- Apprentice Lawyer
Redrafting commercial leases post COVID-19: Inspiration from New Zealand
COVID-19 has been a major setback to small and medium scale businesses around the world, especially in India. The epidemic has also laid bare the inadequacies of the law to deal with emergencies of this nature.
While epidemics are undoubtedly tragic events that cause unimaginable loss of life and livelihood, they also present an opportunity to take a step back and review what was once inconceivable.
The impact of COVID-19 has been most noticeably felt by the commercial real estate sector, particularly commercial leasing operations. This author has in a previous article discussed the applicability of the doctrine of frustration in context of lease agreements and opined that the present pandemic does not satisfy the onerous conditions under Section 108(B)(e) of the Transfer of Property Act, 1882 (TPA), to permit a discharge of commercial rental obligations of the tenant by relying on the doctrine of frustration/force majeure.
Subsequent thereto, the Delhi High Court in Ramanand & Ors v. Dr. Girish Soni, rejected an application seeking suspension of rent for the duration of the lockdown period owing to the COVID-19 outbreak, a force majeure event. The Court held that Section 56 of the Indian Contract Act, 1872 has no applicability to lease agreements and could not come to the aid of the tenant. The Court further held that in order for the tenant to be able to claim protection under Sec. 108(B)(e) of the TPA, there had to be a complete and permanent destruction of the property, due to the force majeure event.
Resultantly, the Court held that the temporary non-use of premises due to the lockdown imposed in view of the COVID-19 outbreak could not be construed to render the lease void under Section 108(B)(e) of the TPA.
The aforementioned view of the Court reflects the author’s opinions about the long standing law on commercial tenancy. However, this judgment has exposed the inadequacy of the 19th century tenancy laws and standard tenancy contracts in safeguarding the legitimate interest of commercial tenants.
This article addresses why traditional force majeure clauses are incapable to address the plight of the commercial tenant and why we need to look to the Kiwis for inspiration.
Commercial Tenancy and its unique problems
Real estate prices in India, post liberalization, have been amongst the highest in Asia, especially in metropolitan cities like Delhi and Mumbai. Rentals, ironically called fixed costs, are amongst the highest costs incurred by a business to remain operational. The one and a half century old tenancy laws do not reflect the economic realities of the real estate in such metropolitan cities.
Businesses today associate a large amount of goodwill and brand value from the physical location of their business. Today, with soaring real estate prices, commercial tenancies have become the norm and outright ownership an exception. Often, large amounts are invested by these businesses into commercially leased properties to establish their brand and goodwill. In such a situation, businesses stand to lose out on a great deal of tangible and intangible value if they are suddenly ousted from a property which has become a part of its brand identity.
For businesses, there is often more economic value in continuing with an expensive and loss making lease than the potential economic loss due to the disruption in business and loss of brand identity. However, the economics of such tenancies comes under even greater strain when an unexpected force majeure event occurs.
What are the traditional options?
Traditionally, only two options are available for tenants in a force majeure situation, either to claim a frustration of the lease in terms of Sec. 108(B)(e) of the TPA or to claim a waiver of payment obligations under the rarely included force majeure clause of the lease agreement.
Frustration, under Sec. 108(B)(e) of the TPA as discussed previously, is available to tenants only in the rarest of situations, when the property in question has been completely and permanently destroyed. Even when Sec. 108(B)(e) is invoked successfully, the lease terminates and the property must be handed back to the lessor.
On the other hand, the traditional force majeure clause, rarely found in Indian lease agreements, is relatively easier to invoke. However, it too would not grant the tenant the right to continue possession. Moreover, even when lease agreements are found to contain force majeure clauses, they often specifically exclude payment obligations from their ambit.
Even the International Chamber of Commerce’s Force Majeure and Hardship Clause, updated in view of the COVID-19 outbreak in March 2020, under Clause 5, provides the other party the right to "suspend the performance of its obligations, if applicable, from the date of the notice."
While a tenant seeking to avoid the entire lease can rely upon the force majeure clause, this clause may not come to the assistance of a tenant who merely seeks abatement of full or part rent.
Thus, it is clear that neither of the two alternatives is an efficacious remedy for a tenant today and both sound a possible death knell for a business that is tied to its leased property.
