PROPERTY
Earthquake-prone buildings: brace yourselves
David Gilbert and Kelly Bunyan look at who is responsible for earthquake strengthening

In the wake of the Canterbury earthquakes, lawyers, landlords, and tenants are carefully examining lease clauses (possibly for the first time) to determine who is responsible for strengthening earthquake-prone buildings and to what extent. One such clause is the Improvements Rent clause, which potentially gives landlords the right to pass on earthquake strengthening costs to tenants.

This article investigates the scope of the Auckland District Law Society 2008(2) Deed of Lease (ADLS Lease) Improvements Rent clause, and the impact the new building-strengthening requirements may have on landlords and tenants and future leasing arrangements.

What is the Improvements Rent clause?
The ADLS Lease provides that, where a landlord is required by any legislation or requirement to spend money improving or altering a property, the landlord can charge an amount additional to the rent up until the next rent review date. The additional amount is a percentage (typically this is recorded as between eight to 12 per cent), specified in the lease, of what the landlord spends.

Does the Improvements Rent clause cover earthquake strengthening?
A landlord of an earthquake-prone building is required by law to make improvements to the building to bring it up to the current Building Code. An ‘improvement’ is anything of a nature that constitutes a betterment of the land which is substantial and permanent. Thus, earthquake strengthening is likely to come within the scope of the Improvements Rent clause provided the works undertaken are substantial and permanent.

Who pays for earthquake strengthening a building?
We anticipate that the landlord of an earthquake-prone building will be entitled to recover part of the strengthening costs from its tenant under the ADLS Lease Improvements Rent clause. However, recovery of costs may not be straightforward for a prudent landlord who strengthens a building beyond minimum requirements to future-proof against legislative changes, or simultaneously strengthens a building while undertaking maintenance. In both instances, the cost of the strengthening works required to bring the building up to the current Building Code must be separated out from the cost of the additional works so the tenant is charged correctly.

In addition, the Improvements Rent percentage will only apply from completion of the works to the next rent review date (typically three years). While the ADLS lease assumes that the rent will be reviewed to market, there is no guarantee that the market will make a correlation between the social and economic value of an earthquake-strengthened building and a rent increase.

A landlord undertaking strengthening work intended to serve as a temporary fix until a more permanent solution is found, or strengthening work of non-earthquake-prone buildings as part of a long-term asset management plan, may not be able to recoup costs under the Improvements Rent clause. Moreover, if the strengthening work required is not carefully planned by the landlord, strengthening costs may be classed as capital expenditure by the Inland Revenue and therefore not tax deductable.

Is the tenant liable for the cost of strengthening an earthquake-prone historic building?
Earthquake-strengthening works to historic buildings are complex as the Resource Management Act 1991 and Historic Places Act 1993 contain additional requirements that create tension between heritage preservation and public safety. However, the cost of strengthening may outweigh the value of the historic building, which may force landlords to make stark financial decisions about the future of their investment.

Despite the complexities, tenants are likely to be liable for part of the cost of earthquake strengthening a historic building under the ADLS Lease Improvements Rent clause provided the work required is substantial and permanent.

Some local authorities have heritage funds that provide limited financial assistance to landlords that are required to strengthen historic buildings. Any incentive or grant made by the Council to the landlord for the purpose of strengthening should be passed on to the tenant by offsetting the amount received against the total amount expended by the landlord.

What happens if the tenant needs to relocate while the building is earthquake strengthened?
The ADLS Lease does not contain an express right for the landlord to restrict access to premises or, if required, for the tenant to relocate to temporary premises while earthquake strengthening is completed. As a result, access to the premises to undertake the strengthening works and relocation of the tenant to temporary premises is likely to be a result of an agreement between the parties. However, tenants may be forced to rely on the terms of their business-interruption insurance policies for assistance during this time.

How long does the landlord have to strengthen an earthquake-prone building?
Generally speaking, local authority’s earthquake-prone building policies currently require building owners to undertake strengthening works within time frames ranging from five to 30 years, unless the building is subject to significant alterations or a change in use.

The Christchurch City Council’s current earthquake-prone building policy allows building owners between 15 to 30 years to undertake earthquake-strengthening works. In Auckland, the Council has adopted a more flexible approach, and will work collaboratively with the parties involved to agree upon a course of action and time frame in which the strengthening must be completed. Buildings deemed to be ‘dangerous buildings’ will be subject to much shorter time frames.

Can a tenant terminate a lease because a building is earthquake-prone?
There have been several reports in the media recently about commercial tenants vacating premises following assessments about a building’s likely performance in an earthquake. By way of example, Contact Energy vacated 160 retail operations and head office staff from their Lower Hutt premises after finding that the existing facility was potentially earthquake-prone.

Given the current attitude to building safety and a heightened awareness of an employer’s obligation to provide a safe working environment, Contact Energy’s reaction is understandable. However, tenants must be careful not to act prematurely and ensure that they take legal advice before vacating, as they may have obligations under the lease to, among other things, keep the premises open for business during usual trading hours.

