The Government announced last week it will legislate to imply a term into some commercial leases allowing tenants to claim a “fair” rent abatement because of restrictions put in place to combat Covid-19. But not all tenants will be able to claim the abatement, and the new implied term differs significantly from existing abatement provisions. Bell Gully partners Jane Holland and David Friar, and senior associate Morgan Powell, explain.
The Government-ordered lockdown as a result of Covid-19 has had a significant impact on both tenants and landlords. Many tenants have faced a loss in revenue, both because of their inability to access their premises and difficult economic conditions. Equally, a number of landlords have encountered financial difficulties as a result of tenants who have not paid any rent during the lockdown.
Under clause 27.5 of the Auckland District Law Society standard form lease, tenants are entitled to an abatement of a “fair proportion” of rent if they are unable to access their premises to fully conduct their business in an emergency because of a government restriction on occupation (among other things).
Some other leases contain similar clauses – although many other leases don’t.
Some landlords and tenants reached commercial agreements in which rent was abated or deferred during the lockdown, while others were unable to do so. Many of the agreements reached relate to leases which do not include clause 27.5, or a similar clause.
Now the Government has announced it will be amending the Property Law Act to imply a new contractual term into existing leases that will give some – but not all – tenants the right to seek an abatement of rent. It has not yet drafted the legislative provisions intended to give effect to this new implied term, but has released the minutes of the cabinet committee decision. Based on those minutes and the underlying paper, we summarise the key points expected to be included in the legislation.
What does the implied term require?
Under the implied term, a qualifying tenant will not be required to pay a “fair proportion of rent and outgoings” if the tenant’s business has suffered a “material loss of revenue” because of “restrictions put in place to combat Covid-19”.
Who is a qualifying tenant?
The clause will only be implied into commercial leases. It will only apply if the tenant has 20 or fewer full-time equivalent staff per lease site, is New Zealand-based, and hasn’t already come to an agreement for a rent abatement with their landlord. The final definition of a “New Zealand-based” business is yet to be determined.
What about tenants and landlords who have already reached agreement?
Tenants who proceeded on the basis of the existing terms of their lease and the current statutory provisions, and reached an agreement with their landlord about rent abatement, will not have the benefit of the new implied term. Some tenants will no doubt have already reached agreement on terms that may be less satisfactory than those that might now be available under this implied term. However, it is clear that only qualifying tenants, who have not reached agreement, will get the benefit of the retrospective change.
There is an exception. If a landlord insisted on strictly enforcing the terms of the lease in response to a tenant’s request for a rent reduction, the tenant will still be a qualifying tenant and the new implied term will apply.
It remains to be seen whether a qualifying tenant who agreed a rent deferral (rather than a rent reduction) will still be entitled to seek a rent abatement in accordance with the implied term. It is also unclear what the position will be for a landlord and tenant who agreed on a rent abatement for Levels 4 and 3, but none for Level 2. Will the new implied term apply for Level 2?
What is a “material loss” of revenue?
The implied term refers to a “material loss” of revenue, but does not define what constitutes such a “material loss”. The absence of any guidance on the meaning of “material loss” may lead to disputes. So, too, may differing views over what period of time the “material loss” relates to. A tenant may have suffered significant losses during alert Level 4, but seen an increase in revenue during alert Level 2. Should these periods be considered individually or in the aggregate?
What are the “restrictions put in place to combat Covid-19”?
The implied term requires the material loss of revenue to result from “restrictions put in place to combat Covid-19”. It is unclear if this is limited to restrictions directly applying to the tenant’s business, such as prevention of access, or could reflect consequences arising from restrictions more generally. Is a tenant in the international terminal of an airport entitled to relief since it will suffer loss because of the restrictions around international flights, or does the fact that the tenant is able to open –with few direct restrictions – mean the controls on international flights can’t be taken into account?
What period does the implied clause apply to?
The amendments are proposed to apply from June 4, 2020. The implied term would come into force on this date, even though it is yet to be drafted. It also appears to allow parties to reassess rent and outgoings dating back to the beginning of the Covid-19 crisis.
The implied term is proposed to apply for a period of six months, with the minutes noting the cabinet committee considers there is “some benefit” to allowing parties to agree a “slight” rent reduction for a period following the end of formal restrictions.
What is a “fair proportion” of rent and outgoings?
The implied term allows a tenant to cease paying a “fair proportion” of rent and outgoings. But how is that to be assessed?
The “fair proportion” language is a used in the ADLS lease, where its interpretation has caused considerable debate. For example, tenants have argued the amount of the rent abatement under the clause should be assessed based on the tenant’s ability to access the premises to fully conduct their business, rather than broader notions of “fairness” that take into account the landlord’s financial position and mortgage obligations.
However, the new statutory provisions will allow a much broader range of factors to be considered, including:
- the impact of the Covid-19 restrictions on the tenant’s business,
- any mortgage obligations relevant to the leased premises,
- any financial support available to the parties,
- the parties’ revenue and profit levels in recent years,
- the parties’ ability to survive financially the effects of official requirements to counter an outbreak of Covid-19, and
- any difference in size and resources between the parties.
How will disputes be resolved?
If the landlord and tenant can’t agree on a fair proportion, they must resolve the dispute by arbitration. The government will provide a $6,000 subsidy for the cost of arbitration (although not for the parties’ legal fees).
What about clause 27.5?
The government is proposing to imply the new clause into all eligible commercial leases, including leases that already include clause 27.5 of the ADLS lease.
It also said that it “may be” necessary to modify by statute any leases with an existing clause 27.5, so the existing clause is consistent with the new statutory clause. If this occurs, the new law will effectively repeal existing contractual terms agreed by the parties and replace them with an alternative clause drafted by the Government after the fact. This would be the case, for instance, for the PCNZ Office and Retail Leases.
What about sanctity of contract?
The cabinet committee paper notes the Government’s proposals “go against the legal principle of sanctity of contract” because “they would add contractual terms and obligations to leases that the parties did not mutually agree”.
Landlords are likely to question whether it is appropriate for the Government to change the terms of existing leases by legislative decree.
Likewise, tenants who have already settled for lesser amounts than they would otherwise be entitled to under the new implied term are likely to question whether they should be treated differently to those yet to settle.
The terms of the proposed draft legislation will be critical. In the interim, we expect tenants and landlords won’t want to agree on any reduction in rent until the law is passed.
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