This article was updated on 9 June 2020 to reflect further guidance from the government.
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 (ADLS) 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 contain no similar provision.
Some landlords and tenants have reached commercial agreements in which rent is abated or deferred during the lockdown, while others have not been able to reach agreement. Negotiations have been ongoing over the past few months, and many of the agreements reached relate to leases which do not include clause 27.5 (or a similar clause).
Now more than 10 weeks after New Zealand moved to Alert Level 4, the government announced this week that 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.
While the government has not yet drafted the legislative provisions intended to give effect to this new implied term, it has released the minutes of the Cabinet Committee decision. We summarise the key points that are expected to be included in the legislation, based on those minutes.
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, and will only apply if:
- to sites where the tenant employs 20 or fewer full-time equivalent staff,
- if the tenant is New Zealand-based, and
- if the tenant has not already come to an agreement for a “rent adjustment" with their landlord.
What is the employee threshold?
The Cabinet paper had recommended that a qualifying tenant would be one with 50 or less full-time equivalent staff. The Cabinet decision instead reduces that number to 20, but assess it based on the number of staff that the tenant employs on each leased site, rather than the tenant's business as a whole. This change will benefit tenants with dispersed businesses (such as service stations) over tenants that operate from one site (such as a manufacturer). It will also mean that some large businesses may have a claim for those sites where 20 or less staff are employed.
What is a New Zealand-based business?
The Cabinet Committee minutes note that 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 have proceeded on the basis of the existing terms of their lease and the current statutory provisions, and reached an agreement with their landlord about a rent adjustment, will not have the benefit of the new implied term. It also appears that a tenant who has agreed a rent deferral (rather than a rent reduction) will not be able to revisit the arrangement either.
Some tenants will no doubt have already reached agreement with their landlord 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 change in the terms of their lease.
There may be an exception to this: if a landlord has insisted on strictly enforcing the terms of the lease (in response to a tenant's request for a rent reduction or other arrangement), then the new implied term will apply.
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". In contrast, clause 27.5 of the ADLS lease refers to the tenant's ability to gain access to the premises to “fully conduct" their business. In the absence of any guidance on the interpretation of “material loss", this may lead to a further area of dispute between landlords and tenants, as well as disputes as to what period of time the “material loss" must relate to.
For example, a tenant may have suffered significant losses during Alert Level 4, but may have seen an increase in revenue during Alert Levels 3 and 2. Should these periods be considered individually or in the aggregate?
What are “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 only to restrictions directly applying to the tenant's business, such as prevention of access, or if regard needs to be had to consequences arising from restrictions more generally. For example, 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 that the controls on international flights cannot be taken into account?
How long does the implied clause apply?
The amendments to the Property Law Act are proposed to apply from 4 June 2020. This means that the implied term will come into force on this date, even though it is yet to be drafted. It is unclear whether the implied term will allow parties to reassess rent that became due before 4 June 2020. The Cabinet Committee minutes note that under Alert Levels 4 and 3, some landlords demanded full rent from tenants, and some tenants refused to pay any rent at all. The minutes record the Minister of Justice's concern that “some landlords and tenants are not coming together" to reach agreement, and say that the purpose of the amendments is to “provide landlords and tenants more tools to assist in their negotiations". This suggests that the amendments will apply to rent that fell due under Levels 4 and 3.
However, guidance published by the Ministry of Justice on its website says that the implied term will not apply to rent obligations arising before 4 June 2020.
This is obviously a critical issue for resolution, as the scope of the proposed amendments will be significantly reduced if they only apply to the impact of COVID-19 restrictions on rent obligations arising on or after 4 June 2020.
The government is proposing that the implied term will apply for six months, with the Cabinet Committee minutes noting that there is “some benefit" in allowing parties to agree to a “slight" rent reduction for a period following the end of formal restrictions on business.
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 the same as that used in the ADLS lease. That language has caused considerable debate as to its proper interpretation. Our earlier updates here address the meaning of a “fair proportion" of rent and outgoings and provided an overview of the competing arguments that landlords and tenants may make. For example, tenants will argue that the amount of the rent abatement under the clause is to be assessed by reference to the tenant's ability to access the premises to fully conduct their business, rather than on 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. Those factors go much further than focusing on the effect of the restrictions on the tenant, and require the financial position of the landlord to be taken into account. In particular, the legislation will specifically allow the assessment of a “fair proportion" to take into account:
- the impact of the COVID-19 restrictions on the tenant's business, including the impact of restrictions that are no longer in place,
- 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,
- any difference in size and resources between the parties, and
- any other relevant factors.
How are disputes to be resolved?
If the landlord and tenant are unable to agree on a fair proportion, they will be required to resolve the dispute by arbitration. The government has said that it will provide a subsidy of NZ$6,000 (including GST) per dispute to contracted providers to deliver a “streamlined" arbitration service. However, the parties will still need to meet their own legal (and other) fees associated with proceeding to arbitration.
What about an existing 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.
Further, the government has said that it “may be" necessary to modify by statute any leases with an existing clause 27.5 so that the existing clause is consistent with the new statutory clause. If this is followed, the new law will effectively repeal existing contractual terms agreed to by the parties and replace them with an alternative clause drafted by the government after the fact. This would be the case, for instance, of the PCNZ Office and Retail Leases which contain a more limited “no access" clause.
Comment
The Cabinet Committee minutes note that the government's proposals “go against the legal principle of sanctity of contract". This is because, as the minutes note, “they would add contractual terms and obligations to leases that the parties did not mutually agree".
Although the Property Law Act already implies some contractual terms into leases, the parties are aware of these terms before they enter the lease. Under the government's new proposals, existing leases will be retrospectively amended by the Act.
Landlords are therefore 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 who have not yet settled.
Finally, the terms of the proposed draft legislation will be critical. In the interim, we expect that tenants and landlords will not want to agree on any reduction in rent until the legislation is passed.
If you have any questions about the matters raised in this article, please get in touch with the contacts listed, or your usual Bell Gully adviser.
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Disclaimer
This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.