COMMERCIAL LEASES AND COVID-19 – WHERE ARE WE AT?

30 Apr 2020

There has been a lot of “chatter” around how COVID-19 will affect what is payable under the various lease forms that exist throughout New Zealand – ranging from bespoke to standard printed form leases (the PCNZ and the ADLS Lease being the most common). This chatter effectively started as soon as the initial restrictions were announced – with some major tenants announcing they would not pay rent while access was restricted.

Landlords and tenants were therefore immediately undertaking a detailed analysis of their leases to see if any “no access” provisions formed part of the terms – to (in either case) make an assessment of their obligation to make and/or receive rent and opex under the lease during any restricted access period. 

From the numerous discussions we have had with landlord and tenants, we can report that there have been numerous (and varied) approaches taken by both landlords and tenants.  The large majority however appear (notwithstanding what form of lease may be in place) to be coming up with ‘sharing’ solutions which will allow both parties to come out the other side.  We believe this is a sensible approach as both parties need each other – the tenant (generally) needing immediate support and the landlord needing a tenant when the restrictions are lessened/removed.

Whilst this is the commercial approach taken by many parties, we think it remains vital that both parties are aware of the contractual position when entering into such discussions. Key considerations include:

  • The position around payment of rent and open during a lockdown.
  • If an abatement is possible – how much should this be and how long should it apply?
  • If a “fair proportion” is referenced, how is this to be determined ?

Where a lease doesn’t include a “no access” provision the strict contractual position is that no form of tenant relief is required.  That is not to say landlords are refusing to offer relief in such circumstances – as the commercial reality can dictate otherwise.

The majority of discussions in mainstream media and legal/property publications have centred around the ADLS “no access” provisions.  The majority of our comments will therefore address this provision and how it could be interpreted in the current scenario – and as the Alert Levels are reduced.  We will also touch on the PCNZ retail lease and address bespoke leases (and earlier ADLS versions) which do not contain “no access” provisions.

ADLS Lease

Access Specific Interpretation

This interpretation centres entirely around accessibility. If the property is simply unable to be accessed by the tenant (the Alert Level 4 lockdown being the perfect example) then a full abatement of rent and outgoings should apply.  Taking this position one would argue that the factors noted below (around determining a fair proportion) simply don’t come into play as the clause is simply access based.  Tenants will argue that they suffer the most in the current circumstances and that the clause is designed to provide much needed relief (where revenue drops and expenses (such as wages) remain).  For many tenants there will not be much difference in Alert Level 3.

The Subjective Assessment Approach (“SAA”)

The SAA takes the view that whilst clause 27.5 is about access, the “fair proportion” reference requires that a subjective assessment based on the particular circumstances be undertaken.  One might also put forth that a “proportion” cannot mean 100% as “proportion” (by definition) means a part of something i.e. it cannot be all or nothing.  That argument may or may not be sustainable.  The SAA  would look to factor in a number of variables (for both landlord and tenant) to come out with the relevant percentage.

Factors that may be considered include the following:

  • Remote working – does the tenant have an ability to work remotely and generate income – potentially relying on equipment based in the premises.
  • Storage – tenants store equipment/materials etc in the premises during any period of no-access, which could be considered of value.
  • Use – some tenants will continue to generate income from the premises, which will in a large part be unaffected by the lockdown e.g. a storage facility.  As noted above, other uses will be able to continue to work remotely e.g. accountants, lawyers.
  • Financial position – the respective financial position of each party – essentially the ability of each party to suffer financial pain – to include the potential implications where a tenant may simply have no funds and a landlord who is very highly leveraged and exposed to non-payment of rent on commercial property (or to the impacts of COVD-19 in general). 
  • Outgoings – many items of opex will continue to be payable.  It is arguable the tenant will receive an ongoing benefit from payment of some items e.g. rates, insurance, service maintenance contracts. 
  • Insurance — the fact that a pandemic is not an insurable risk.  Who should bear the risk in such circumstances or where such an uninsurable event occurs should the pain be shared?

Initial Positions

From what we have seen to date, it is very rare for a full rental and opex abatement to be provided – however we must note that some parties are agreeing interim positions which are not set in stone.  It is not entirely out of the question that a court could interpret clause 27.5 as being access specific, however at this point in time the majority view would appear to be that whilst the clause is about access, the reference to “a fair proportion” requires that each case be considered on its merits.

The Government has enacted several measures to look to address the financial position of each party (e.g. wage subsidy, reintroduction of depreciation etc), however the initial feedback is that these measures do not go far enough.  Such measures do not (of course) affect the contractual position under the lease, however it is still a case of watch this space as the Government’s response is rapidly evolving.

Moving to Alert Level 3

Whilst welcomed by most, this will provide further challenges as many tenants (in particular food and retail) will be doing all they can to recommence trade (on a limited basis, as there cannot be any customer contact). This will (again) force the parties to consider what a “fair proportion” is in the revised circumstances.  It may be a case of the landlord needing full disclosure of the tenant’s sales figures to assess how trading under restriction plays out – as it is certainly possible that tenants will find the going tough in Alert Level 3.

The logical view would however be that where parties have been able to reach agreement on Alert Level 4 relief, that it should be easier to agree what is payable under Alert Level 3. Again, this will likely be based on the parties acting reasonably and looking to ensure each is doing what it can to ensure the relationship continues. 

Alert Level 2 and below

Whist distancing restrictions and restrictions on social and leisure activities remain, it’s likely that a large number of businesses will be operational – and have full access to the Premises to fully conduct the tenant’s business.  Some tenants may be able to claim they remain unable to “fully conduct” their business.

Property Council of New Zealand Leases

The No Access clause in the PCNZ retail and commercial leases that have been in place for some years is similar in effect to the ADLSi commercial lease in referring to a “fair proportion” of rent and opex being abated in the event of a lack of access in the operation of an emergency but the critical difference is that the Landlord is obliged under those forms of lease to allow abatement only where the Landlord is able to claim under its loss of rents policy for such abated rent.  All loss of rents policies these days, as far as we are aware, specifically exclude the impact of epidemics, so the clauses do not offer the Tenant relief.  PCNZ does recommend tenants and landlords negotiate in good faith to determine what is a “fair proportion” of rent to abate (in circumstances where there is a clause that does apply in the current circumstances), and (where there is not) to still take a considered approach to payment of rent and opex during these restricted access times based on the continued viability of both parties’ businesses.

Summary

Rather than parties seeking to argue over strict legal interpretation, a pattern is emerging of the majority wanting to agree a ’joint’ way out of this – essentially agreeing to share some of the pain to ensure both come out the other side.  In order to do this parties are getting creative around the packages that can be put together, examples being:

  • Rent and opex abatements – some in return for tenants exercising renewals or agreeing extended term;
  • Payment deferrals and lengthy repayment periods (mostly with no interest charges)
  • Interim rents and a wait and see approach.

Remember:  Every situation will be different and have its own complexities and we are available to guide you through these matters as and when necessary.