By: Jeff Kenny
Published: 18/07/2012
A break clause may benefit a landlord in a rising market.

Alternatively, a tenant can also benefit from a break clause because it helps them manage risk.

One important thing to keep in mind when looking at break clauses it that the sanctity of contract and property rights[1] are critical.  A break clause terminates property rights. So the Court takes a cautious approach and strictly construes a break clause.  Any conditions or notices required by the break clause must be met within any time limits specified.
 
Property Council Retail Lease break clause
The current Property Council Retail Lease is more landlord friendly than the ADLS Lease. The break clauses are contained in clauses 7.1 and 7.2

Clause 7.1 provides
"If the premises are damaged or destroyed so as to render them unfit for use or if the Centre shall be totally destroyed or if any part or parts of the Centre shall be so destroyed or damaged as to render the Centre substantially unfit for use and if repair and reinstatement shall in the opinion of the Lessor be impracticable or undesirable then at the option of the Lessor the Lease shall determine as from the date of such destruction or damage but without releasing the Lessee from Liability for Rent and other money up to that date or any previous breach of the Lease."

Clause 7.2 further provides:
"If the premises are damaged but are not unfit for use and there has been no damage to the Centre to the extent that the Lessor is faced with a major rebuilding thereof (the Lessor to be the sole judge of what shall constitute "major rebuilding")… then the Lessor shall reinstate the premises."
 
Ambiguities in Clause 7
Clause 7.1 is not straight forward. The clause can be read in at least two different ways.

One can read the clause as:

"That the premises are damaged or destroyed so as to render them
1.         unfit for use; or
2.         if the Centre shall be totally destroyed; or
3.         if any part or parts of the Centre shall be so destroyed or damaged as to render the Centre substantially unfit for use and if repair and reinstatement shall in the opinion of the Lessor be impracticable or undesirable

then at the option of the Lessor the Lease shall determine as from the date of such destruction or damage but without releasing the Lessee from Liability for Rent and other money up to that date or any previous breach of the Lease."

Or alternatively:

"That the premises are damaged or destroyed so as to render them
1.         unfit for use; or
2.         if the Centre shall be totally destroyed; or
3.         if any part or parts of the Centre shall be so destroyed or damaged as to render the Centre substantially unfit for use

and if repair and reinstatement shall in the opinion of the Lessor be impracticable or undesirable then at the option of the Lessor the Lease shall determine as from the date of such destruction or damage but without releasing the Lessee from Liability for Rent and other money up to that date or any previous breach of the Lease."

There are also issues about what “unfit for use” means.

The property Council has tried to tidy up these problems in its new office lease but the provisions are still unsatisfactory.
 
Auckland District Law Society Lease break clause
A break clause is contained in clause 26.1 of the ADLS Deed of Lease (5th edition, 2008)

This clause provides:

"26.1     If the premises or any portion of the building of which the premises may form part shall be destroyed or so damaged

(a)        as to render the premises untenantable then the term shall at once terminate; or
(b)        in the reasonable opinion of the Landlord as to require demolition or reconstruction, then the

Landlord may within 3 months of the date of damage give the Tenant 20 working days notice to terminate and a fair proportion of the rent and outgoings shall cease to be payable as from the date of damage.


Any termination pursuant to this clause shall be without prejudice to the rights of either party against the other."
 
Russell v Robinson
The meaning of the word “untenantable” was explored in Russell v Robinson. The Court referred to a number of cases to provide guidance for the term "untentantable."

The Court made reference to DFC New Zealand Limited v Samson Corporation Limited which described untenantable as:

"Nothing more nor less than bale to be used and enjoyed by tenant.  Within that general catalogue of clause 26, subclause (a) involves some degree of permanence.  In other words, something which is merely transitory or temporary will not make a building untenantable.  However, where there is a substantial interference with the tenant's ability to enjoy, use and operate, particularly when one is talking about commercial premises, then you have "untenantability."

