Buried in the back of many leases are clauses which relate to both force majeure events and damage and destruction. For many years in New Zealand (and presumably Australia) these clauses were largely untested and were considered boilerplate.  

In light of recent natural disasters, and notably the Christchurch earthquakes, these clauses are being interpreted and applied in a manner which has had some surprising results.

The "drop-zone" or cordon issue

Typically a lease states that if a building is damaged (so as to make the building untenantable) then the lease will automatically terminate.  This is standard language that is used in most leases in New Zealand.  In an earthquake scenario this is easily applied, provided as a matter of fact it can be shown that the building is not tenantable as a result of damage.  There is some limited case law in New Zealand that describes what "tenantability" means:

"[Tenantable] means nothing more nor less than able to be used and enjoyed by tenant.  [It] 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’."

There are a number of buildings in Christchurch where tenants cannot gain access to them because they are within a cordon, or a "drop-zone" of other buildings which may collapse.  However, it is as a result of health and safety, not damage, that the buildings are not able to be entered into and used.  Therefore the standard wording does not apply.

Because leases are typically silent on this point, the lease will not automatically terminate and remains in place.  Whether an abatement of rent and outgoings will apply will depend on the individual lease and possibly the consent/ agreement of the landlord.  The standard form of lease however, only abates rental where there has been damage - not a lack of access.  Under standard provisions, it is the tenant who assumes this risk.

Who should bear the risk?

Going forward, the question is raised as to who should bear the risk of not being able to access the workplace - the landlord or the tenant?

Most people consider that in this situation the tenant’s obligations should be relaxed or terminated on a “user pays” argument i.e. if the tenant cannot use the premises, then the tenant should not pay for it.  However, how long does a tenant have to be “locked out” before termination or rent abatement should apply?

The tenant may be able to source alternative premises and continue to work - a lot of professional firms for example have sufficient remote access that business can continue from home, or other temporary offices.  Many tenants have business continuity plans in place and are able to keep operating if the premises are inaccessible. In that light, a tenant is better placed to manage the risk than the landlord.

The landlord is not so lucky. As the owner of a property in a "drop-zone" they cannot relocate the building. The building may still be tenantable.  The landlord is holding up its end of the bargain under the lease and the tenant has contractually agreed to pay the rent.  And of course, there are still bills to pay - the landlord’s financier is not going to stop charging interest on any debt outstanding on the property, and expenses may continue to accrue.

Drafting new clauses

As the standard damage and destruction clause does not apply, leases currently being drafted in New Zealand are anticipating the "drop-zone" scenario.  Typically they are being redrafted by tenants who want to ensure that they have the flexibility of being able to terminate the lease if, in the event of a natural disaster, they cannot access their building.  This sort of clause will apply even when the building has not been damaged.

This risk issue is, as you would expect, ultimately being decided by insurance brokers.  Is the tenant or landlord in the best place to get business interruption insurance for this contingency?  Typically if a landlord is going to take on the risk of a major disruption denying a tenant access, then this will increase the landlord’s insurance costs.  This will be passed through to the tenant by way of increased operating expenditure and/or the rent.

Alternatively, the tenant could insure this risk itself.  Some of the major corporate tenants with group policies may find this more cost-effective.

To date, the response we have seen from insurance brokers has been mixed; brokers on some leasing transactions differ as to which party is best placed to hold this insurance.  This uncertainty is not surprising given the current state of the insurance market generally, in the wake of recent natural disasters.

In the meantime the commercial arm-wrestle between tenants and landlords as to who bears the cordon or "drop-zone" risk will continue.

This article was written by Lloyd Davies for the Australasian Legal Business Magazine (issue 9.08, August 2011).