Aspects of dilapidations

At the end of a lease a landlord wants its tenant to return the property in the state of repair required by the lease.  If the tenant does not do that, then the landlord will serve a schedule of dilapidations on the tenant.

A    FOLLOW THE PROTOCOL

There is a Dilapidations Protocol, published in January 2012, which provides a framework for the conduct of dilapidations claims on commercial property.  A separate protocol deals with claims for disrepair in relation to residential tenancies.

The protocol recommends procedures, timescales and standard forms for both landlords and tenants to follow.  The aim is to speed up the settlement of disputes by suggesting a timescale, providing a consistent process and by improving the quality of information passing between the parties.  There is no law which requires parties to follow the Protocol, but if either does not they are at greater risk of not recovering their costs in any eventual court proceedings.  That concentrates the mind!
Preparing a Schedule of Dilapidations is principally the landlord’s building surveyor’s task, but a property lawyer should be consulted.  This is to be sure that the repairing obligations in the lease have been interpreted and applied correctly.

Most leases expressly provide for the way in which the notices should be served between the parties.  However, the Dilapidations Protocol provides that the schedule of dilapidations and quantified demand should also be provided electronically.  This helpfully allows the tenant to respond and comment upon the schedule and/or quantified demand in a new column in the same document, entry by entry.

B    THE TIGER ASPECT CASE

The recent case of Sun Life Europe Properties Limited -v- The Tiger Aspect Holdings Limited was a case in the High Court.   It does not break new ground, but it helpfully summarises the law on dilapidations cases in a scenario which often happens.

The mechanical and electrical equipment in the building was “state of the art” when it was installed in 1973/74, but it was certainly not so by 2008!  The judge’s summary of the facts made it clear that Tiger Aspect (the tenants) had “patched and made do” throughout their occupation, rather than replacing the broken systems in the buildings.  So, were Tiger Aspect required to repair the plant and equipment in the buildings as at 1973/74 specification levels, or to compensate for the cost of repairing and replacing those systems up to 2008 specification systems?

1.    New kit for old?  The case confirmed the principle that the standard of repairs which applied was to be judged by reference to the condition of the equipment and fittings at the time of the grant of the lease (in this case 1973/74) and not the condition which would be expected of an equivalent building at the expiry of the lease in 2008.   Tiger Aspect were obliged only to replace “like with like”, and not to upgrade.

2.    Supersession – English statute law says that a landlord cannot recover any damages for breach of a repair covenant if it is shown that the premises would (at or shortly after terminating the lease) have been pulled down or such structural alterations made to them so as to render valueless the repairs covered by the agreement (i.e. superseded).  Tiger Aspect (eventually) conceded that there was a letting market for the property if it had been returned in the state of repair in which they should have returned it. There was therefore a claim which needed to be satisfied.

Notably the judge ruled that the fact that the landlord had carried out more extensive works than were needed to put right the tenant’s breach of its repairing obligations did not of itself prevent the landlord from recovering the costs of the works that would have been necessary to remedy the breach.  The landlord was entitled to spend more on a solution to the items of disrepair than the tenant needed to spend to meet its obligations.  Of course, the landlord could recover only the amount that the tenant should have spent in order to meets it obligations, but it avoided having its claim for those items struck out altogether.

3.    Diminution of value – English statute law states that damages for breach of a repair covenant cannot exceed the amount by which the value of the reversion in the premises (i.e. the value of the landlord’s investment interest) is diminished owing to the breach of such covenant.  This means that if the investment value of the property is reduced by less than the cost of the works then the landlord only recovers the loss of investment value and not the actual cost of the repair works.  In the Tiger Aspect case the diminution in investment value was found to be more than the amount of compensation and so the landlord recovered the amount of compensation in full.  So, if more items of the landlord’s claim had succeeded at higher values, it may have been frustrated by this rule.

It is important to note that this argument does not relate to non-repairing obligations (such as stand-alone obligations to redecorate or to replace carpets), which need to be paid up in full.

4.    Compliance with laws – Tiger Aspect’s buildings included an air-conditioning system which ran on the HCFC coolant called R22, which since 1 January 2010 is being phased out by December 2014.  Accordingly, although it was able to return its lease to the landlord in 2008 with an R22-operated air conditioning in repair, if that lease was to come to an end now it is probably reasonable for a landlord to replace the air conditioning system with one which has new lawful coolant at the tenant’s cost.  This will be much more expensive than patching-up an old system.

C    WHAT SHOULD A NEW TENANT TAKING A LEASE DO?

• Carry out a building survey.
• Consider whether the lease repairing obligation needs to be limited by way of a photographic schedule of condition.
• If taking over an existing lease, consider taking a reverse premium
• During the lease carry out a programme of proactive maintenance
• Before the end of the term of the lease, take legal advice and a building surveyor’s advice to assess whether it is better to spend money carrying out repair works, or not to carry out the repair works but to engage in negotiation of a dilapidations settlement using the “diminution in value” argument.
• Be ready to respond promptly to any claim made by a landlord, following the Dilapidations Protocol
• If the tenant relies upon the “diminution in value” principle to seek to diminish the landlord’s compensation claim, then it must make that clear in its response and to provide a detailed valuation report in its defence to such a claim.
• Once a schedule of dilapidations has been received by the tenant, test the schedule against the state of the building and apply to it the terms of the lease and the applicable law.  This needs to be done carefully and very thoroughly with each item being assessed individually.  As the tenant is likely to have left the building by now, it should take photographs to record its state and condition as it leaves, to prove what damage it caused and what its landlord or others may have done afterwards.

Engaging a building surveyor and a lawyer with experience of these claims is vital to protect the interests of both the landlord and the tenant in these cases.

If you have any questions please contact Michael Higgin