Commercial leases - calculating a “Fair proportion”

We continue to receive numerous enquiries from owners of commercial properties seeking our advice on how to deal with their tenants who are requiring rent relief arising from business disruption directly attributable to the Alert4 Covid 19 status declared by the New Zealand Government.  The government’s recently announced support for commercial landlords and tenants provides no form of rent relief to assist tenants.

The most widely used form of lease in New Zealand is the Auckland District Law Society form of lease.  Recently, the 2012 edition of this lease has received a fair amount of attention (refer our previous article here) and many commentators have quite rightly pointed out clause 27.5 likely governs the situation.

This clause provides that a fair proportion of rent and outgoings shall cease to be payable during an emergency which specifically includes an epidemic.  But what constitutes a “fair proportion” of rental is the core issue.  We have been unable to find any case law directly on clause 27.5 which could have provided some guidance as to how to interpret the phrase “fair proportion”.

We have had discussions with fellow professionals and other industry stakeholders such as Commercial Real Estate Agents, Valuers and Landlords and it appears some common threads are emerging as to how the words “fair proportion” are intended to be interpreted in this context.

It clearly is preferable for landlords to “front foot discussions” in negotiations with their tenants to find out how their business has/or will been affected both in the short to medium term.  We encourage Landlords to try to gain an understanding as to whether the tenant is encountering a short term cash flow issue in which case the timing of payment may be more relevant as opposed to reducing the amount of rental payable.

In our experience the starting point of any negotiation appears to be a 50% rental abatement for the next 1-2 months giving the parties a reasonable amount of time to complete a further assessment once the future economic climate becomes clearer.

The actual “fair proportion” is then weighted above or below 50% level depending on the agreement reached.

The business use of the premises is likely to be a relevant factor and some general principles have emerged suggesting some uses will require a greater or lesser reduction than others, i.e.;

• Industrial, warehousing and bulk retail appear to warrant a more modest percentage of rental relief. The rational being the premises still retain their core function of housing the business assets such as stock, plant and equipment.
• Office and retail may justify a greater rental reduction as these businesses have either ceased trading or have relocated to a home office type environment. 

We suggest the following factors should also be considered during the negotiation process:

• What is the financial impact of the access restrictions on the tenant? We are aware of some landlords requesting their tenant’s trading records so they can establish the actual financial impact on the tenant of the Alert 4 lockdown. 
• What area of the economy does the tenant operates in? This will provide a guide as to the severity of economic impact the tenant will encounter. The tourism and aviation industries seem to be particularly hard hit.
• How difficult will it be to find a new tenant? Landlords are urged to recognise the value of the parties’ long-term relationship and the costs of finding a new tenant should the tenant’s business fail without Landlord support over the short to medium term.  There may be an oversupply of some commercial properties which will then lead to longer vacancy periods before a replacement tenant is secured.  It is also possible that inducements to attract a good quality tenant such as rent holiday or relocation assistance may become more common than they have been previously.  There are also the costs of third parties such as Valuers, Real Estate Agents and Compliance Consultants.
• What are the practicalities of recovering outstanding rental etc? Terminating a lease and pursuing a personal guarantee can be a lengthy and expensive process with the potential of there being no financial result at the end.   It is highly possible that tenants will have trusts to protect any large assets such as family homes.   See our article on the governments recent announcements on extending time frames before landlords can terminate leases and mortgagees can exercise rights to sale or repossession.

Finally, in conclusion, our philosophy is that a negotiated settlement that by and large recognises and accommodates each parties’ needs will provide the foundation of a long-term commercial relationship for the parties is the preferred outcome. Almost invariably it is the most cost efficient outcome for both parties as opposed to the cost and uncertainly of embarking on a more formal resolution process.

We have not addressed the issue of what other remedies may be available to the parties in this commentary, e.g.; lease cancellation.  We are hopeful the Alert 4 lockdown will have been successful and on the 22 April 2020 we can all begin to operate in a more normal and business friendly environment.

Please feel free to contact our team at Turner Hopkins should you wish to talk further about the issues raised herein.

Stay safe
Mike Newdick