K3 Insights

Landlords and commercial tenants are negotiating or arm-wrestling over "who pays" while premises are unoccupied under Levels 3 & 4 of the Covid-19 Alert. Commentary to date has favoured tenants, suggesting that standard clause 27 of the updated ADLS lease requires reduced rental while premises are empty.

While a negotiated outcome may be desirable, some tenants may be overstating their leverage, based on an incorrect reading of Clause 27. The message that tenants can simply avoid paying rent is wrong; it is also unreasonable, as landlords have fixed costs that must be met. Fairness is a 2-way street.

The fine print in Clause 27.5 states “A fair proportion of the rent and outgoings shall cease to be payable”.

As with most contractual disputes, the outcome depends on a few key words, adopting a plain reading and having regard to context. The obvious issue is the meaning of "fair proportion", in light of Level 3 or 4 Covid-19.

"Fairness" is unlikely to mean zero. The first issue that must be in everyone’s mind at that point is what does a “fair proportion” mean? Clearly it can’t be nothing, can it? What do you have to have regard to? The fact the office is being used to house all of the business assets? What does "fair" mean in this context?

Isn’t the clause at its heart a quick and dirty attempt by the drafters to set up some form of future discussion to “agree to agree”? And as everyone knows agreements to agree are not binding. So isn’t this clause so uncertain it has to be struck out of the contract. There is room for a view that a Court would have to strike this clause out. But is this the end of the matter?

No. Arguably not. The same ADLS lease includes an arbitration clause. So if this clause hasn’t been removed then the parties have agreed to refer all disputes to an arbitrator and not the Court. It could then be open for a tenant to argue that in contractually providing for an arbitrator, the parties have impliedly included the following wording into clause 27:

“The parties agree that if they cannot agree on what constitutes a fair proportion of rent and outgoings for this clause” then they shall appoint and arbitrator who shall determine what a fair proportion is, acting reasonably”.

So what is a fair proportion in this context? I would argue that this would be produced by a suitable valuer adopting the overriding economic arguments relating to the business and its use of the premises.

In essence it would be an economic analysis of the nexus between the use (or loss of tenant’s use) and the tenant’s business.

For example, if the tenant was a restaurant then you would expect the use and business would be completely linked, so it would be fair for the tenant to have a substantial rent reduction, even as high as 100%.

Their business ended with the lockdown. It may require an assessment of the “business” once all of the available subsidies and government supported banking facilities have been quantified.

However, if the tenant was a professional services firm, that had all its staff working remotely and the premises had little or no nexus with their business then the fair proportion could be nil.

Any loss in business could be attributed to normal business factors outside of the premises and it would be inappropriate to transfer all this risk to the landlord.

The government has set up substantial business assistance in the form of wage subsidies and banking support (including government backed guarantees). It is not the time for tenant’s to try and improve their position at the expense of the landlord.

Finally, without amendment, the ADLS lease does not allow the Tenant to unilaterally stop paying rent or part of the rent. It can only do this by agreement, with a Court order, or as determined by an arbitration.

It may well be that landlords choose to work with tenants through this, but that is at the landlord’s discretion. I wouldn’t just decide to drop rents. If I were a landlord I would want to carefully consider this and record any agreement in writing (a deed might be difficult/impracticable in the current environment) .

For example, you may want to extend the term of the lease by the corresponding period of the rent reduction, at the landlord’s option. As with all these matters, a degree of caution is prudent.