December 2011

Damage to Leased Commercial Premises

Consequences for the Tenant

Damage to leased commercial buildings as a consequence of the Christchurch earthquakes has highlighted potential plight of tenants of commercial premises which suffer serious damage.

Most commercial leases include a provision that in the event of the premises being destroyed or suffering damage rendering them untenantable, the lease shall terminate.

Typically the lease would further provide that if the damage does not render the premises untenantable and the damage is covered by insurance, then the landlord will effect repairs to the extent permitted by the insurance moneys and the rental will abate in respect of any damaged part of the premises pending completion of repair.

The most common commercial lease form is that published by the Auckland District Law Society Inc which provides that if the damage is such as to render the premises untenantable, then the lease shall “at once terminate” and further includes a provision that if the damage “in the reasonable opinion of the landlord” requires demolition or reconstruction of the building, then the landlord may within three months of the damage give the tenant one months written notice to terminate the lease with abatement of a fair proportion of the rent from the date of damage.

In the recent case Russell v Robinson ([2011] 2NZLR 424) a three storied commercial building was badly damaged by fire on the first day of the lease term through painters having masked halogen lights and the masking tape catching fire when the lights were turned on.

The building was unable to be occupied and the insurance assessor estimated that repairs would take nine to ten months to complete.

Pursuant to the provisions of the lease, the landlord gave notice of termination both upon the grounds that the building was untenantable and also upon the grounds that they required reconstruction and gave one months notice of termination accordingly.

The Lessee was a Trust the Trustees of which did not wish to relinquish the lease as they had foreseen a positive income flow from sub-letting the building as offices.

They therefore challenged the right of the landlord to terminate the lease.

The Judge in the District Court ruled in favour of the landlord. The lessee had made submissions stating that it was happy to be bound by the lease despite the damage. However, the Judge stated that if the premises were found to be untenantable (being something more than merely transitory or temporary) then the lease terminated at once.

The Judge found in this case that the damage was so extensive that the building was for the purposes of the lease “untenantable” and the lease terminated automatically.

The Judge further found that owing to the extent of damage and time required for repair, the landlord could validly in such event give notice of termination on the grounds that the building required reconstruction.

The District Court decision in favour of the landlord was upheld by the High Court on appeal by the lessee.

Accordingly, tenants of buildings which suffer substantial damage involving major repair or reconstruction, should not assume that they have the legal right to a continuation of their lease or a new lease in the event of ultimate reconstruction of the premises. Therefore, if the location of commercial premises is vitally important, it may be appropriate for the lessee to propose at the outset that the lease provide for the tenant the right to a new lease of premises on the site if they are reconstructed or repaired within a specified period after they have suffered serious damage. This would be a matter to be addressed at the time of negotiation of the lease terms.

We would recommend that before signing an Agreement to take premises on lease, you should consult us, as it is likely that the Agreement to Lease will bind you to the standard terms of the Auckland District Law Society lease form and it may not fully suit your circumstances.