The cases identified the need for a level of permanence in relation to the damage.
It would not be reasonable to allow a tenant to terminate a lease if the damage was able to be repaired quickly.

However, on the practical application of this limb we are left questioning how long does the tenant have to be unable to occupy or use the premises.

It appears that the test will be based on the time it will take to reinstate or repair the damage in relation to the balance of the remaining term.

This test was applied in DFC New Zealand Limited v Samson Corporation Limited.  This case involved a fire in the premises which damaged part of the building.  The damage was going to take about 10 weeks on a 6 year lease to repair.  The Court held that the damage was of a temporary nature and the claim that the premises were "untenantable" must fail.

In Russell v Robinson a fire broke out in the building causing significant damage.  Repair was going to take 10 months on a 4 year lease of the premises.  This was held a sufficient time to satisfy the permanence limb of the test.

Comparing DFC New Zealand v Samson Corporation Limited with Russell v Robinson we see that a repair time of say 20 % of a tenant’s lease term at first glance appears to be a good guide as to the level of permanence.  However, when we apply this to a 100 year lease a 20 year repair seems a very unreasonable length of time for a tenant to wait to be able to occupy and use the premises for the permitted use.

In Russell v Robinson the lease was for a term of 4 years with one right of renewal for a period of 4 years.  The Court did not seem to take into account the right to renew the lease but this is a moot point.

The level of permanence is therefore likely to be decided on a case by case basis taking into account the term of the lease. 

Permanence of damage is required because at the time of contracting the parties would not expected minor damage to trigger a termination of the lease.  The parties would only expect a right to terminate to arise if there had been a substantial interruption.

The context of the lease will also be taken into account, for example, if a tenant was to take a lease in war times the parties would be implied to have accepted the risk of damage to the premises.[2]
 
GP 96
G P 96 Limited v F M Custodians Limited involved the use of s26.1(a) of the ADLS lease and issue of untenantability arose.. An inner city hotel which was damaged in the February Earthquake.  The landlord sent a letter to the tenant to say that the lease was terminated pursuant to clause 26.1(a) of the lease.  The tenant argued that the premises were not "untenantable".

The damage was described as being "minor structural and moderate cosmetic damage" and was going to take approximately 15.4 weeks to repair.  The lease was for a term of six years with two rights of renewal for a period of six years each. 

The tenant disputed the validity of the termination of the lease.

On deciding whether the premises were "untenantable" for the purposes of clause 26.1(a)  the repair was balanced against the remaining term of the lease.  The Judge held that the remaining term of the lease was sixteen and a half years.  The rights of renewal were included as being part of the term.  The Judge held that a 15.4 week repair was not sufficiently permanent for the premises to be held "untenantable".
The judge was also not prepared to tackle the issue of the impact of buildings being in the "red zone".

One concerning element of this judgement is that the renewals are taken as being part of the term of lease.  The exercise of a renewal of lease is at the option of a tenant and once exercised the parties enter into a new lease for the renewed term on the same terms and conditions as the old lease.  The rationale behind the inclusion of the renewals overlooks common leasing sense.

It may be more appropriate to require a level of permanence of damage to the extent that it substantially interferes with the tenants use of the premises under the lease.

Understandably many time frames will be uncertain.  It may therefore be preferred in light of recent events that "uncertainty" is also taken into account in relation to level of permanence. 

When attempting to terminate a lease using clause 26.1(a) a tenant or landlord should first make enquiries as to the extent of the damage and timeframes in which such damage would be likely to be repaired in the post-quake building climate.  By doing this they will have a gauge as to their ability to argue that they rightfully exercised their right to terminate the lease if it is challenged.
 
New Lynn Compliance Centre Ltd v Birdwood Custodians Ltd
Unfortunately this case adds further confusion. The premises were damaged by fire and the landlord purported to terminate the lease. The tenant counter-claimed for damages for conversion of chattels.

Whether the tenant could succeed depended on whether they had been unlawfully denied entry to the premises. Clause 26.1 of the ADLS Inc lease was crucial to these issues.

