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Quakes Prompt Rethink of Leases
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By: Jeff Kenny
For instance, the Canterbury quakes left many landlords and tenants unsure whether their leases were still in place. They were also uncertain about what happened if premises were cordoned off and whether the tenant still had to pay rent.
For some tenants and landlords, the uncertainty has been crystallised by later events. But for some, the uncertainty will remain and may be expensive to resolve. And this has a knock-on effect leaving parties uncertain when dealing with their insurers.
Landlords, tenants and their advisers need to learn from this. In cities such as London and New York affected by terrorism, building owners and tenants have learned from their new situation and responded to it. We should too.
The new insurance environment means insurers require much higher premiums and excesses. Some premises may simply be uninsurable against earthquakes, and this will have to be taken into account.
This will be a very important issue when the rebuild starts in earnest. Both landlords and tenants will need to be careful to seek legal advice about leases and understand how risks and costs are shared. In addition, both parties will need to make sure their bankers and insurance brokers approve of their lease agreements.
So, with this in mind, if a landlord or tenant is thinking about entering into a new lease, what sort of terms should they be looking for?
Standard clauses say the landlord has to insure the building. What if insurance is not available or the terms are too tough? If the landlord does not get insurance the tenant will suffer if the building is damaged and could sue the landlord. Therefore special clauses should be included recognising that insurance might be unavailable or limited.
Insurance excesses have now become so large that they pose a significant risk for landlords, tenants, and financiers. All will need to understand who pays what if a building is damaged and make provision for it. Liability for excess can be shared by the tenant agreeing to pay a share, in a lump sum or with outgoings. This sort of thing is regulated by the Property Law Act 2007 and requires special wording.
Alternatively the landlord could try to insure the excess amount. This is expensive but if the landlord can do it the tenant will usually be liable for the premium. It is a good idea for landlords and tenants to discuss this issue as part of the leasing process. Ideally they would then agree on how to share the risk of damage within the excess amount.
A landlord will not want to have a damaged tenant's fitout inside a building that has been repaired. So the landlord will want to know that the tenant has insurance cover to fix damage they are responsible for. The landlord will then want the tenant to promise to claim on their own insurance for the repair. Such additions to leases also need special clauses.
Usually a tenant has to ensure they do nothing that voids the landlord's insurance policy. It is in both the landlord's and the tenant's interest that the insurance works properly, so it is a good idea for the lease to require the landlord to disclose the terms of the insurance policy to the tenant. It is a good idea for the lease to include a provision covering this disclosure.
Standard form leases do not deal properly with what happens when premises are badly damaged or cordoned off. When something like this happens, and there is a contract involved, the law of frustration occasionally comes into play. Frustration is very rare and occurs when something outside the parties' control makes the contract so radically different that they could not be expected to follow it. Frustration is especially a rare clause in leases. So because this frustration hurdle is high it is common for landlords and tenants to lower it by including clauses in the lease to deal with some risks.
One such clause is called a breakout clause. For this to work, the particular situation has to be within the scope of the clause. It is also a good idea for a breakout to be clear - common forms of lease include them but they often fall sort of the mark.
So landlords and tenants should think about making some changes. One key change is to put a time limit on the premises being out of commission so that landlords and tenants have more certainty about whether their lease is terminated or not. Another key change for tenants is to make the trigger for a breakout clause not just serious damage to the premises, but a lack of access or essential services.
The landlord should discuss this type of provision with their insurance broker and align it with loss-of-rent insurance cover where possible.
Breakout clauses go hand in hand with another common contract term dealing with rent abatement. Under such a provision, a tenant's rent is suspended if the premises are damaged. From a tenant's perspective it is a good idea to extend this so that it applies where they cannot get access as well.
Where a building is damaged but the lease is not terminated, the landlord will want some special lease provisions. For instance the landlord may not want to rebuild unless the tenant is committed to a lease of a reasonable length. So a landlord might want to reset the lease term and get confirmation from the tenant that they will remain. The landlord will also want to make sure they have sufficient insurance money and consents to rebuild, although this is usually dealt with in standard leases. One thing a landlord might wish to add is whether the rebuild is economic, as it is undesirable to have to rebuild a white elephant.
These are just some of the lease issues that landlords and tenants face. They are very important in the current environment and will remain so. When rebuilding gets into full swing, further risk issues will become important which landlords and tenants should get good advice on before signing on the dotted line.
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