Photo: Lynn Grieveson

Attention commercial tenants: Under clause 27.5 you’re entitled to a deduction in rent. Don’t settle for a deferment.

Halfway through the Level 4 lockdown and there’s still confusion as to the rights of commercial landlords and tenants about the payment of rent.

Here’s a summary of what we know so far:

– If your lease was entered into before Nov 2012 it almost certainly will not have any provisions that deal with inability to access premises due to a pandemic. Legally, rent is still payable in full.

– If your lease is the Auckland District Law Society (ADLS) sixth edition that was released in November 2012, it will contain the critical clause 27.5. The clause covers a situation where an emergency “including a plague or epidemic” stops a tenant accessing their rented space. As many as 70 percent of commercial leases in New Zealand are thought to be on the ADLS form.

(See Newsroom’s original story about ADLS clause 27.5.)

– If your lease is bespoke, that is drafted by a commercial landlord like a mall owner or major property investor, then it may or may not include clause 27.5 or a version of it.

(See Newsroom’s story “Pay up, shopping mall landlord warns tenants“.)

– Tenants or landlords with business interruption and/or loss of rent insurance will be disappointed to learn that pandemics are specifically excluded from almost all insurance cover, a practice that became industry standard after the SARS epidemic.

Clause 27.5

Most of the focus in the last fortnight has been on clause 27.5 leases and how they respond to the current lockdown.

It’s now widely accepted that the current emergency triggers clause 27.5 and the all-important sentence which says “a fair proportion of the rent and outgoings shall cease to be payable” during a period where a tenant can’t access their premises.

Those thirteen words raise two key questions:

– What does “cease to be payable” mean?

– What is a “fair proportion” of rent and outgoings?

Deduction not deferment

There’s been some discussion and confusion between landlords and tenants as to what “cease to be payable” means. Does it mean the tenant doesn’t pay some or all of the rent and operating expenses, or is it merely a deferment of the obligation to pay?

However there isn’t any confusion in the minds of lawyers Newsroom has spoken to, including Bryce Town, a commercial law partner at Morrison Kent and convener of the ADLS Property Law Committee.

For Town, clause 27.5 clearly provides for a deduction not a deferment. This clarification is significant because a number of commercial tenants Newsroom has spoken to say landlords are pressuring them to sign deferment deals.

For example, a landlord might offer a reduction of 50 percent of the rent for three months, but with that deferred amount to be repaid over the balance of the term of the lease.

That is, landlords are arguing the unpaid 50 percent has to be paid back on top of the normal rent which will apply when access to the premises is restored.

That is not the meaning of clause 27.5, Town says. The two sides need to start their negotiations on the common understanding that the entitlement is to a deduction.

What is fair proportion?

By far the most discussion in the past fortnight has been about how to determine what is a “fair proportion” of the rent and operational expenses to be deducted.

There have been numerous law firm newsletters and industry advisories on the point, all of which will tell you that there’s no mechanism in the lease or in property law statutes that provides a formula to work out what is fair.

That particular omission was deliberate when the clause was drafted, according to an ADLS media release issued this week.

“At the time of the lease revision it was decided that the fair proportion would not be defined in the lease by, for example, prescribing percentages. It was recognised that each situation would be different and it was not workable for a precedent to have a universal solution.”

The ADLS release also said: “The present Covid-19 pandemic is an emergency that was contemplated [in the drafting of clause 27.5] although probably not to the extent we now have on a nationwide basis.”

Without a legal mechanism or Government intervention to determine “fair proportion”, landlords and tenants are being left to their own devices with, unsurprisingly, widely different outcomes.

Some landlords are providing a complete rent deduction for a defined period, whereas other landlords are offering a deferment deal – or no deal at all. Other landlords are taking a more collaborative approach of a rent deduction to be followed by a period of turnover rent while the tenant’s business gets back on its feet.

Don’t stop talking

If there is one message common to all the various advisories being put out, it is that landlords need to take a longer term view on their business if they want it to be sustainable. As commercial real estate company NAI Harcourts advised its clients:

“If you are a landlord or a commercial property manager, it is important to keep the end outcome you want to achieve in mind. That should be to retain or keep your tenants that are operating a business from your premises.”

The ADLS has a message about the best way to achieve that goal.

“Parties are encouraged to collaborate, negotiate and seek to agree on a fair outcome either on an interim ‘wait and see’ basis or on a more permanent basis, with longer-term relationships.”

The ‘wait and see’ approach assumes the Government is going to act to provide assistance or at least guidance. Thus far, however, it has been distancing itself somewhat, advising that the whole area of commercial leasing is under consideration.

Some clarity or certainty can’t come too soon, say lawyers.

Tompkins Wake property specialist Kate Searancke says some of her clients are already looking at the dispute resolution clauses in their lease agreements. Most provide for mediation and/or arbitration, but this would normally be confidential between the parties and therefore would not provide a precedent to apply to other situations.

Searancke also notes, as does the ADLS release, that where a tenant defaults in the payment of rent due to a dispute over the amount to be paid – and that would include disagreement on what would be a fair deduction under clause 27.5 – the landlord cannot invoke the lease’s default provisions.

What happens at alert Level 3?

To complicate things further, there’s a new problem which may be just a fortnight away. While there is universal agreement that alert Level 4 meets the definition of ’emergency’ and will trigger clause 27.5 rent reductions, the same cannot be said of alert Levels 3 and 2.

And, as Searancke says: “What happens if we go down to alert Level 3 or 2 and then back up to alert Level 4?”

In the meantime, Australia is moving to clarify the situation there. The government across the Tasman says it will implement a mandatory code of conduct to impose a set of good faith leasing principles that will apply to retail, office and industrial contracts.

The aim is to “ensure that the burden is shared between landlords and tenants”.

It remains to be seen whether our government is prepared to impose a code that forces landlords and tenants to be kind to each other.

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