The Court held that cl 26.1(a) is for the benefit of the tenant and the question of “tenantability” should be viewed from the tenant’s perspective.

The Court found that that, by contrast, cl 26.1(b) logically applies where the tenant remains in possession and the landlord wishes to terminate. So that clause was for the benefit of the landlord.

Therefore cl 26.1(a) could not be interpreted  to allow a landlord the choice about whether to terminate the lease or not. Any “choice” is reserved to the tenant about whether the premises remain tenantable.

It would be expected this choice would be exercised reasonably. If a tenant perversely chose to stay the landlord could always terminate under cl 26.1(b).

This is contrary to Russell v Robinson where the Court found that untenantability is an objective test.
 
 
WHAT TO DO

These cases show the messy situation with break clauses under NZ standard leases. They all share the common problem of:

1.         Not being clear enough in real world situations.
2.         Not dealing with real world risks such as lack of access or lack of services.

Not only are the break clauses inadequate but the insurance provisions fall short as well.
As background to all that, in hindsight I don’t think insurance brokers, lawyers, landlords and tenants have paid enough attention to understanding risks (although this is hard to do), allocating risks under lease terms, and aligning insurance cover to those risks. I think we should think about changing some things to fix it.

Some ideas are:

Landlord to insure building
Insurance might not be available at all. Standard clauses allocate risk unfairly in that situation as the landlord not only loses the building from disaster but can be sued for breach of lease by tenant. The amount of the damages claim by the tenant will probably be unclear but some cases have found it to be the amount of the insurance payout that should have been received. I don't think that's right here though. It will probably be the cost of relocating and possibly lost profit.
Also consider:
  1. Only indemnity insurance may be available.
  2. Insurance excess terms and conditions.
  3. The clause should also be clear about whether the landlord still has to insure even if the tenant voids the policy.
Level of insurance
Standard clauses don't properly comply with s271 of the Property Law Act 2007. Consider allowing the landlord to claim excess after damage but before termination. However landlord still cannot recover excess if automatic termination caused by disaster.

Tenant to claim on its insurance
Consider requiring the tenant to claim on its own insurance to repair fitout. An alternative is to require repair regardless of insurance but might be seen as unreasonable.

Disclosure of terms and conditions of Landlord's insurance policy
Consider requiring the landlord to disclose policy terms to tenant on request. This is important for a tenant as they have to ensure they don’t void the policy.

Disclosure of information by Tenant relevant to obtaining insurance
Consider requiring the tenant to disclose information to landlord on request. This is important for a landlord as they have to give information to their broker when arranging insurance.

Notification of damage or loss
Consider requiring the tenant to disclose damage they know about to landlord. This is important for a landlord as they may have to disclose damage to their insurer under the policy terms.

Damage or destruction
Consider allowing termination if the building cannot be accessed or repaired for a long period (say 6 months). This corrects the uncertainty problem about termination under the existing lease provisions.
The landlord will not wish to rebuild if the tenant can terminate so a provision is added about that.
The landlord should discuss this provision with the broker and align it with loss of rents insurance cover.

Partial destruction/damage
Consider allowing the landlord to terminate if new insurance cannot be obtained as well. Again standard clauses do not deal with this fairly.
However, this clause can be of concern to a tenant as the landlord is sometimes only obliged to reinstate the premises rather than the building. A tenant might want to amend that.
Consider adding a right to a lease extension in case the tenant has to repair fit out near the end of the term.

Abatement
Make sure this covers rent and Opex and the abatement is triggered by damage or lack of access or services etc.
Also amend the standard clause to say the tenant isn't allowed rent abatement if they have voided the insurance. This corrects the unfair position of the landlord missing out on loss of rents cover and payment by the tenant where the tenant is at fault in voiding the policy.




[1] A man's house is his castle and his rights in relation to his castle should not easily be taken away
[2] As in Adam v Kerr (1949) WL 9818

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