With the totally new situation we have been thrown into due to COVID-19, many people are facing uncertainty about their rental obligations as landlord and tenant. Because lockdown has prevented tenants from accessing their business premises, landlords may be seeking cover from their insurer for their tenant’s rental costs, while tenants may be seeking reduced rent from their landlords.

Will the landlord’s insurer pay the tenant’s rental costs?

The first step is to determine whether the landlord’s insurance covers loss of rent. If loss of rent is covered, the insurer will pay the landlord their tenant’s rental cost when the tenant is unable to access the property because of a covered loss.

Losses which are covered by the policy will be defined in the landlord’s policy document. However, as a general rule, loss will be defined along the lines of ‘physical loss or physical damage’. The courts have directly addressed the interpretation of ‘physical loss’ in a line of cases following the Christchurch earthquakes. Unfortunately for both landlords and tenants, physical loss does not include the inability to access the premises due to lockdown.

The most relevant approach to interpreting “physical loss” is the High Court’s decision in O’Loughlin v Tower Insurance Ltd in 2013.[1] In that case, the residents were prevented from accessing their property due to a Red Zone being established after the Christchurch earthquakes. The court stated that physical loss had been treated in many cases as requiring disturbance to the physical integrity of the property. On this basis, it went on to hold that there was no physical loss to the tenants.

In 2015, the Court of Appeal took the same approach in its decision in Kraal v Earthquake Commission.[2] The court interpreted “physical loss or damage” as requiring a physical effect on the property. A council notice preventing residents from accessing their property therefore did not meet this threshold.

The situation faced by the tenants in both of these cases is similar to the situation of many tenants during the COVID-19 lockdown. In both situations, the inability to access the property is due to government regulation rather than physical damage to the property.

Therefore, the courts have made it clear that a standard loss of rent clause in a landlord’s insurance policy, which only covers physical forms of loss, will unfortunately not cover the rent of tenants who can’t access the property during the COVID-19 lockdown.

Is the tenant entitled to discounted rent?

Many leases use the standard form leases produced by ADLS. Under a standard ADLS lease entered into from 2012, clause 27.5 will entitle a ‘fair proportion’ of rent to be discounted when there is no access to the premises in an emergency.

The Property Council has been putting together a rent subsidy proposal for the government and are anticipating a government announcement will arrive soon. However, in the meantime, we have no guidance from either the government or the courts on how to determine what a ‘fair proportion’ of rent is.

As a result, there has been a large amount of discussion around how to interpret a fair proportion of rent. There is widespread consensus that setting a universal proportion of rent to be discounted would not be the right approach, given the individual circumstances of each tenant and landlord relationship.

The Property Council has made it clear that the focus should be on tenants and landlords negotiating in good faith, while finance minister Grant Robertson has asked landlords to work together with their tenants.

Joanna Pidgeon, a member of the ADLS property law committee, states that both landlord and tenant should come to the table with evidence of what is a fair proportion given their particular circumstances. The Chief Executive of the Property Council, Leonie Freeman, has stated that when negotiating, parties should take into account their contractual position of their obligations under the lease itself, the commercial position of ensuring the survival of businesses, and the ethical position of what the fair thing to do is for both the parties and the community.

Further discussion has proposed that parties should consider to what extent the tenant is still using the premises (e.g. for storage) and the fair cost of that use, the ability of the tenant to work without accessing the premises and how their work has been affected, and the cost of expenses such as rates and insurance which the landlord (or possibly tenant) will still be paying. Both landlord and tenant should also consider how their approach to negotiations might affect their relationship in the long term.

It is therefore down to landlords and tenants to work together to reach a fair solution. The factors discussed above should provide some insight into what is fair to each party. However, each landlord-tenant relationship will have individualised circumstances which affect their negotiations. Parties should discuss these circumstances in good faith to reach a mutually satisfactory outcome, and record that outcome in writing.

Unfortunately, it won’t always be possible to reach agreement. Where you come to a standstill in negotiating, it is always open to either party to propose mediation. At mediation, an independent mediator will help both parties to talk through their position and work towards a solution. A mediator will never impose a decision on the parties – it will be down to landlord and tenant to reach agreement.

If mediation is unsuccessful or the other party refuses to attend, clause 43 of the standard 6th edition ADLS lease allows either party to refer the matter to an arbitrator. However, clause 43 states that before a dispute can be proceed to arbitration, the parties must try to reach an agreement and the referrer must propose mediation to the other party.

This article was written during COVID-19 Alert Level 4 lockdown.  If you would like to discuss your commercial lease and what your position is in relation to rent reduction during lockdown, please do not hesitate to contact us.

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