Business

Does clause 27.5 apply in Level 3?

For many commercial tenants, clause 27.5 in their lease agreement is a small miracle - two lines which mean they shouldn’t have to pay some or all their rent during the level 4 lockdown. But what about when we move to level 3?

For Tom*, a small business owner with his partner Rosie, moving to alert Level 3 fills him with dread not relief. 

“Moving to Level 3 makes business WORSE for most retailers,” he wrote to Newsroom when the change from Level 4 was announced.

Like many retailers, Tom and Rosie have been relying on clause 27.5 of the Auckland District Law Society lease to get a reduction in rent during the closedown.

Clause 27.5 was put into the standard ADLS lease used by many (but not all) landlords and tenants after the Christchurch earthquakes. The aim was to help businesses not able to get into their premises - including if there is a pandemic.

“If there is an emergency and the tenant is unable to gain access to the premises to fully conduct the tenant’s business … then a fair proportion of the rent and outgoings shall cease to be payable,” the clause says.

At Level 4 lockdown, it’s pretty obvious. No one is allowed into their buildings. It’s like the Red Zone without the tape.

But at Level 3, the words “fully conduct the tenant’s business” become more open to interpretation. 

If you are in a mall, nothing changes - as long as your lease has 27.5 or an equivalent clause (and unfortunately for tenants, some of the big commercial landlords don’t have that clause in their leases

Under Level 3, malls can’t open.

But what if, like Tom and Rosie, you can get into your shop or cafe, but your customers can’t. You might sell a bit online or as takeaways, but turnover is going to be a fraction of normal.

What then?

“Level 3 may turn out to be a disaster for us,” Tom says. “The implication of the clause is that we are no longer prevented from accessing our retail premises. I expect that our landlords will see this as a green light to return to 100 percent rent at a time when we can barely trade.

Online sales are about 20 percent of the couple's retail business. "This won’t pay the rent, let alone the cost of stock, web store, Vend and social media marketing.

 “We spoke to other retailers, including a florist today, and they are dismayed we’re all potentially going to be worse off.”

 Newsroom talked to two specialist commercial property lawyers and asked them when they thought.

Jane Holland is a partner with law firm Bell Gully. She confirms moving to Level 3 will make the situation way less clear than it was at Level 4, and the interpretation for clause 27.5 will focus around the extent to which a tenant can “fully” conduct business from the premises.

Bell Gully partner Jane Holland. Photo: Supplied

For some businesses nothing will change. Most bars have a liquor licence which doesn’t allow customers to drink off the premises, so they won’t be able to trade under the Level 3 rules. Same with hairdressers and other beauty shops - nails, eyebrows, waxes. Level 3 expressly forbids them from opening or from going to their customers’ houses. 

But Holland says with other businesses “there are more questions than answers when it comes to whether clause 27.5 rent suspensions apply. 

“For instance, if a restaurant can’t operate with customers on premises, but can sell its food online, does clause 27.5 apply at all? That hypothetical restaurant may be able to legally access the premises but can’t fully operate their business.  

“Landlords will consider that many premises can be accessed, and say that the clause does not apply, while tenants are likely to focus on the references in the clause to being unable to fully operate their business, and for a fair suspension of rent.”

There’s a similar message from Kate Searancke, a partner at law firm Tompkins Wake, although she has more positive news for tenants. 

Tompkins Wake partner Kate Searancke. Photo: Supplied

Searancke says although there is no longer a national state of emergency, Covid-19 will likely still be an emergency for the purpose of clause 27.5, and tenants should be able to argue for some rent reduction at least. 

“It will depend on the individual circumstances of the lease but it's unlikely tenants who can partially access premises in alert Level 3 will no longer be entitled to a rent abatement under clause 27.5, provided they are still unable to “fully conduct” their business,” she says.  

What may change is the proportion of rent a tenant doesn’t have to pay, she says. 

Holland says landlords and tenants need to continue to talk. 

“Many have reached a commercial solution for the last four weeks, and we would hope they continue to take a similar approach to Level 3.”

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