Businesses’ response to COVID-19 has been rapid as many face significant revenue falls and need to put contingency measures in place immediately to mitigate as much cost as possible.
As rental costs are generally the second largest cost after people, focus has quickly turned to rental abatement and other remedies. Many businesses are desperate for relief and there is significant online commentary, advice and pleas for landlords to assist and for Government to get involved (as it has in the residential area).
Equally, there’s concern amongst landlords as they face uncertain times and potential revenue loss.
In part 2 of our blog on rent abatement and related issues, we’d like to share some further insights gained over the last few days at the coalface:
We reiterate the need for tenants to start meaningful engagement with their landlords on a without prejudice basis. As noted in our earlier blog, while a lease is a contract, it is also a business relationship with each party reliant on the other. We are actively working with several clients and helping them with these discussions. We’re also actively talking to our landlords for our two premises. They have generally been supportive and flexible in our experience.
Know your rights
While you may choose not to seek abatement or other support from your landlord, you first need to know what’s in your lease and what your options are. You also need to be forward-looking and consider what happens if the lockdown is extended or if we go back into a lockdown phase later in the year. Understanding your lease helps inform the engagement process. We are reviewing a range of leases and lease types to identify the key provisions that could apply.
There is general consensus that clause 27.5 of the 2012 Sixth Edition of the Auckland District Law Society (ADLS) Lease – a ‘No Access In Emergency’ provision – can activate the abatement of rent. We believe the Government-enforced Level 4 alert restrictions is an ‘emergency’ and has prevented non-essential businesses from accessing their premises to fully conduct normal business.
As a result, we believe that for most normal, non-essential businesses, ‘a fair proportion’ of the rent and outgoings may be abated. This may also extend to car park rent where it is included in the definition of the premises. Clearly, each lease needs to be carefully checked. We are actively pursuing abatement options for clients with these lease provisions.
What is a fair proportion?
In some cases however, tenants and landlords are finding it difficult to interpret what is ‘a fair proportion of rent and outgoings’. Our starting view is that 100% abatement should apply as the premises are not being used/cannot be used. However, there are a variety of factors that inform what is fair and how the premises are being used during the emergency.
In some cases, a tenant will not be conducting any normal business from the premises – however, it wouldn’t be unreasonable for a landlord to argue that areas used for storage and IT server rooms remain in use and therefore are removed from the abatable area. Equally, a landlord may argue that, while the tenant may not be able to conduct normal business during the emergency, the landlord is still obliged to keep the premises operational (eg rates, insurance, security etc) and therefore it is reasonable to expect the tenant to pay its fair proportion of those outgoing costs. In the case of gross leases, some fair deduction of fixed operating expenses may be needed.
Ultimately, the solution lies within positive engagement between the parties. We are considering this point on case-by-case basis.
We’re also considering the abatement options open for essential businesses who may only have a handful of staff working. In this case, it could be fair to argue that abatement is applied on a pro rata basis – ie for those areas not occupied by essential staff.
There is also an argument that even some essential, desk-based staff are not using the workplace/premises as the Level 4 alert level requires businesses to keep staff home. As a result, desk-bound, essential workers cannot access the premises in any event regardless of the type of work they are doing.
Are there other options?
Clearly the parties have discretion to agree an appropriate solution even if the lease is silent on abatement in these circumstances. We are seeing deals being struck where landlords are offering 50% abatement during the lockdown period as a goodwill gesture for example and other hybrid solutions. Even where abatement has been agreed, we are also seeing arrangements being made to cushion the impact on the landlord’s cashflow, including deferment of rent or extended lease terms.
As noted, these arrangements need to be carefully considered. Where tenants have leases that predate the Sixth Edition ADLS and have no access/rent abatement provisions, there may be other provisions such as force majeure or ‘frustration’, but applying these principles can be onerous. Again, engagement between the parties is critical to finding an amicable and reasonable solution.
Should tenants stop paying rent?
We don’t think tenants should unilaterally stop rental payments without first engaging with their landlord. Equally, we don’t think landlords should automatically assume the rental is due without engaging with their tenants and understanding their financial position and circumstances and, if payment is not made, we definitely don’t think landlords should enforce penalty interest or other recovery methods at the moment.
Where there is disagreement, the parties should truly apply the principles of reasonable endeavors to reach a solution before applying the dispute resolution options available through a typical lease.
What is Government doing?
Grant Robertson has indicated Government is working with the Property Council and others to provide some guidance. He said on Wednesday that "Lots of tenants and commercial landlords have come to good arrangements already about that and that's to be encouraged… Unfortunately, that hasn't happened everywhere so we are looking actively at what can be done there... to support especially those small-to-medium enterprises."
Our take is that any guidance/regulation from Government will aim to deal with the landlords who are being totally unreasonable and inflexible. In these cases, they may direct landlords to abate or defer rental for the lockdown period at a minimum. Clearly it is a complex issue that governments generally don’t want to get involved with. Generally, governments prefer parties to come up with a workable commercial solution. But, in this case, we have a force majeure event and unprecedented measures may be needed.
Where are the insurers?
There is again various commentary online (not all consistent) on the application of loss of rents insurances (for landlords) and business interruption insurance (for tenants/businesses). The initial consensus is that these policies probably have a carve out for a pandemic to let insurers off the hook (what a surprise!). Like leases, the exact provisions will come down to the policies and landlords and tenants should look closely at their policies with their brokers/advisers.
Loss of Rents Insurance
Some ADLS leases have amendments to clause 27.5 linking any ability to abate rental to the landlord’s ability to claim on their loss of rents policy. We’ve also seen leases with an amendment to the emergency definition linking this more simply to the premises being ‘inaccessible’ due to ‘the act of a civil authority’.
Each case is somewhat unique. In our view, where the standard wording applies (ie the emergency definition in the 6th Edition which includes reference to plague and epidemic among other emergency events) or a more specific inaccessible definition, landlords should have set up their loss of rents policies to cover this type of eventuality in addition to the normal drivers for a loss of rents policy such as fire, earthquake or other damage. We believe the linking of inaccessibility to loss of rents creates an obligation on the landlord to have the appropriate policy in place.
We’ve spent 30 years working closely with tenants to support them through a wide range of lease negotiations and renegotiations. If you need some support with these conversations, please get in touch. We can help – it’s what we do.
Auckland Team (covering Auckland, Hamilton, Tauranga and northern NZ region)
Wellington Team (covering Wellington and balance of NZ including South Island)