Update – The ADLS Lease and Epidemics

Commercial Law
Apr 21 2020

Since the Christchurch earthquakes the Auckland District Law Society form of lease (ADLS Lease) has contained “No Access in Emergency” clauses (Emergency Clauses).

Obviously, with New Zealand now in a lockdown situation, the Emergency Clauses have come under scrutiny.

The issues to consider are:

  • Does it apply while NZ is at COVID-19 Alert Levels 4 and 3?
  • What happens to the rent and outgoings?
  • Will this be covered by the indemnity insurance cover for loss of rents and outgoings?

The Emergency Clauses

The Emergency Clauses apply where the premises become partially or completely unusable for the purpose of the tenant’s business.

Where this occurs, the clauses provide two responses:

  • A rent abatement when the premises are unavailable for a short period of time; or
  • A right of cancellation by either party when the premises will be unavailable for the period set out in the First Schedule to the ADLS Lease (No Access Period). The ADLS Lease provides a default period of 9 months and I would think most leases are set to this level.

Rent Abatement Clause

Clause 27.5 (the Rent Abatement Clause) deals with the first situation and is particularly relevant right now. I will only cover the impact of this clause.

The Rent Abatement Clause is triggered when there is an “emergency” and the tenant is “unable to gain access to the premises to fully conduct the Tenant’s business”. That inability must be linked to “reasons of safety… or the need to prevent reduce or overcome any…harm or loss”. The clause provides several examples of measures to reduce harm or loss, including “restrictions on occupation of the premises by any competent authority”.

If the Rent Abatement Clause is 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”.

An “emergency” is defined in the lease as being a situation that “is a result of any event, whether natural or otherwise, including…plague, epidemic” that “causes or may cause loss of life. illness or in any way seriously endangers the safety of the public”.

Government Response to Covid-19

The Government has three sets of powers for responding to health crises like the Covid-19 Pandemic.

  • Under the Health Act 1956, the Medical Officer of Health (MOH) for each region can impose a wide range of prohibitions, including prohibiting the use of buildings, placing people in isolation or quarantine, prohibiting travel either into or inside New Zealand or requiring building owners and occupiers to take certain steps to render them safe.
  • These powers can be exercised either under a state of emergency or an epidemic notice, or if the Health Minister authorises the powers to be used.
  • Failure to comply with these directions is a criminal offence and carries a maximum penalty of six months’ imprisonment or a $4,000 fine.
  • Under the Epidemic Preparedness Act 2006, when there has been a qualifying outbreak of disease, the Prime Minister may issue an Epidemic Notice.
  • An Epidemic Notice lasts for up to three months and grants the Governor-General (acting on the advice of Cabinet) wide ranging powers to alter and suspend legislation, where this is reasonably necessary to allow the legislation to continue operating under the circumstances of the epidemic. It also brings into effect a number of planned variations already written into specific legislation.
  • An Epidemic Preparedness (COVID-19) Notice has been issued and came into force on 25 March – https://gazette.govt.nz/notice/id/2020-go1368. This has been issued to cover the full three months.
  • A state of emergency has now also been declared which supplements the existing powers, particularly by allowing rationing and requisitioning where needed.

Covid-19 Alert System

Using the powers granted under the Health Act, Cabinet has created a four-stage response system to deal with the current outbreak of Covid-19. NZ is currently at Alert Level 4.  It is anticipated we will move to Alert Level 3 from Tuesday 28 April.

At Alert Level 4, almost all businesses are required to cease using their premises. Essential services are permitted to remain open, but others will not be able to continue working out of their offices and stores.

Do the Emergency Clauses Apply?

COVID-19 has triggered the Emergency Clauses. The following elements are all met:

  • COVID-19 carries a risk of serious illness and endangers public health.
  • As a result of NZ moving to Alert Level 4 and the issue of an Epidemic Notice, tenants in non-essential businesses are clearly unable to gain access to their premises to fully conduct their businesses.
  • The inability to gain access is linked to the need to prevent, reduce or overcome harm or loss.
  • COVID-19 has put us in an “emergency” situation, as it is an epidemic that has caused illness and, sadly, will cause further loss of life in NZ.
  • The restrictions on occupation have been imposed by the Government.

Accordingly, a tenant that operates a non-essential business may seek a rent reduction under the Rent Abatement Clause.

At Alert Level 3 most, but not all, businesses will be able to open. They will need to take health measures to keep their workers safe. This will include appropriate physical distancing and working from home (if working from home is possible).

Retail and hospitality businesses will only be able open for delivery and contactless pre-ordered pick up. Customers will not be able to enter stores.

Businesses will not be able offer services which involve face-to-face contact or sustained close contact. Unfortunately, getting a haircut is still out of the question.

In home services can be delivered if it is safe to do so (like tradespeople for repairs or installations).

Do the Emergency Clauses Apply at Alert Level 3?

COVID-19 has triggered the Emergency Clauses in many leases. The following elements may be met, dependent on the tenant’s business use:

  • COVID-19 carries a risk of serious illness and endangers public health.
  • As a result of NZ moving to Alert Level 3 and the issue of an Epidemic Notice, many tenants in non-essential businesses will be able to gain access to their premises, but not to fully conduct their businesses from the premises.
  • The limitations on access are linked to the need to prevent, reduce or overcome harm or loss.
  • COVID-19 has put us in an “emergency” situation, as it is an epidemic that has caused illness and may cause further loss of life in NZ.
  • The restrictions on occupation have been imposed by the Government.

