Covid-19

Wondering if your business must pay rent? Look for clause 27.5

Businesses in lockdown are looking to a previously little-considered clause in many commercial lease contracts which makes it legal to not pay some or all of their rent. 

For thousands of business landlords and tenants all over New Zealand, April 1 was crunch day. April Fools was the first commercial ‘rent due’ date since the country went into Covid-19 lockdown. 

Tenants stuck at home with their companies slowed or stopped altogether were wondering if they should pay all, some, or none of their rent.

Landlords, many of whom have debt to service, were trying to work out whether they could charge rent for unusable buildings - and if so how much.

Dusty leases were pulled out of drawers; phone calls made to property lawyers.

And the answer? Step one is to find out if you have clause 27.5.

What’s this clause 27.5?

This crucial clause is in all standard ADLS (Auckland District Law Society) leases drawn up since 2012. And not just in Auckland. For some historical reason Newsroom hasn’t been able to fathom, the ADLS contract is the go-to document nationally for all but the biggest and most corporate landlords.

You’ll find clause 27.5 in the most recent ADLS contract under the section: “No access in an emergency”.

As the title suggests, the clause covers any emergency, “including a plague or epidemic” which could seriously endanger the public. If that emergency stops a tenant accessing their rented space, 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”.

In English, this means tenants with ADLS contracts don’t have to pay all their rent if they can’t run their businesses because they are shut out of their building. 

For example, during a Covid-19 national lockdown.

Photo: Lynn Grieveson

You can imagine huge sighs of relief from business owners discovering this week they were on leases containing 27.5, although deciding what “a fair proportion” is won’t be straightforward (more of that below).

The situation is more difficult for tenants and landlords without the clause.

It started with the red zone

Clause 27.5 sounds like it was designed for Covid-19, but in fact it owes its existence to the 2010-2011 Christchurch earthquakes. In the quake aftermath, rent relief was only available for companies which couldn’t operate from their buildings because they were damaged. 

If your rented space was intact, but you couldn’t use it because it was inside the red zone, then - well tough. 

Legally you still had to pay your rent - even if the building was out of bounds for months or even years.

“There were a lot of tenants pushing for a fairer position under the leases,” says Bell Gully partner Jane Holland. “They didn’t feel they got a fair deal.”

How widespread is 27.5?

It’s hard to know what proportion of commercial lease contracts in New Zealand contain ‘no access’ rent suspension clauses - either via the ADLS contracts or similar provisions in other leases.

Holland estimates the majority of leases entered into after the earthquakes will contain the clause, although big commercial property companies and mall owners tend to have their own contracts, and they often don’t contain the ‘no access’ provision.

Kate Searancke at Tompkins Wake, has a similar view. She told Newsroom around 70 percent of the contracts she was seeing contained a ‘no access’ clause. 

But other law firms we spoke to reported different experiences.

David Gilbert from MinterEllisonRuddWatts estimated only between a third and half of landlords and tenants he’d talked to this week were using contracts containing the 27.5 clause; Greg Allen from Simpson Grierson said it was less than 20 percent among his clients.

While “the vast majority of SMEs, smaller offices and high street retail stores would use the updated ADLS form,” Gilbert says, “the bigger issue is with malls, which have their own leases, which may or may not contain that clause. 

“And large corporate landlords tend to prefer their own form of lease.”

In addition, Newsroom understands some landlords might use an either older version of the ADLS lease or have their own bespoke leases.

Samson Corporation, for example, which has been a commercial property owner in Auckland since the 1940s and owns a lot of retail and office space in Auckland, including strips of shops on Ponsonby Rd, has some tenants with older bespoke contracts which don't include the ‘no access’ clause.

Samson property manager Celia Wells says the majority of the company's leases are newer, however, and contain a clause based on the ADLS 27.5 wording.

She says Samson is negotiating about rent with tenants regardless of whether their lease contains the 'no access' clause.

Determining “fair proportion”

Property law specialist Jack Porus from Glaister Ennor says fair proportion will likely depend on the circumstances of the lease.

We are generally using a 50/50 share of the rental as a starting point and negotiating from there

“Where there is very little disruption to income, for example a self-storage facility, the level of abatement will be small,” he says. “But in cases where the tenant is deprived of all income, the proportion will be high, although it is unlikely to be 100 percent.”

With an office, landlords might argue that the tenant is able to work remotely, using computer servers on the premises,” Porus says.

But a cafe owner, for example, won’t make any money during the lockdown.

“We are generally using a 50/50 share of the rental as a starting point and negotiating from there,” Porus says. “But some tenants are simply saying they will not pay anything and there is little the landlord can do about this during the lockdown.”

Newsroom knows of three big retail chains - The Warehouse, Harvey Norman and H&M - which have already told their landlords they won’t be paying rent this month.

Gilbert says it’s not just the rent, but the operating expenses that are in play with clause 27.5 - things like rates, electricity in common areas and the landlord’s insurance.

“You’d expect some reduction in opex payments, but still, the landlord is incurring those costs during the weeks of lockdown.”

Needing clarity

Property Council chief executive Leonie Freeman says it’s critical to get some certainty around the commercial rental situation, or the country could face a tsunami of expensive litigation as landlords and tenants fight over unpaid rent.

We are all in this together. We might have to share a bit of pain, but we have to find the right way through.

“This could be hugely problematic. We don’t want to get through this pandemic lockdown and suddenly have a whole lot of legal action.

“If people do crazy things - tenants stopping paying rent with no communication with their landlord, or landlords [with leases that don’t contain the 27.5 clause] demanding 100 percent of the rent, the only people that gain are lawyers.

“We are all in this together. We might have to share a bit of pain, but we have to find the right way through.” 

Freeman says the Property Council is working with the Government to find solutions “so the commercial property sector can still function in three months’ time.

“We are looking to create some sort of consistent approach.”

Declaratory judgment

One option to clarify the “fair proportion” component of leases which contain clause 27.5 is a declaratory judgment, says former High Court judge Kit Toogood, QC.

A declaratory judgment is basically a relatively quick and easy way of clearing up a matter of legal uncertainty - if it’s considered an important issue.

“Someone would need to gather evidence of sufficient widespread and immediate concern about the issues around fair abatement of rent and outgoings, and that it’s a matter of real importance to the parties,” Toogood says.

You’d need a company or organisation to bring the issue to court - a large landlord or tenant, for example, the Property Council or the Auckland District Law Society. 

But after that the process could be fairly fast, Toogood says. 

“The applicant sets out the issue and there’s a filing of affidavits usually with uncontested facts. There isn’t usually cross-examination and you don’t have months of discovery.

“You just file and get it in front of the judge.”

The 2006 Epidemic Preparedness Act would also help a speedy decision, he says.

“The courts can set aside the normal procedural rules to get things dealt with quickly, if you can show urgency,” he says.

It’s unlikely a judge could come up with an absolute number for “fair proportion” - 50 percent rent reduction, for example. Toogood says that will depend on the circumstances of each landlord-tenant situation.

“But you could get an answer saying ‘Yes clause 27.5 applies and these are the kinds of criteria the court would take into account in deciding what is fair’.” he says. “And that would be helpful in the future if parties were having an argument.”

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