What does COVID-19 Alert Level 3 mean for commercial leases

Following the Government’s announcement that the COVID-19 alert level will drop from Alert Level 4 to Alert Level 3 at 23:59 on Monday 27 April, landlords and tenants will need to consider what this means for their commercial lease arrangements.

Following the release of details of what restrictions will apply to businesses and workplaces under Alert Level 3 it is clear that there will continue to be significant restrictions on the use of certain commercial premises for the foreseeable future.

Alert Level 3 restrictions

While there remains a lack of detail around the exact restrictions to apply at Alert Level 3, it is apparent that there will not be a great deal of difference to the restrictions currently applying under Alert Level 4.

At Alert Level 3:

• People must work from home unless that is not possible.
• Workplaces can only open if:
  • Workers are unable to work from home; and
  • Workplaces are operating safely (including meeting all health and safety requirements and utilizing alternative ways of working); and
  • Customers are not allowed on the premises; and
  • The businesses can trade without contact with the public.

While Alert Level 3 will allow many more businesses to resume, such as construction, manufacturing and retail and takeaway food services (as long as there is no physical contact with customers) there will still be a number of commercial tenants that are not able to access and use their premises to fully conduct their business.

Even those businesses that are able to access their premises may not be able to fully use their premises in accordance with the terms of their lease, eg restaurants will not be allowed to cater to dine in customers.

No access provisions

Since the Government imposed the Alert Level 4 lockdown at 23:59 on 25 March there has been a lot of debate around the right of commercial tenants to an abatement of rent during the current lockdown period. The answer to this question will depend on the specific wording of each lease. However, there has been a particular focus on the application of clause 27.5 of the standard Auckland District Law Society (ADLS) lease to the current circumstances, given its wide use and general acceptance in the market.

Clause 27.5 of the ADLS lease provides that a tenant is entitled to an abatement of a fair proportion of the rent and operating expenses if there is an emergency and the tenant is unable to gain access to the premises to fully conduct its business because of reasons of safety to the public or property or the need to reduce or overcome any hazard.

It is clear that clause 27.5 applies during the lockdown under Alert Level 4 but to what extent will it apply once the Government drops the alert level to Level 3?

Application of clause 27.5 at Alert Level 3

It seems likely that very little will change for the majority of tenants when the alert level is reduced to Alert Level 3.

Under clause 27.5, tenants will remain entitled to an abatement of a “fair proportion” of the rent and outgoings where they are unable to able to access and use their premises to fully conduct their business due to the restrictions imposed by the Government under Alert Level 3.

The question of what constitutes a “fair proportion” will remain the key issue for both landlords and tenants. While this will need to be determined on a case by case basis, taking into account the circumstances of both the landlord and the tenant, it seems clear that the “fair proportion” will be determined on the basis of the benefit that the tenant continues to derive from the premises during the restricted access period.

By way of example, under Alert Level 4, retail and hospitality tenants would have been entitled to a significant abatement due to their inability to use their premises, arguably even a 100% abatement of rent. At Alert Level 3, there is an increased ability for such tenants to use their premises, eg for takeaway food preparation and e-sales. This increased ability to use the premises for the permitted use under the lease, while not full use, will need to be taken into account when determining the “fair proportion”.

While each case needs to be assessed on its particular facts, commentary seems to indicate that, in addition to the above, the following will likely be relevant for determining what constitutes a “fair proportion”:

• The extent to which the tenant is still using the premises (eg an essential services provider);
• Whether the tenant is able to conduct business remotely (taking into account servers and other equipment within the premises which facilitate this remote working);
• The value inherent in the premises (eg fitout, storage, goodwill, business continuity); and
• The balance of the term of the lease.

One important point to note is that what constitutes a ‘fair proportion” will likely be different for rent and operating expenses.