instructed to stay at home;
educational facilities closed;
businesses closed except for essential services (e.g. supermarkets, pharmacies, clinics) and lifeline utilities;
rationing of supplies and requisitioning of facilities;
travel severely limited; and
major reprioritisation of healthcare services.

While a premises may still physically be able to be accessed, in the case of educational facilities and non-essential businesses, the tenant is required by the Government to close. The example in 27.5(c) of a “restriction on occupation of the premises by any competent authority” clearly anticipates a scenario where the premises is physically accessible but prohibited by Government or another authority.

This element is unlikely to be satisfied where the tenant is an ‘essential business’.

Element 3: Is that inability because of reasons of safety of the public or property or the need to prevent, reduce or overcome any hazard, harm or loss?

The Government has clearly escalated New Zealand to alert level 4 for reasons of safety of the public (and to prevent, reduce and overcome harm).

What is a fair proportion?

If clause 27.5 does apply, a fair proportion of the rent and outgoings shall cease to be payable by the tenant until the tenant is able to regain access to the premises to fully conduct the tenant’s business from the premises. The ADLS Lease does not specify how the ‘fair proportion’ is to be calculated. We think it is likely to depend on the particular situation taking into account factors such as:

that COVID-19 is outside of the control of, and not caused by, the landlord or tenant;
the extent that the tenant is continuing to use the premises (e.g. to store its possessions or advertise its business); and
that the landlord is unable to use or re-lease the premises in the meantime.

Ideally, the landlord and tenant will agree what constitutes a fair proportion. If an agreement cannot be reached, the dispute resolution process in clauses 43.1 to 43.4 of the ADLS Lease will apply. If the dispute is unable to be resolved by mediation or other agreement within 30 days of the dispute arising, the dispute will be determined by arbitration.

Termination

Clause 27.6 states:

“This subclause 27.6 applies where subclause 27.5 applies and the premises or building of which the premises form part are not totally or partially destroyed or damaged resulting in the lease being cancelled as provided for in subclauses 26.1 or 27.4. Either party may terminate this lease by giving 10 working days written notice to the other if:
(a) the Tenant is unable to gain access to the premises for the period specified in the First Schedule; or
(b) the party that terminates this lease can at any time prior to termination establish with reasonable certainty that the Tenant is unable to gain access to the premises for that period.
Any termination shall be without prejudice to the rights of either party against the other.”

Government has advised that alert level 4 will last for at least four weeks, although it may continue for longer than that. At this stage, it seems unlikely that a lease will be able to be terminated on the basis of clause 27.6(b), unless the no access period has been shortened to 4 weeks (the default no access period is 9 months[4]). This may change as the likely duration of alert level 4 becomes foreseeable.

Other forms of lease

Where the lease is based on a pre-2012 version of the ADLS Lease, or another form of lease which does not contain a clause similar to clause 27.5, it may be worth considering an argument that the lease has been frustrated on the basis that the restrictions imposed by alert level 4 make performance of the lease impossible or radically different to what the parties had agreed. The effect of a contract being frustrated is that it is automatically terminated.

Due to the high thresholds of ‘impossible’ or ‘radically different’ a contract is not easily frustrated and the consequences of a lease being frustrated (i.e. termination) may not be in the interests of the landlord or tenant.

Way forward

We think the best outcome will be achieved through early communication and give and take on both sides. In most cases, it will be in the landlord’s interests to assist the tenant so that it can resume trading after the alert level drops. Similarly, the tenant will need a premises to operate from going forward.

The effect of COVID-19 on a commercial lease will depend on the surrounding circumstances and the nature of the tenant’s business (as well as the terms of the lease). Even if your lease is based on the ADLS Lease, we recommend that you take specific advice. If you would like advice about the effect of COVID-19 on your lease (as tenant or landlord), or you would like our assistance with another legal matter you are facing, please contact your usual point of contact at Kemps Weir or contact us here.

Disclaimer: This publication should not be construed or acted on as legal advice. It is brief and general in nature. Specific advice should be sought.

[1] Clause references are from the ADLS Lease (Sixth Edition 2012(5))

[2] A reference to the word “including” is to be interpreted without limitation (refer to clause 47(r))

[3] In any case, the list of ‘events’ in clause 47.1(d)(1) is not exhaustive (refer to clause 47(r))

[4] Clause 15(1) in the First Schedule

Mike Kemps