COVID-19 - Commercial lease update - the operation of leases under Alert Level 3
As businesses continue to struggle with the economic impacts of COVID-19 the situation has evolved since our previous article on how commercial leases operate under COVID-19. We now know that New Zealand will return to Alert Level 3 on 28 April 2020 for at least a 2 week period before the Alert Level is reviewed again.
Leases will operate differently under Alert Level 3. In this update, we set out information on:
A summary of the support measures currently offered by the Government for commercial landlords and tenants.
Our thoughts on how leases will operate under COVID-19 Alert Level 3.
What level of rent and outgoings abatement would be fair under Alert Level 3 (if any).
As ever, how each lease will operate will ultimately depend on the wording of the lease itself and the circumstances of the parties.
The Government support package
In our opinion the measures announced by the Government on 15 April 2020 to support commercial landlords and tenants did not go as far as they should have. The measures included:
The notice period for a landlord to cancel a lease will be tripled from 10 working days post-service to 30 working days. i.e. tenants have more time to catch up on overdue rent and outgoings payments
The notice period for banks to initiate mortgagee sale proceedings has double from 20 working days to 40 working days for mortgaged land, and from 10 to 20 working days for mortgaged goods. i.e. landlords have more time to catch up on overdue mortgage payment
The introduction of a tax loss carry-back scheme which will allow a business to offset a loss in a particular tax year against a profit in a previous year and receive a refund of the tax paid in the previous profitable year.
We do not believe that measures will offer much in the way of immediate cashflow support to tenants who are struggling to meet their commitments under leases. We do note the comments of the Minister for Small Business on 18 April 2020 that a further assistance package may be incoming, possibly in the Government’s annual Budget due to be delivered on 14 May 2020.
Given the current lack of a silver bullet in the form of a government subsidy, the choices for landlords and tenants remain the same: you either take opposing positions as to how your lease should be interpreted or enforced, or you come to a commercial agreement you can both live with.
What does Alert Level 3 mean for commercial leases?
Alert Level 3 relaxes some elements of the lockdown. Perhaps the simplest way to look at it is that Alert Level 3 asks Kiwis to restrict their movement, rather than simply stop it. We are still asked to reduce contact with each other wherever possible, so many businesses’ ability to trade fully will remain affected.
The following restrictions will apply under Alert Level 3:
People are asked to stay at home in their bubble, other than for essential personal movement including going to work or school. People must however work from home and continue home-schooling where possible.
Workplaces and offices that are only accessed by staff without a customer function can only reopen if staff can’t work from home and the workplace can be operated safely following strict hygiene and physical distancing rules. The specific health and safety requirements will be detailed here. Clients will not be allowed to enter offices.
Retail and hospitality business can open their premises and trade, but customers cannot enter their stores. Only contactless delivery or pickup of phone or online orders (aka ‘click and collect’ or via a drive-through) will be allowed. Note:
Many liquor licenses for restaurants and bars require that alcoholic beverages are consumed onsite, rather than being allowed to be taken away. These laws remain the same under Alert Level 3, so bars with this sort of liquor licence won’t be able to sell liquor under Alert Level 3.
Malls and food courts are not allowed to reopen under Alert Level 3.
Businesses cannot offer services which require face to face or sustained close contact. Hairdressers, beauticians, masseuses, etc will therefore be unable to trade under Alert Level 3.
Supermarkets, dairies, and petrol stations remain an exception under Alert Level 3 and can have customers enter their premises.
Public premises (e.g. gyms, food courts, cinemas, food courts, etc) must remain closed under Alert Level 3.
The movement of goods by freight will be permitted provided contactless delivery is possible. Previously freight was restricted to essential goods only under Alert Level 4.
So, what does this actually mean for your lease? Do the Alert Level 3 restrictions allow for further rental abatements?
How a lease will operate under Alert Level 3 will depend on the lease’s specific wording. In general, there is an increased scope under Alert Level 3 to argue that because a tenant has an increased ability to operate, the tenant has a decreased entitlement to an abatement.
Let’s look at this argument now.
How do ADLS leases that contain a no-access clause 27.5 operate under Alert Level 3?
Clause 27.5 of a standard 6th edition ADLS lease provides that a “fair proportion” of rent and outgoings should be abated for as long as the tenant cannot access their premises to “fully” conduct its business due to an emergency.
In our opinion a tenant will continue to be legally entitled to a fair abatement of their rent and outgoings under Alert Level 3 if two limbs can be met:
There is an ‘emergency’ (we believe that an ‘emergency’ does still exist under Alert Level 3); and
The tenant is unable to access their premises to fully conduct their business because of that emergency.
