Shaking up the industry - the importance of seismic clauses in leases
Following the Canterbury earthquakes in 2011 and the Kaikoura earthquakes in 2016, the leasing industry has undergone changes due to the lessons learned by both landlords and tenants.
One of the industry changes includes the introduction of clauses in leases to record the parties’ rights and obligations in respect of a building’s earthquake resilience. These seismic clauses vary widely in their content and their usefulness. We discuss the most common approach taken by landlords and tenants to determine a building’s seismic rating, and to record the parties’ obligations if that rating changes in the future.
Why does this matter?
For tenants, a lease may be the most critical contract their business has by providing them with premises to operate their business from. A lease also provides landlords with a source of income from a capital asset.
Leases often establish long-term relationships between landlords and tenants. The importance of a lease and the length of the relationship it creates makes it essential for the parties to ensure that contingencies are in place, so that the parties understand their rights and obligations if things change during the term of a lease. Below, we identify both unhelpful and helpful approaches to drafting these clauses (for both landlords and tenants).
Determining a building’s seismic rating
Seismic ratings are often referred to as a percentage of New Building Standard (NBS), being the current earthquake building code (NZS 1170.5:2004). Under the NBS, any building below 34% NBS is considered “earthquake prone/very high risk”, which means that there is a high risk of damage or injury in the event of a severe earthquake. Buildings between 34% and 80% NBS are considered “high-to-medium risk”. Anything above 80% NBS is considered “low risk”.
A building’s NBS is determined by a structural engineer. There are two methods of investigation: a relatively quick and simple Initial Evaluation Procedure (IEP), or the longer and costlier Detailed Seismic Assessment (DSA). Due to IEPs being very high-level and lacking detailed investigation, a DSA is a more typically accepted method of investigation.
Following their investigations regarding a building’s materials, design, and construction, engineers then apply their findings to the NBS and produce a report advising what the building’s NBS rating is. Experience shows that different engineers may report the same building as having different NBS ratings.
A common first step is for the landlord to provide a tenant with a seismic report advising what the building’s NBS rating is, so both the parties understand how the building will perform in an earthquake. This is usually important to both landlords and tenants from a health and safety perspective.
There is no common approach to what NBS ratings might be acceptable to tenants. Some tenants are happy with a building that is anywhere above 34% NBS (i.e. not earthquake prone). Many other tenants (such as public entities) require a much higher seismic rating, particularly where the tenancy is long-term.
Changes in a building’s seismic rating
Over time, a building’s NBS rating can change. The building may become damaged due to a future event (such as an earthquake), or, the NBS itself could be updated to become stricter, so that a building that is 100% of the 2004 NBS may have a lower rating under a future NBS.
This is where seismic clauses in leases become relevant. The content and quality of seismic clauses varies widely across the market, depending on the nature of the building and the requirements of the parties.
We commonly see suggestions that a landlord provide a warranty in a lease that a building meets certain NBS rating. While a warranty can assist a tenant with satisfying its health and safety obligations, in isolation it may not assist if there is a change to the NBS rating during the term of the lease. A breach of warranty does give rise to a damages claim, and in some cases (where the warranty has been expressed as an “essential term”), a tenant may be able to cancel a lease.
Useful seismic clauses
The more useful approach is for seismic clauses to specify a process to deal with any changes to a building’s NBS rating, rather than stating a fact. It is important to tailor the clauses to fit the tenancy in question.
Good questions for the parties to consider and agree upon are:
- Is there a minimum seismic rating that the landlord must keep the building above during the lease term?
- Who can get a seismic report in the future? Does there need to be triggering event first?
- Who pays for the seismic report?
- and, most importantly: What happens if a subsequent seismic report advises the building is below a particular seismic rating?
That last question is critical because the answer will determine what process the parties agree to follow if a building no longer meets a minimum standard. The particular process will depend on the tenant, landlord, building, city, availability of engineers, and how much work might be required.
If a subsequent seismic report advises the building is below a particular seismic rating, the parties need to think about:
- Is the landlord required to improve/repair the building to increase the seismic rating?
- How do the parties agree on what work is required?
- Who does the work?
- How is the scope and timing of the required work agreed?
- Who pays for the work?
- Does a rent abatement apply? If so, for what period?
- Can the landlord require a tenant to temporarily vacate to allow the landlord to complete the works?
- What if the landlord does not want to do the work?
- Are there any termination rights that should apply in favour of either a landlord or tenant?
These are a small sample of the kinds of questions that need to be asked, particularly in regions that are at higher risk of earthquake damage.
We can help
The right seismic provisions in a lease can be the difference between a tenant having to pay for premises that the tenant (or its staff) do not feel safe in, or starting a helpful dialogue between the parties to figure out whether their leasing arrangement will continue to suit them should a building’s NBS rating change during the lease term. Our property team has extensive experience with drafting and negotiating seismic clauses to meet the needs of our clients. If you are entering into a new lease as a landlord or tenant, or need some advice regarding a lease you already have, we would be delighted to help.