1. Background:

a. At the date of this memorandum the Government has determined that Level 4 applies in relation to the Covid-19 pandemic. This precludes commercial tenants from carrying on business in commercial premises which are not an essential service. At the date of this memorandum Level 4 is applicable for a period of 4 weeks, and may be extended. For the purposes of this memorandum that period is knows as the “Lockout Period”.
b. Both landlords and tenant are considering whether or not:

i. The Tenant has a right to terminate a Lease;
ii. Whether or not the Tenant is entitled to reduce payment of rent or outgoings during the Lockout Period;
iii. How to calculate reduced rent and outgoings during the Lockout Period; and
iv. If the Tenant is entitled to reduced or nil rent and outgoings, whether they can deduct this amount from the rent and outgoings due to the Landlord.

2. Terms of the Auckland District Law Society Lease (“ADLS Lease”)

a. Clause 1.1 of the ADLS Lease includes the following provision: “All rent shall be paid without any deductions or set off..”. That clause makes no reference to outgoings.
b. Following the Christchurch earthquakes in 2012 a new clause was added to the ADLS Lease as clause 27.5, where the relevant parts of that clause are as follows:
“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: …
(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 ceased.”

c. The ADLS Lease prior to 2012 contained no provision relating to lack of access.

3. Right of Termination

a. The ADLS Lease contains an express provision, both prior to and after 2012, for termination of a Lease where the premises are destroyed in full or in part. The ADLS Lease after 2012 also provided that if the Tenant had no access for a certain period of time, then either the Landlord or Tenant could terminate the Lease. The default period was 9 months for this clause to apply.
b. The Courts have considered whether or not the doctrine of frustration applied to leases. This is where a contract ends if events occur which are beyond the reasonable control of the parties which would make performance of the contract impossible. An example of this would be a painting contractor who agreed to paint a house, and that house was destroyed in a fire. The painter could not be expected to paint the house, and also could not ask the home owner to pay them.
c. The leading case on frustrated contracts is National Carriers Limited v Panolipna (Northern) Limited [1981] AC 675. It was found that the doctrine of frustration did apply to leases in rare situations. The Tenant in that case sought to terminate their 10 year lease, as the only access they had to the premises was by means of a road which was closed for 20 months on account of a heritage building which was unsafe and might fall onto the road. The heritage building was not owned by the landlord. The Court found that a lack of access for 20 months over a 10 year period was not enough to say the lease was frustrated and should come to an end.
d. It seems clear that the doctrine of frustration will not assist most commercial tenants in terminating a lease, unless the term of the lease is particularly short, in which case the right to terminate has little commercial relevance e.g. if the Lease was a month by month lease, the tenant would just give 1 months notice anyway.

4. Can the Tenant reduce their rent and outgoings during the Lockdown Period?

a. For the 2012 ADLS Lease, as noted above, there is an express provision for reduction of rent and outgoings during the Lockdown Period. The elements needed, referenced back to the current circumstances are as follows:

i. An Emergency –Clause 45.1 of the ADLS Lease defines an emergency as including an epidemic which may cause loss of life. The Covid-19 epidemic meets this criteria.

ii. The Tenant must be unable to gain access to their premises, by order of a competent authority. The inability to access premises, for all other than essential services, arises under the Civil Defence Emergency Management Act 2002 and the Health Act 1956. This requirement is met under the ADLS Lease.

b. For the ADLS Lease in use since 2012, assuming that the Tenant cannot access their premises at all, Covid-19 permits the Tenant to reduce their rent and outgoings for the period where the Tenant is not permitted to have access to the premises.
c. The ADLS Lease prior to 2012 had no provision to reduce rent or outgoings during an emergency. The only clause which dealt with a similar scenario was an abatement of rent and outgoings where the premises were subject to partial or total destruction. The question then is whether or not a Tenant could seek a reduction in rental or outgoings in the absence of an express clause. This matter was considered in Grant v Hannay (2010) 11 NZCPR 283. The parts of that judgement of relevance are:

i. The premises were a Waiheke Island restaurant where the Landlord sought to terminate the Lease on account of the failure of the Tenant to pay rent;
ii. The Lease included the usual provision that there should be no right of set off or deduction;
iii. During the first 3 months of the Lease the Tenant did not have access to the premises on account of significant renovation works being undertaken by the Landlord. The Tenant considered that they should not be obliged to pay rent for that 3 month period;
iv. The Landlord succeeded in obtaining an order for termination of the Lease. The issue of the 3 month period where the Tenant did not have access to the premises was not an issue the Court needed to consider in detail as the rent arrears were far more than the 3 month period where the Tenant did not have access. The Court therefore did not need to consider in detail the 3 month period where the Tenant did not have access;
v. The Court did however consider whether or not a lack of access to the premises would give rise to abatement, and said that if the Tenant had a claim in damages against the Landlord, then they would in reality get an abatement of rental and outgoings but would need to show their claim in damages;
vi. The Lease, as noted above, precluded set off or deduction, so even if the Tenant had a claim for reduced rental and outgoings for the 3 month renovation period the Tenant could not unilaterally make a deduction against the rent and outgoings they were otherwise obliged to pay the Landlord.

