What Is A Fair Proportion Of Rent Abatement?

This article is one of a series of articles which we have published in relation to COVID-19 and the consequences of the Government intervention which we have seen to date.

In this article, we address clause 27.5 (No Access in Emergency) of the Sixth Edition of the Auckland District Law Society’s Deed of Lease form (“ADLS Lease”). Specifically, we consider how a “fair proportion” of rent and outgoings might be determined if clause 27.5 has been engaged.

Please note that it is important to establish whether clause 27.5 has actually been engaged before moving on to an enquiry regarding what a “fair proportion” is. We have written a separate article regarding this here.

While we consider that it is better to take a commercially minded approach and attempt to come to an agreement as to what a “fair proportion” is, it is important that both landlords and tenants have an understanding of how clause 27.5 applies. This is because (a) it should colour each party's approach to negotiations and (b) legal recourse to clause 27.5 may need to be relied upon if the party's are unable to come to an amicable agreement.

SUMMARY

To date, we have seen a lot of general commentary regarding what a “fair proportion” might be.

Use based considerations

A lot of that commentary suggests that clause 27.5 ought to be interpreted based upon the extent to which a tenant is still able to access and “use” its premises during the COVID-19 Lockdown. We touched on some of those “use” based considerations in a prior article which can be accessed here.

Other important considerations

However, while “use” based considerations are important, we consider that there are other, important considerations relating to the attributes of the parties themselves and their ability to carry risk. These other considerations are things such as whether a party is insured against the risk, the reliance of the tenant’s business on access to the premises, and the financial position of the parties.

These matters need to be considered based on the purpose of clause 27.5 and the principle that the person best placed to bear a risk should shoulder it.

First we discuss the wording of clause 27.5, some background behind the clause, and how clause 27.5 ought to be interpreted. Second, we consider what matters should be taken into account when applying clause 27.5. Third we comment on what should be paid during the intervening period (as the parties attempt to come to an agreement as to what a “fair proportion” is).

The wording of clause 27.5

The full wording of clause 27.5 is as follows:

No Access in Emergency

27.5 If there is an emergency and the Tenant is unable to gain access to the premises to fully conduct the Tenant’s business from the premises because of 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:

a) a prohibited or restricted access cordon applying to the premises; or

b) prohibition on the use of the premises pending the completion of structural engineering or other reports and appropriate certifications required by any competent authority that the premises are fit for use; or

 c) restriction on occupation of the premises by any competent authority.

then a fair proportion of the rent and outgoings shall cease to be payable for the period commencing on the date when the Tenant became unable to gain access to the premises to fully conduct the Tenant’s business from the premises until the inability ceases.

The origins of clause 27.5

Clause 27.5 was added to the ADLS Lease in response to the Christchurch earthquakes. Just after the earthquakes, restricted access cordons were put in place. Those cordons prevented access to premises irrespective of whether premises were seriously damaged or even damaged at all. This meant that tenants (who at that time were on earlier editions of the ADLS Lease), were liable to continue to pay their rent and outgoings even though they couldn’t access their premises. To make matters worse, no one knew how long the cordons would be in place for. This raised additional questions about how long this situation could go on for and whether leases could be cancelled if the situation went on for a long time. This placed tenants and landlords in a very difficult and uncertain position.

While this may sound harsh, or surprising, it is well established under general lease law that in the absence of (a) a clause such as clause 27.5 of the ADLS Lease, (b) a suitable force majeure clause, or (c) a successful frustration argument [1] a lease remains legally binding, and a tenant must continue to pay rent and outgoings throughout any period of inaccessibility (this is the “Default Position”). [2]

The Christchurch earthquakes brought this inaccessibility risk to the forefront of people’s minds. Clause 27.5 of the ADLS Lease was a response to this particular problem.  It was aimed at creating some certainty and fair risk sharing between landlords and tenants.

Therefore in interpreting clause 27.5, its origin as a mechanism to apportion risk between a landlord and a tenant (and depart from the Default Position) needs to be borne in mind.

Other things to bear in mind

Other things to bear in mind about clause 27.5 are:

• Clause 27.5 is a “one size fits all” clause; it applies to a range of premises, from storage units to restaurants. However, this does not mean that the abatement will be the same for all premises.

• Clause 27.5 also applies to a range of situations, from a complete prohibition on using the premises to a partial restriction on using the premises.