Some, but not all tenants, will be restricted from accessing and fully operating from their premises under Alert Level 3. For example:
A retail, hospitality or service provider tenant will not be permitted to have customers inside its store until we reach Alert Level 2. Any such tenant which cannot operate contactlessly will therefore have to keep its premises closed and arguably will not be able to fully conduct its business. A retail or hospitality tenant which cannot trade remotely may therefore feel that their position has not changed under Alert Level 3, and they should therefore be entitled to the same level of abatement that they received under Alert Level 4. The counterargument however is that a tenant should have a duty to mitigate their loss, and therefore they should be exploring ways of trading remotely under Alert Level 3.
An office tenant will be restricted from letting its employees return to the office unless they are unable to work from home (please note that this restriction can’t be eased just because it is inconvenient for the employee to work from home). Furthermore, office tenants will not be allowed to meet with customers or clients on site. As such, an office tenant will arguably be unable to fully conduct its business from the premises and should accordingly be entitled to a proportionate level of abatement.
Essential services and other tenants may be able to access and fully trade from their premises under Alert Level 3 e.g. a construction firm will be able to operate from their premises under Alert Level 3 if they follow hygiene restrictions.
The issues for a lease under Level 3 are therefore twofold:
During Alert Level 4 it was often relatively clear that non-essential tenants could not access their premises to fully trade. Level 3 introduces more greyness. It will be open for interpretation as to when a tenant could be said to be able to “fully” conduct its business given some access and trade will be allowed under Alert Level 3.
A consequence of this greyness under Alert Level 3 is that it may be more difficult to ascertain what level of abatement is ‘fair’.
The problem is compounded because the standard lease form does not define what a “fair proportion” is, and neither has clause 27.5 been interpreted by the courts.
We suggest that a range of factors should be considered when assessing what level of abatement is fair.
What proportion of abatement is ‘fair’ under Alert Level 3?
What is a “fair proportion” of abatement must be a subjective assessment, considering several factors including the circumstances of both the landlord and tenant. The New Zealand Law Society has issued guidance on this issue suggesting that, while each case is fact-specific, the following factors could be considered:
The balance of the term of the lease.
Whether the premises is bare land, retail, offices, warehousing or industrial. The level of abatement will not be the same for all types of premises .For example it may be fair to conclude that a hospitality tenant that depends on customers visiting the premises is worse affected than a different tenant who mainly uses a warehouse for the storage of stock.
The extent to which the tenant can still use the premises e.g. is the tenant still providing ‘essential services’ or able to store/prepare goods onsite for delivery or pick-up?
Whether tenant can conduct its business remotely, yet still benefit from the premises e.g. it stores servers or other equipment onsite.
Whether there is other value inherent in the premises (e.g. business continuity, fitout, or goodwill).
The impact on the tenant if is required to pay the rent i.e. whether the tenant’s business will remain viable.
The impact on the landlord if the rent was not paid i.e. the landlord’s financial position and whether the property is mortgaged.
The level of any insurance cover available to the landlord or the tenant (although we suggest it is likely that most cover will exclude pandemics).
The level of any subsidies or other funding assistance available to the landlord or the tenant.
Whether it is fair that in the circumstances that outgoings such as rates or insurance should also be abated to the same level as rent.
Perhaps, most importantly the strength of the relationship between the landlord and the tenant.
The fact that the proportion must be “fair” suggests that an element of reasonableness should be considered – what should a reasonable tenant still have to pay, and what should a reasonable landlord require is paid.
A landlord and tenant also have options regarding the timing of any abatement:
Rent or outgoings could be immediately discounted e.g. only X% rent and outgoings is paid for the month of April.
Payments could be deferred to a later date and repaid by equal monthly payments from an agreed start date (with or without interest).
A combination could be agreed e.g. X% of rent and outgoings is paid in April, while the payment of the remaining balance is deferred.
Every situation is different. There may also be other alternatives for structuring a deal which are right for your circumstances. Please contact us to discuss your specific circumstances.
What about leases that don’t include a no access clause?
Other leases, such as bespoke leases or leases using the ADLS 5th or earlier editions, do not immediately entitle a tenant to a rental discount on legal grounds. However, landlords and tenants may decide that some form of discount is still appropriate due to their relationship and other commercial factors such as the sustainability of the tenant’s and landlord’s respective businesses.
Our advice for now:
Over the past weeks Cavell Leitch’s experts have assisted both landlord and tenants in resolving disputes as to what level of abatement was fair under their specific leases. In some cases, this has involved reaching a commercial compromise that involved sharing the pain to an extent that everyone could live with. In other cases, it was fair that a stricter approach was taken.
We suggest that communication will be key, and that discussions are held on a without prejudice basis where the parties reserves the rights to review the contractual position and seek redress later. Regardless, it is very important that any agreement is considered and then documented carefully. We can help in this regard.
Cavell Leitch’s team of experts are well versed in the competing arguments and factors which should be considered. We have also amassed a detailed knowledge of the trends that have developed in the marketplace, and we are ready to assist you with your specific situation. Please contact the writer or a member of Cavell Leitch’s property team for assistance.