d.  We consider that for an ADLS Lease prior to 2012, or indeed any lease with no provision as to reduced rent and outgoings during an emergency, that a Tenant may have a claim in damages for losses arising from the Tenant being unable to access the premises. We are presently considering the extent to which a claim for loss can be pursued where the cause of the loss is unrelated to the conduct of the Landlord, and we anticipate updating this article, or writing a further article, which considers this particular issue.  The difference though, as explained below in regard to set off or deduction, is that for a pre-2012 Lease the Tenant needs to prove its claim for damages, and cannot simply deduct any loss from rent and outgoings.

5. How to you calculate a reduction in rent and outgoings during a Lockdown Period?

a. It is submitted that calculation of any reduction in rent and outgoings for a pre-2012 and post-2012 ADLS Lease must be the same. It will be a measure of damages as to the loss suffered by the Tenant arising from their lack of access to the premises.
b. The express clause in the 2012 ADLS Lease refers to a “fair proportion” of rent and outgoings ceasing to be payable from the date from which the Tenant could not access the premises to the date that they are able to do so. The question then is how you determine what is “fair and reasonable”.
c. Clause 27.5 of the ADLS Lease has not been tested, and there is no caselaw. The only academic publication or commentary we can find is a thesis submitted to Canterbury University which was The Doctrine of Frustration, Commercial Leases and the Canterbury Earthquakes which was submitted in 2016. That thesis suggests that calculating any reduction in rent and outgoings may have regard to:

i. If the premises were within the “red zone” cordon of Christchurch, meaning there was a prohibition against public access, then a 100% of rent and outgoings often occurred. At the same time, the thesis noted that many Landlords did not argue this as they were insured for loss of rent on account of the earthquakes;
ii. An alternative argument made was that rental and outgoings should be paid to the extent to which the premises could be used. For example, if the premises were a retail shop, which carried stock, then the rent should reduce to a level which would be payable for storage, in which case outgoings should remain payable; and
iii. Rather than this being a legal issue, it is a matter of valuation evidence, and a registered valuer is better placed to determine the level of rent reduction.

d. Having regard to the analysis in the thesis referred to above our view is that only reducing rent to a level which involves storage would be at odds with the Lease, as to the intended use of the premises. We do not consider that a reduction in rent down to a level which was not the use sought by the Tenant is a sustainable argument.
e. We also need to consider the question of reduction of rental where the premises can be used during Covid-19. For example, a supermarket can remain open during Covid-19, and there should be no abatement of rent or outgoings.
f. We do consider however that there may be circumstances where a partial abatement of rent and outgoings would be a sustainable position. An example of this would be a business which supplied products to the health industry as part of their business activity, which was an essential service to be continued during the Lockdown Period, while other business activities had to cease for the Lockdown Period. If the “essential service” part of the Tenant’s business was 50% of revenue we could see an argument that any reduction in rent and outgoings should only be 50% of what was payable. Similarly, if you consider a business where its main activity is storage of paper files for businesses, its revenue would remain unchanged in the main, it would only have lost the opportunity to charge customers to retrieve and add files for storage. In this case, a registered valuer may determine that rent and outgoings should only reduce to the extent of the fall in revenue as most of the Tenant’s business of storage of paper files could continue.
g. The ADLS Lease refers to abatement of rent and outgoings. We can find no authority on the question of which outgoings should be allowed for in any reduction of outgoings. We speculate that rates should necessarily follow rent, but for insurance it is not unreasonable for the Tenant to keep paying insurance to insure against fire, earthquake etc.
h. We consider that a reduction in rent and outgoings by a “fair proportion” will always depend on the circumstances. In the main, the reduction will be for 100% of rent and outgoings, except perhaps insurance, for the Lockdown Period. The exceptions to this rule would be a Tenant who provides an essential service, or where the business of the Tenant does not require access to the premises as being a key matter to enable that Tenant to operate their business.

i. A further interesting question is what occurs after Level 4 reduces to Level 3 or below. If you consider a restaurant as an example, they may have capacity for 150 to dine, but may only be able to permit 100 to dine. We do not consider that the 2012 ADLS Lease makes any provision for a reduction in rent or outgoings except where the Tenant has no access. There is no provision for limited access. That being the case a Tenant in those circumstances would suffer loss, but would not have a right under the Lease to deduct for that loss. The Tenant would therefore need to bring a claim for its loss under the Lease under the arbitration provision of the Lease.

j. Another issue likely to arise is where the Tenant is in office premises, where staff can operate from home. In a pre-2012 ADLS Lease, we consider the ability for the Tenant to mitigate their loss by working from home may well reduce their claim for compensation. For the 2012 ADLS Lease we consider that the ability to operate from home is less relevant as the clause in the 2012 ADLS Lease refers to a fair reduction of rent and outgoings where the Tenant cannot “fully” operate their business, and it would be difficult to say that a Tenant can fully operate their business without access to its premises.