• The clause refers to an abatement of both rent and outgoings. So regard needs to be had to both of those things.

• The clause refers to an “abatement” rather than a complete cancellation of rent and outgoings. So clause 27.5 leaves room for a portion of rent and outgoings to remain payable.

• The wording of some of clause 27.5 is the same as some of the wording of clause 27.3 of the sixth edition of the ADLS Lease (Partial Destruction). Clause 27.3 provides for a fair abatement of rent and outgoings where premises are damaged but not badly enough for the lease to end. However, despite the similarities in wording it is important to keep in mind that clause 27.3 and clause 27.5 deal with different situations (the former dealing with damage and the latter dealing with inaccessibility which is unrelated to damage). So the similarity in wording does not mean that clause 27.5 should be applied in the same way as clause 27.3.

• Clause 27.5 is relatively new. There is no case law determining how it should be applied. [3]

Another important point about clause 27.5 is that unlike the market rent review provisions of the ADLS Lease, clause 27.5 does not include a method for actually determining the amount of the rent and outgoings abatement. Instead, the clause seems to contemplate that the parties will come to an agreement on the amount of the abatement, and, if they cannot agree, the dispute will be arbitrated under clause 43 (Arbitration) of the ADLS lease.

A clause structure like this (which contemplates the parties reaching an agreement), when coupled with the use of the word “fair” (which introduces the idea of reasonableness) in clause 27.5, suggests that when considering how clause 27.5 should be applied, we should be asking: [4]

• What a reasonable landlord and a reasonable tenant would consider were relevant matters; and

• What weight a reasonable landlord and a reasonable tenant would give to those matters; and

• After considering those matters and their weight, what rent and outgoings abatement would a reasonable landlord and a reasonable tenant agree to.

So these things, and the purpose of clause 27.5 need to be borne in mind when considering how the clause applies.

If clause 27.5 has been engaged how does it apply to a particular lease?

As we have discussed, to apply clause 27.5 we need to consider what matters a reasonable landlord and a reasonable tenant would consider relevant, and then attach weight to them.

There are some matters that clearly should be taken into account. These relate to the tenant’s loss of use of the premises. We will deal with these first.

There are then some “other risk sharing matters” that arguably should also be taken into account due to the “risk sharing” purpose of clause 27.5. We will deal with these second.

Tenant’s loss of use (loss of benefit from the premises)

A tenant’s loss of use of the premises and any ongoing use of the premises is clearly important. So we think that a reasonable landlord and a reasonable tenant would consider the following matters relevant to deciding what rent and outgoings abatement ought to be agreed on:

• What is the tenant’s actual loss of use of the premises? To consider that, the following things need to be considered:

• What are the tenant’s business activities conducted from the premises that are within the scope of the tenant’s allowed “Business Use” under the lease. [5]

• What of those business activities are legally prohibited or restricted by the COVID-19 measures.

• What of those business activities can the tenant continue to use the premises for, such as storage of stock and plant and operating IT equipment.

• The length of time that the prohibition or restriction applies.

• What are the tenant’s continuing goodwill benefits arising from the premises such as the presence of the premises and signage.

• What weight should be given to that loss of use? For example if the premises are used for hospitality purposes or retail purposes involving large numbers of customer visits, a prohibition or restriction on access may have a much greater impact than on premises used for storage purposes with infrequent visits. In the former case (hospitality or retail) one would expect a reasonable landlord and a reasonable tenant to place greater significance (resulting in a larger abatement) upon the loss of use.

• What amount of rent and outgoings would a reasonable landlord and a reasonable tenant agree that a tenant should pay for a tenant’s continuing use of the premises (for example for storing stock and plant and operating IT equipment) and continuing goodwill benefits arising from the premises.

• What rent and outgoings abatements have been agreed on by others for comparable premises. We would expect reasonable parties to refer to market based evidence in determining an abatement.

Other risk sharing matters

There are then a range of other matters that a reasonable landlord and a reasonable tenant may consider relevant. These relate to the sharing of risk between the landlord and the tenant rather than the loss of tenant benefits.

Whether these risk sharing matters ought to be taken into account is less clear than the matters relating to the tenant’s loss of use of the premises and ongoing use of the premises. The reason for this is that these risk sharing matters apply to the parties themselves. Matters such as the financial positions and other attributes of the particular parties are usually disregarded in rent review processes. So there is an argument here that the financial positions and particular attributes of the parties ought to be disregarded when fixing a rent and outgoings abatement.