Accordingly, a tenant that operates a non-essential business and that is impacted by the limitations on access may seek a rent reduction under the Rent Abatement Clause. This will particularly impact on office environments and hospitality businesses, to differing degrees.

This will not apply to businesses that are able to fully operate from the premises again (essentially because they cannot otherwise work from home). This will be the case for many industrial operators I suspect.

Importantly, under the current Alert Level 4 restrictions, the Government has formally taken the step of closing all non-essential premises. It is likely under Alert Level 3 that the Government will use its powers to order isolation of individuals rather than to close premises. It is arguable that this will not constitute a “loss of access” under the lease. On balance, I don’t think that this argument will prove to be the stronger – but it might provide some leverage for landlords in their discussions as to an appropriate abatement.

Rent Abatement in Practice

Once the Emergency Clauses are triggered, the question of their effect becomes important.

The Rent Abatement Clause provides for a “fair proportion” of the rent and outgoings to cease until the tenant can operate from the premises. It does not specify how a fair proportion is to be calculated.

To assess a fair proportion, you should consider the purpose of the clause. It is related to the occupancy of the premises for business purposes. The rent should be reduced with reference to the extent that the tenant is unable to conduct its business from the premises.  This is where the main difference between Alert Levels 3 and 4 will come in to focus.

Having said that, surely it must be a fair proportion to both parties, not just to the tenant. It seems to me that the legal position is unlikely (although I guess possible) to ever be that the abatement should be 100%*.  This will almost certainly be the case once NZ moves to Alert Level 3.

*It is arguable, for instance, that if a retail tenant is completely unable to conduct business from the premises, then the abatement should be 100%.  I personally do not consider that this would be the correct position to take.

A DISCLAIMER: THE FOLLOWING PARAGRAPH IS MY PERSONAL OPINION ON THE “FAIR PROPORTION” ISSUE AND IS NOT LEGAL ADVICE AS SUCH. THIS MAY HELP YOU TO FORMULATE YOUR OWN COMMERCIAL APPROACH TO THIS UNPRECEDENTED MATTER.

This will naturally require consideration of the different purposes for which a building is used. If I were to apply a range of 1 (no ability to conduct business from the premises) to 5 (complete ability to conduct business from the premises), I might make the following assessments:

Alert Level 4

Level Business/Building Function  Proportion of rent and outgoings to cease
1 Retail/Hospitality 25-70%
2 Offices (tenant still able to operate remotely) 25-60%
3 Industrial/logistics (manufacturing/logistics and storage components) 15-50%
4 Warehousing 10-25%
5 Essential Business

Alert Level 3

Level Business/Building Function  Proportion of rent and outgoings to cease
1 Retail/Hospitality – Contactless pre-order and pick up not feasible 25-70%
2 Retail – Contactless pre-order and pick up feasible 20-50%
2 Offices – Workers are still able to operate remotely but some will need to work at the office 10-25%
3 Industrial/logistics (manufacturing/logistics and storage components) 0-10%
4 Warehousing 0-10%
5 Essential Business

In most cases of course, a fair proportion will be what the tenant and the landlord are able to agree between themselves. The key is to have this discussion early, agree terms and move on.

As a last resort, the parties could leave the matter to an arbitrator to decide. There is substantial risk to both parties in leaving the matter to a third party to determine, and there is no guarantee that an arbitrator will take a commercially pragmatic approach.

Other Leases

This article has only dealt with the ADLS Lease (2012 editions). If the lease is an older ADLS form, bespoke or the Property Council Lease (where the abatement only applies in situations where the premises are inaccessible and the Landlord is otherwise covered under the loss of rents insurance policy) then my view is that the tenant is still contractually obligated to pay the rent.

Such leases could be impacted by the law of frustration (where the situation is such as to fundamentally undermine the lease contract) and other common law arguments.

Insurance

As far as I am aware, all loss of rents insurance policies contain wording to the effect that they do not cover loss in connection with a Notifiable Infectious Disease under the Health Act 1956 or a notifiable disease under the Biosecurity Act 1993.

COVID-19 falls within the exclusion so unfortunately there will be no relief forthcoming from insurers.

“Assistance” for Tenants and Landlords

The Government’s response to the call for relief for tenants and landlords has been particularly weak:

  • Tenants (who, for instance, have not been able to trade and cannot meet their lease obligations) will have at least 30 working days (rather than 10 working days) notice before the landlord cancels the lease for non-payment of rent; and
  • Landlords (who, for instance, are not receiving rent and cannot meet their mortgage obligations) will have at least 40 working days (rather than 20 working days) notice before the Bank forecloses on their property.

In my experience, this will only delay the inevitable. I say this because:

  • Notices are normally only issued when there is little hope of the default being rectified.
  • Credit is going to be even further constrained in the short to medium term.

Conclusion

Ultimately, and notwithstanding the contractual rights and obligations of the parties, my view is that it is in the landlord’s interest to share at least some of the tenant’s pain.

The goal should be to allow the tenant to remain solvent and to be in a position where it can continue business as soon as it can do so.

If both parties take a pragmatic commercial position to determining an appropriate level of abatement, this should be achieved.

Written by Simon Collett
Contribution from Tim Conder

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