The Kiwi Twist - No access in Emergency Clause
Inspiration then can be taken from our common law cousins in the southern hemisphere, the Kiwis. Following the earthquake in Christchurch, New Zealand, the Auckland District Law Society (ADLS) published its 6th Edn. of a model lease deed. This newly updated model lease deed came in specific response to the tenants having no recourse to seek abatement of rent, despite having no physical access to the undamaged buildings for safety reasons.
This 2012 edition incorporated, inter alia, a ‘No access in emergency clause’ (NAE Clause), which provides that in an emergency, if a tenant is unable to gain access to the premises to fully conduct its business because of reasons of safety or in situations of emergency, then a fair proportion of the rent would cease to be payable for the period the tenant remains without access.
The NAE Clause further provided either party the right to terminate the lease after giving 10 days’ notice, if the tenant was unable to gain access to the property beyond a period specified under the contract, or if there was reasonable certainty that the tenant would not be able to gain access to the property for the specified period in the future.
The ADLS lease also defined emergency vide Clause 45.1 (d) to include a situation resulting from any event - including plague and epidemic - that may cause a loss of life, serious injury or serious endangerment to public safety and the said event had not been caused by either party. Thus, the ADLS lease specifically includes plague and epidemic within the ambit of emergency, while leaving open the possibility of other ‘situations’ not expressly contemplated.
While terms such as ‘fully conduct business’ and ‘fair proportion of rent’ still remain vague and subject to interpretation, parties are always free to modify the clause to incorporate more precision to the contract. Even otherwise, if such clauses are adopted without explicit definitions, courts are provided a better context to adjudicate the claims of the parties in the event of a dispute.
Although there are no reported judgments on the NAE clause as yet, the New Zealand High Court in Zheng Li Trustee Ltd v. Henderson, has adjudicated an issue relating to the ‘partial destruction clause’. The Court, while adjudicating on what constituted a fair proportion of rent, ruled that in case the property was partially damaged in an earthquake, the business of the tenant was substantially affected due to the scaffolding placed outside the entrance. Thus a fair proportion in the facts of the case would amount to the entire rent for the period of repair. Presently, the COVID-19 outbreak has seen a number of tenants in NZ relying upon the NED clause in a number of instances.
Why we must consider the NAE Clause?
The COVID-19 lockdowns and the impact on businesses emphasise the need for a relook at how we draft our emergency clauses. As real estate inevitably becomes more expensive, commercial leases have to be drafted with much more precision to ensure that no future disputes arise due to socio-economic-political or environmental uncertainties. It is always in the best interest of the parties to ensure that all terms are ironed out in advance so as to avoid future litigation expenses and discords. While novel force majeure clauses may be tailored to fit lease agreements, NAE clauses provide an exhaustive and ready-made solution, subject to suitable modifications.
The NAE clause offers four primary advantages to both the lessors and lessees which should weigh with any contract drafter:
1. Firstly, under the NAE, the tenant is not forced to pay the full rent for the duration the premise remains inaccessible, the determination of rent payable, if at all, depends on the circumstances of the business and the facts of the case.
2. Secondly, the NAE Clause avoids the unpleasantness of having to negotiate with the lessor at a time when the tenant will be in an inordinately weaker position. Thus, such a clause pre-empts force majeure circumstances and secures an equal bargaining power for the tenant.
3. Thirdly, the NAE Clause provides certainty, convenience and security to the lessor. The lessor is no longer obliged to negotiate at every step of the force majeure event, nor is the lessor obliged to enter into additional agreements in order to secure the understanding of the parties, nor is the lessor forced to indefinitely wait for the emergency to abate to be able to rid herself of the tenant.
4. Fourthly, the concept of a fair rent makes it possible for both parties to have space to negotiate an understanding at the time of the occurrence of the event. However, parties may also explicitly define conditions relating to fair rent in advance, to bring about more clarity and avoid any subjectivity.
Thus, an incorporation of the NAE Clause in Indian lease agreements will provide much needed security to commercial tenants in times of emergencies and will help streamline the real estate sector, which would be a boon for both lessor and tenant, and the industry as a whole.
The author is an Advocate based in New Delhi. He holds a Master of Laws from The London School of Economics & Political Science. He currently practices law in the courts of Delhi. He can be reached at Ramchandramadan@gmail.com.
The author acknowledges the valuable inputs by Mr. Sean Conway, Barrister & Solicitor of the New Zealand High Court, currently working for the NZ Crown Law Office. Mr. Conway can be reached at firstname.lastname@example.org.