However, that view does not properly take into account the purpose of clause 27.5, which is to share risk between the landlord and the tenant (as discussed earlier). If matters relating to the sharing of risk are taken into account, then a number of matters revolving around each party absorbing a level of risk are relevant. We think that a reasonable landlord and a reasonable tenant would consider the following matters relevant to the sharing of risk between the landlord and the tenant:

• Does the landlord have loss of rents cover which has been engaged? [6] If so, then we would expect the tenant to be relieved of the obligation to pay rent and outgoings to the extent of that cover.

• Does the tenant have interruption insurance which responds? If so, then we would expect the tenant to pay rent and outgoings to at least the extent of that cover.

• Are the rent and outgoings a large sum or a small sum? If it is a small sum then an abatement is less likely to be significant so the level of abatement may end up being driven by the landlord and tenant to maintain goodwill between each other.

• How reliant is the tenant’s business upon access and use of the premises? The more reliant a tenant is on access and use, the more likely a reasonable landlord and a reasonable tenant would agree upon a larger abatement.  However if the tenant is able to operate its business remotely then it will have a greater ability to absorb risk making it more likely a landlord and a tenant would agree on a smaller abatement.

• What is the tenant’s funding and solvency position. The stronger the tenant’s funding and solvency position then the greater its ability to absorb risk making it more likely a landlord and a tenant would agree on a smaller abatement.

• What is the landlord’s funding and solvency position. The stronger the landlord’s funding and solvency position then the greater its ability to absorb risk making it more likely a landlord and a tenant would agree on a larger abatement.

When these other risk sharing factors are taken into account it may significantly change the outcome of an assessment that is solely based on a tenant’s loss of use. This is particularly so where a landlord or a tenant is insured or the landlord and the tenant have significantly different capacities to absorb risk.

Once all the relevant matters are identified and given appropriate weight the parties may reach agreement on a “fair” (in other words “reasonable”) abatement of rent and outgoings. If the parties are unable to reach agreement then the dispute will be referred to arbitration under clause 43 of the ADLS lease. But essentially the arbitrator will be asking the same questions as a reasonable landlord and a reasonable tenant would about what matters are relevant and what weight they should be given.

What should be paid while landlords and tenants are trying to determine what a “fair proportion” is?

Unfortunately, the ADLS lease does not say what should be paid while an agreement is reached regarding what a “fair proportion” is.

This means that:

• Landlords are exposed to the possibility of a tenant deciding to pay nothing until an agreement is reached; and

• Tenants are exposed to the possibility of having to pay default interest for failing to pay the correct “fair proportion”.

In order to mitigate those risks, it is possible to agree to “interim payment amounts” while an agreement is reached. This is an option which may be utilised to address cash flow and bank concerns. However it can also be a disadvantage because:

• It can disincentivise the parties agreeing to any different amount as being a “fair proportion”; and

• It creates a perception that the “interim amount” will be close to the actual amount which remains to be agreed.

Therefore, if an agreement as to “interim payment amounts” is reached, it is important to carefully record that it is without prejudice to the determination of what a “fair proportion” is.

Next Steps

This article sets out some guidance on how clause 27.5  ought to be interpreted and applied. It is of general application and is not a substitute for specific advice. So whether you are a landlord, or a tenant, you should seek specific professional advice to help you determine your agreement on a fair abatement under clause 27.5 and to help you record such agreement correctly.

Disclaimer

The above information is of a general nature only. The information in this article does in no way constitute legal advice and all readers should contact a law firm for advice relating to your specific circumstances.

[1] In the context of leasing, frustration is a very high bar and such an argument is unlikely to succeed.

[2] For the avoidance of doubt, we are referring to “inaccessibility” as a result of something beyond the Landlord’s control. 

[3] There is some case law on clause 27.3. However it is not particularly helpful on showing how clause 27.3 should be applied let alone clause 27.5.

[4] This is similar to how certain rent review provisions are interpreted.

[5] The tenant’s allowed “Business Use” will be set out in Item 13 of the First Schedule of the lease.

[6] Please note that this is unlikely in the case of the Covid-19 Pandemic.