6. Can the Tenant deduct payment of rent and outgoings?

a. Clause 1.1 of the ADLS Lease, as most leases provide, preclude deduction or set off. In general terms if a Tenant has a claim against a Landlord, they cannot unilaterally deduct what is due to them from the Landlord in terms of rent and outgoings.
b. In Auckland Council v. Cosdo Equity Limited [2014] NZHC 1900 there was a specific provision in the Lease where the Landlord was obliged to repair any airconditioning defects within 24 hours, and if they did not do so, rent would be abated. The term abatement is more commonly used in relation to the clause of the standard ADLS Lease which deals with total or partial destruction of a building. The argument made by the Landlord was that the Tenant had to pay the full rental, and could not make a deduction themselves as this would be a “set off” which was prohibited by the Lease. The specific clause of that Lease provided that if the air conditioning was not repaired in 24 hours then “a fair proportion of rent and outgoings shall cease to be payable”. The Court determined that this provision of the lease was equivalent to abatement, and a rent reduction as provided for in this clause was not precluded by set off.
c. Clause 27.5 of the ADLS Lease since 2012 provides for “a fair proportion of the rent and outgoings shall cease to be payable…”. Considering the judgement referred to above, we consider that a Tenant may make a deduction against rent and outgoings during the Lockdown Period, as the Lease specifically allows for a fair proportion of rent and outgoings to “cease” to be payable.
d. We have also considered whether or not there is any statutory right of abatement or to pay reduced rental. Section 218 of the Property Law Act 2007 includes a statutory right of abatement for the matters listed in Schedule 3 to that Act. The events that give rise to a statutory right of abatement include fire, flood, explosion, lightening, storm, earthquake or volcanic activity. It also includes a right to abate where the risk is covered by the Landlord’s insurance. If the Landlord was insured against a loss of rent in a pandemic then the Tenant would have a statutory right to abate.
e. In regards to insurance most loss of rent policies we are aware of have an exclusion for loss, damage or interruption in connection with a “notifiable infectious disease” under the Heath Act 1956. Schedule 1 to the Health Act 1956 contains a list of notifiable infectious diseases. Covid-19 was added to Schedule 1 of the Health Act 1956 by an order in Council of 11 March 2020. Most policies will therefore provide no cover for Covid-19, and hence any statutory right to abate under Section 218 of the Property Law Act 2007 will not apply.
f. In regards to an ADLS Lease prior to 2012, or a Lease which makes no provision for the Tenant to “cease” to pay rent, or abatement of rent, then the Tenant may have a claim against the Landlord for their losses, but has no right to deduct against rent and outgoings. Instead they need to make a claim against the Landlord for their losses, and under the Lease will need to seek compensation in arbitration which is a lengthy and costly process. Some Landlord’s knowing the cost and time for arbitration will reject the Tenant’s request to reduce rent and outgoings. Other Landlord’s knowing the Tenant will ultimately prevail will allow a reduction in rent and outgoings by agreement.

7. Key Conclusions:

a. Where the Lockdown Period is insignificant compared to the term of the Lease, a Tenant will not be able to use Covid-19, and its lack of access, as a reason to terminate the Lease. The doctrine of frustration has a high threshold for leases, and we cannot see any reasonable basis for termination of a Lease.
b. If the ADLS Lease is the 2012 version or later:

i. The Lockdown Period under Covid-19 qualifies as an event which allows a reduction in rent and outgoings.
ii. In the main rent and outgoings, with the possible exception of insurance, will abate by 100% for the Lockdown Period. The exceptions to this will be businesses that operate an “essential service” during the Lockdown Period or circumstances where access to the premises is less relevant.
iii. The Tenant can deduct rent and outgoings, despite the Lease saying that they have no right of set off.

c. If the ADLS Lease is prior to the 2012 version, or if a lease makes no provision for “no access” then:

i. The Tenant will have a right to claim for its losses or damages, by not being able to access the premises, which may well end up being a fair and reasonable proportion of rent or outgoings, similar to the clause in the ADLS Lease since 2012.
ii. If the Tenant provided an essential service, entirely or in part, then in a similar way their claim to damages would be reduced.
iii. We do not consider that a Tenant can unilaterally deduct rent and outgoings payable to the Landlord. In the alternative, they need to pay and claim later.

d. Most business interruption insurance policies, and loss of rent, will have an exclusion for Covid-19. That is not to say that all of them have the same provision, so this needs to be considered on a case by case basis.
Disclaimer: This memorandum is general advice as to the issues relating to commercial leases as a consequence of the Covid-19 epidemic. Specific advice as to your specific circumstances should be sought, and this memorandum should not be relied upon as if it is specific legal advice to you