In the wake of recent severe weather events, earthquakes and a global pandemic, we look at ways to make your commercial premises lease “emergency ready” to ensure you’re in the best position possible should disaster strike again.
Landlords and tenants will be concerned about many of the same headline issues associated with emergency events – rent relief, insurance, business continuity – but from different perspectives. Making your lease “emergency ready” requires specific consideration of the interests of each party, which are not always easy to align.
This article focusses on the Auckland District Law Society (ADLS) form of Deed of Lease. Bespoke leases may contain similar clauses and concepts, requiring careful attention. In both cases, we recommend that you contact one of our leasing experts to discuss your needs.
Tenants may be entitled to rent abatement – but not in all circumstances
If, as a result of an emergency, a tenant cannot access its leased premises to fully conduct its business, it is entitled to an abatement of a “fair proportion” of rent and outgoings. This “loss of access” clause came into the spotlight during Covid lockdowns, and may now be helpful to tenants of "red-stickered” premises after the recent floods.
The “loss of access” clause does not cover every situation where an emergency has affected business. There may be situations where an emergency seriously affects a tenant’s usual client or customer base and, therefore, its revenue, but in a way that does not restrict the tenant from accessing the premises to fully conduct its business. For example:
- a retail tenant may be able to access its premises to fully conduct its business, but the emergency situation reduces the number of customers that can visit the premises; and
- a tenant who relies on tourists or travel can access its premises and fully conduct its business, but the emergency situation restricts local and/or international travel.
We saw this play out during the pandemic and, more recently, in the aftermath of Cyclone Gabrielle and recent flooding events which devasted roads across the North Island, cutting off access to summer holiday hotspots.
When negotiating your lease, you should consider expanding the scope of the ADLS clauses to cover situations that directly affect your particular business.
What constitutes a “fair proportion” of rent depends on a number of factors
The relevant clause in the ADLS lease does not include any guidance on how to determine a fair proportion of rent and outgoings. Based on our experience during the pandemic and Government guidance, there are several relevant factors – many of which go beyond issues purely related to the degree that access to the premises is restricted – including:
- the size and type of business the tenant is operating;
- whether the tenant can operate its business remotely, and whether the tenant has servers and other equipment in the premises that allows it to keep operating remotely;
- the financial position of both the landlord and the tenant;
- the impact and potential future impact the emergency may have on the use of the premises and revenue; and
- whether a reduction in a tenant’s inability to generate income (profitability) is directly connected to being unable to access the premises.
Determining the rent abatement while maintaining a good landlord-tenant relationship requires good faith negotiations between the parties. In some circumstances, it may be appropriate to agree on fixed percentage abatements at the outset rather than leaving it to later negotiations about what is “fair”.
Parties should consider how the ADLS insurance clauses operate
Landlords and tenants should be aware of the implications of the insurance clauses, and what insurance cover they need to have in place. Insurance is one of the most misunderstood areas of leasing and we recommend taking advice on these clauses from both your lawyer and your insurer.
Landlords should confirm with their insurer that they have an appropriate level of excess, and then reflect that in the lease. Under the current ADLS lease, a tenant is liable to contribute up to $2,000 towards the excess but only where the tenant causes the relevant damage.
Landlords should also understand the extent of their cover for loss of rent and outgoings – it may come as a surprise that most insurance policies will not cover loss of rent where the tenant is entitled to a “loss of access” abatement unless there has been damage to the building. If that is the case, the landlord should get advice to ensure that the scope of the “loss of access” clauses is appropriate.
Tenants should consider whether the landlord’s building insurance is appropriate – under-insurance by a landlord can mean that the landlord does not have to repair the premises if they are damaged.
Damage and destruction - landlord repair requirements under the Lease
If leased premises are totally destroyed to the extent that they are “untenantable”, the lease terminates automatically. If the premises are not untenantable, but landlord thinks the premises should be demolished, it also has the right to terminate the lease – but it has up to three months to do so. Tenants should consider reducing this timeframe, and making it a mutual termination right.
If the premises are partially damaged but not totally destroyed, the landlord is obliged to repair the damage with all reasonable speed – but only if the landlord has received its insurance proceeds, and only to the extent of those proceeds.
While the leased premises are being repaired, the tenant is entitled to an abatement of a fair proportion of rent and outgoings. Tenants may want to make changes for better protection in this scenario, such as an obligation on the landlord to top up its insurance proceeds and termination rights if the landlord takes too long to complete its repairs.
Parties should not rely on the “one size fits all” standard lease clauses
The ADLS clauses provide a useful and generally well understood starting point. However, parties should consider amending them, particularly where there are any types of emergency that are more or less likely to affect them and where they have specific business needs. Some scenarios to consider outside of the current ADLS clauses include:
- Whether there are suitable provisions in the lease dealing with utility outages. If a tenant is able to access its premises, but has no ability to use the utilities, its ability to fully conduct its business will be limited – but, depending on the cause of the outage, it may not be entitled to any rent or outgoings abatement.
- In the case of a ground lease, whether clauses should be added to address damage to the land. The damage and destruction provisions of the current ADLS lease apply only to improvements on the land, and not the land itself. With recent flooding causing significant slips and erosion, agricultural, horticultural and silvicultural businesses on leased land should think about making changes to ensure they are protected under their lease for this type of damage. Insurance considerations also differ when it comes to bare land.
With the increase in disastrous weather events and potential of future pandemics, you are likely to see more situations arise where a state of emergency affects the state of your business. Before signing a new lease, you should consider whether it is adequate for your circumstances.
This article was co-authored by Daniel Lokotui, Senior Solicitor and Lucy Woods, Solicitor, in our Real Estate and Development Team.
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