The Status of Commercial Leases in the COVID-19 Pandemic
New Zealand remains in lockdown, due to the COVID-19 Alert Level 4 shutdown imposed by the Government. In these uncertain and fast-moving circumstances, many in the business community will have questions about their obligations – so what does this lockdown mean in the context of commercial leases?
The first step is to consider the lease document itself. The express provisions contained in the document can provide a starting point to negotiations by clarifying the parties’ positions and obligations.
Commercial leases generally fall into two groups. Firstly, there are leases with specific clauses providing some relief, such as the Auckland District Law Society 6th Edition (2012) Lease (“ADLS Lease”), which contains a clause expressly dealing with access to the leased property in an emergency. Secondly, many other forms of lease do not contain clauses of this nature and may have to rely on other principles.
The ADLS 6th Edition Lease contains a “No Access in Emergency” clause, which was inserted as a direct response to the Christchurch 2011 earthquakes, when many business owners in the red zone were barred from entering their premises, regardless of the extent of damage. Other leases may have clauses of similar nature, and the below discussion may apply to those as well.
The clause applies where there is an emergency and the tenant is unable to access the premises to fully conduct their business due to “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 restriction on occupation of the premises by any competent authority”. Emergency is defined elsewhere in the lease as including an “epidemic”, and as a subset of that, a pandemic such as COVID-19, so this clause is applicable to the current environment.
Is the Tenant prevented from fully conducting their business?
During the current lockdown period, the answer is likely to be yes. Only those businesses which have been classified as “essential”, such as supermarkets or pharmacies, will be operating fully while New Zealand remains at Alert Level 4. The extent to which each tenant will be able to conduct their business will depend on a number of matters.
What can Tenants do in this circumstance?
The clause provides that a “fair proportion” of the rent and outgoings ceases to be payable for the period commencing when the Tenant is unable to access the premises and runs until the inability to access the premises in order to fully conduct business ceases.
The question of what constitutes a fair proportion is a central issue. If the tenant is completely unable to operate its business, for instance as a bar or restaurant, it is arguable that the tenant should not pay any rent or outgoings. There are also a number of possibilities that could mean that some rent is payable. For example a pharmacy may be able to conduct part of its business from the premises on a restricted access basis. It is also arguable that if stock remains on the premises during the lockdown period the premises essentially becomes a storage facility. In a restaurant setting, this could include freezers, fridges and office equipment, along with the usual chattels like tables, chairs and merchandise. However the question arises as to whether storing goods is part of the tenant’s business.
Another question to consider is whether the business can continue operating partially, such as through online sales, as many retailers have done. The question will be whether the tenant is using any part of the premises to conduct online business such as retrieving and selling stock situated on the premises.
Where the tenant is able to partially operate its business from the premises the question arises as to what is a fair proportion of rent and outgoings. Fairness relates to the use of the premises. The landlord and tenant will have to negotiate and agree on what is a fair proportion of rent and outgoings in these circumstances. Landlords and tenants should aim to reach a workable solution against the background of their legal rights given the economic impact that many in the business sector will face in the coming months.
If your lease is not on the ADLS 6th Edition format, it is still important to check the document as a clause similar to the “no access” clause may be present. If not, the presence of a “force majeure” clause could provide relief, or the lease could be terminated by a court using the general principle of frustration.
“Force majeure” and its applicability
“Force majeure” is a legal doctrine under which a party is relieved from liability for non-performance under a lease or contract if the party is prevented from performing these obligations due to circumstances beyond the party’s control. Force majeure clauses do occur in some commercial leases however their terms can vary greatly. The first step is to establish if the lease in question contains such a clause - the principle will not be applicable to a lease that does not expressly allow for it.
If a force majeure clause is present in a lease an important consideration will be whether the lease provides for any specific remedies. For instance, the clause may only provide for the landlord or tenant to cancel the agreement. Neither party may want that outcome. In that case negotiations will need to take place.
If there is any dispute relating to the applicability of a force majeure clause, the lease may provide for a dispute resolution procedure. Otherwise a court will have to decide whether a “force majeure” has taken place and, if so, what remedies the parties have.
Is the contract frustrated?
The general law of frustration may assist landlords and tenants if the lease does not provide for an inability to access the premises in an emergency or a force majeure event. The principle of frustration provides that if an agreement becomes impossible to perform due to unforeseeable events the party experiencing the event may be excused from the failure to perform and the contract is terminated.
Courts have been hesitant in the past to apply frustration to leases where there has been a lack of access to the premises. Usually an inability to access the premises for many months would be required for a court to declare that a lease was frustrated. Further a court would have to be convinced that the pandemic was not foreseeable by the parties. However because the pandemic is a global phenomenon, the scale of which does not appear to have been foreseen by any country a court may be more willing to declare the contract frustrated.
If a court finds that a lease is frustrated the contract is terminated at the point that it was frustrated. The court does have an ability to adjust the position of the parties following termination, but that may not be helpful to many landlords and tenants who wish to continue the lease relationship once the pandemic has come to an end. Once again the parties will have to negotiate a practical and workable solution against the background of their legal rights.
It is important that landlords and tenants are familiar with the terms of their lease and take legal advice early.
If you would like to seek specialist advice in relation to your obligations and rights, please speak to a member of our team.