As such, there are no express rights under the ADLS Lease or implied rights under the Property Law Act 2007 for a tenant to terminate a lease on the basis that the building they occupy has been deemed ‘earthquake-prone’.

A tenant could argue that it can no longer lawfully use the premises for the purpose specified in the lease. However, the building will only be unable to be lawfully used if a ‘notice to fix’ under the Building Act 2004 has been issued. Because notices to fix are only issued if there is damage to the building, or the landlord has failed to earthquake strengthen the building within the set time frame, it is unlikely that a tenant will be able to terminate the lease on the grounds that they can no longer lawfully use the building.

Accordingly, a tenant occupying an earthquake-prone building will more than likely have a continuing obligation to comply with the provisions of the lease, including paying rent, even though the building’s structural performance during an earthquake has been brought into question.

As far as we are aware, the Courts have not yet tested this area of law. However, we anticipate that the Courts will not countenance tenants terminating leases for the reason that their building is earthquake-prone where the landlord is still within the local authority’s time frame to complete the strengthening works required.

What obligations do landlords and tenants of an earthquake-prone building have under the Health and Safety in Employment Act 1992?
This issue is quickly gaining momentum as tenant employers become increasingly aware of the fundamental obligation placed on them under the Health and Safety in Employment Act 1992 (HSEA) to provide a safe working environment, and begin to feel the heat from employees and unions demanding earthquake-safe workplaces.

As reported by The Dominion Post, the Engineering, Printing and Manufacturing Union are currently examining a remit requiring employers to prove their buildings are safe and carry out strengthening work if a workplace is below the earthquake standard. The Union is not ruling out strikes if employers refuse to strengthen earthquake-prone buildings.

While the legality of such strike action is yet to be tested, the threat will undoubtedly cause headaches for many tenant employers around New Zealand who may feel wrongly targeted given that it is generally the landlord’s responsibility to strengthen an earthquake-prone building. Further, a tenant employer has no control over the time frame the landlord is given to undertake the work, which could see a tenant employer facing significant fines if an employee was injured or killed during an earthquake because the necessary strengthening works had not been completed promptly. That said, we suspect landlords will undertake strengthening works sooner rather than later because they also have obligations under the HSEA as the person who ‘controls the place of work’.

So, how should each party proceed to best protect employees and mitigate their own liability under the HSEA?

Tenant employer
Under the HSEA, tenant employers must provide a safe working environment and ensure employees are not exposed to risk or harm in the place of work. These obligations encompass all harms and hazards, exposing the tenant employer to liability if it knew or ought to have known about a potential hazard.

As far as we are aware, there is no case law that confirms that an earthquake-prone building is a hazard. However, tenant employers may have difficulty arguing that a building wasn’t a hazard if it collapses during an earthquake after being deemed earthquake-prone.

Generally speaking, tenant employers of an earthquake-prone building must take all reasonable practical steps to eliminate, isolate, or minimise the hazard to satisfy its obligations under the HSEA. What that involves will vary depending on the building report, but it could include working collaboratively with the landlord to effect the strengthening work required, undertaking temporary works in the interim, and – in some instances – temporarily relocating to another premises.

Landlord
The collapse of the CTV building has demonstrated the devastating consequences of housing employees in potentially unsafe buildings, and following receipt of the Department of Building and Housing’s report on the CTV building, the Police are seeking legal advice on whether there are issues of culpability or liability.

While the extent to which a landlord of an earthquake-prone building may be liable under the HSEA is still uncertain, it is highly unlikely that a landlord will escape liability by turning a blind eye to the strengthening works required to bring their building up to the current Building Code. Thus, landlords of an earthquake-prone building should actively engage with their local authority and tenants and attend to the strengthening work required without delay.

While the Courts are yet to examine earthquake-prone buildings under the HSEA, we strongly recommend that tenants and landlords seek independent legal advice regarding issues that may arise from earthquake-prone buildings – whether those issues relate to earthquake strengthening works, the landlords’ and tenants’ rights under the lease, or their respective obligations under the HSEA.

The future of commercial leasing
The new building-strengthening requirements will no doubt feed into future lease negotiations and see landlords and tenants negotiating risk assessment and risk assignment more heavily than in the past.

Tenants will look to limit the amount of any contribution to strengthening works that may be payable under the Improvements Rent clause and curb any disruption resulting from the works. Conversely, landlords will aim to maximise their investment by passing strengthening costs on to tenants and minimise liability.

To what extent these demands are accommodated will depend on the bargaining power of the parties. However, with the terrible tragedy of Christchurch fresh in everyone’s mind, we suspect landlords and tenants will attempt to balance their interests to best ensure the safety of the people who work in or visit their buildings.

This article provides general information and should not be construed as specific legal advice.

David Gilbert is a partner and Kelly Bunyan is a solicitor in the Auckland office of Minter Ellison Rudd Watts. David and Kelly specialise in commercial property and infrastructure and can be contacted at david.gilbert@minterellison.co.nz and kelly.bunyan@minterellison.co.nz.

NZLawyer \\ issue 188 \\ 13 July 2012