In need of improvement

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(First published in the Estates Gazette on 4 February 2012)

If you are a tenant, we have two questions for you:

1 Are you worried that your repair covenants require you to improve the physical condition of your property?

2 Worse, will you end up paying a rent on review that is increased because of the works you have conducted and for which you have paid?

Assuming that there are worried tenants out there, they can be protected by limiting their repairing covenants to keeping and yielding up the premises in no worse or better state of repair than they were in when the lease commenced. This physical state can and should be recorded in a schedule of condition attached to the lease. Such covenants and schedule are common in leases of secondary property. This is not a situation which would arise with high market and/or new or newly fitted out accommodation.

Furthermore, any physical improvements carried out by a tenant during the lease term, or any increase in rent due to those improvements, can be and generally are disregarded at rent review, so that the tenant should not have effectively to pay for those works twice.

That all sounds fine, but to what extent do these provisions really work in the tenant’s favour?

Covenant to repair

Generally, a covenant to repair is triggered when the physical condition of the property falls below what which existed at the term commencement date.

If there is a disrepair within the term, what works are necessary to put the property back into repair? It should be remembered that "keep in repair" means "put and keep", and while this might be tempered by the schedule of condition, it is rarely, if ever, possible to recreate the original physical state of the property at the lease commencement date excluding any improvement. And the longer the lease, the greater the risk at putting the property into the same state of repair that it was in, say, 1991 is just not viable or possible.

Disrepair of a roof, for instance, might be quite properly remedied by some patching up, but there could come a stage when the only practical and economic way of dealing with the disrepair is replacement. However, as we saw in the case of Riverside Property Investments Limited v Blackhawk Automotive [2005] 1 EGLR 114, the landlord could not require a new roof or one in perfect repair or pristine condition if repair works, which had in fact been conducted by the tenant, was a viable option.

Going the other way, back into the 19th century, in Lister v Lane [1893] 2 QB 212, repair works to a bulging wall involved digging down nearly 20ft underground to carry out underpinning. In someone else's book that might be so radical as to constitute improvement. All in all, it will be a matter of evidence and fact as to when the stage is reached where replacement is necessary and viable.

So, is there any real value in the tenant’s apparently limited covenant and the schedule of condition or, in practice, will works of repair always include an element of improvements? There is no one answer. As we have tried to illustrate, repair works can involve improvements, but still be repair. In Dilapidations, The Modern Law and Practice, Dowding and Reynolds say that many repairs will involve improvement, and that every repair will always incorporate some form of renewal. Everything, of course, will depend on the facts and circumstances applicable from case to case. However, the wording of the covenant and the physical state recorded in the schedule cannot be ignored. This is particularly so when the lease term is short and they physical state of the property has deteriorated little, if at all.

But, if there is further physical deterioration that is not remedied, what is the level of damages a landlord can expect to receive? Do damages reflect the cost of works that might necessarily include improvements (as it is not possible to recreate the original physical state of the property)? Alternatively, are they assessed by comparing the value and physical state of the property at the lease commencement date with the value and physical state of the property at the lease expiry? That would reflect the diminished value of the landlord’s interest. But again, how practical is it to make that assessment when the two dates may be 20 years apart?

Rent review

Generally, premises are valued at rent review by reference to their physical condition at the review date.

However, it would be inequitable for a tenant to gain by its failure to comply with its repairing covenants, or for a landlord to gain if the tenant has, as its own cost, improved the demised premises. Consequently, rent review clauses commonly include:

  • an assumption that the tenant has complied with its covenants; and
  • a disregard of tenant’s improvements unless the tenant was obliged to carry out those works.

So, if, between rent review dates, the premises have undergone significant refurbishment, the tenant will seek to have all of the works disregarded as improvements. The landlord, on the other hand, will want at least some of the works rentalised as having been carried out pursuant to the tenant’s repair obligations and which will be assumed to have been conducted.

Difficulties arise for the rent review arbitrator or independent expert when it comes to looking at the refurbished building at the rent review date. He or she has to assume that the premises are unimproved (or disregard increased rental due to the improvements), but in repair in accordance with the tenant’s covenants.

Using our roof example again, let us say that a roof in disrepair was replaced with a brand new, top-of-the-range roof. The tenant will say those works should be disregarded for rent review purposes, and it should be assumed that, as at the rent review date, the old roof was in place but in repair. The landlord may say that putting the roof into repair and keeping it in repair would have involved replacement, because the roof was too far gone to be patched up. What is an arbitrator or an independent expert to do? Rentalise those works or disregard them? Is there a risk that the tenant will be penalised? Well, possibly.

Even if the arbitrator/expert takes a middle line and says that, even though the new roof would otherwise have constituted an improvement, a new roof would have been required and installed, albeit not to such a high specification, and that the property to be valued for rent review purposes at the review date does have a new roof. But that of course begs the question as to whether replacement, rather than patching up the old roof, was necessary.

It all comes down to evidence. If, for instance, there is a covenant to repair limited by reference to a schedule of condition as at the lease commencement date, do the valuers simply value the premises in the state of repair recorded in the schedule? Or, if the landlord can show that the state of repair deteriorated below that recorded by the schedule of condition and that works of repair would therefore have been necessary, for the purpose of valuing the rent, is there an assessment of the works required to bring the physical condition into repair?

If significant improvements have been carried out, the tenant will have to show this and produce evidence that the physical condition of the property had not deteriorated, and that the covenant to repair had not been triggered at the time the works were conducted.

Timing is again one factor. If it can be shown that the improvements were made soon after the term began and that the property was unlikely to deteriorate, unless the landlord can show otherwise, the improvements may be disregarded. The longer the time between the term commencement date and the date of the works, however, the less compelling that argument may be. In the absence of clear evidence, a tenant may struggle to resist a landlord’s contention that the arbitrator or expert should decide that there was an element of disrepair that needed to be, and should be assumed to have been, remedied. In which case, the tenant will pay twice, first for the remedial works and second by way of a rental uplift.

Tenants would, therefore, be well-advised to have the physical state of the property, originally recorded in the schedule annexed to the lease, re-recorded prior to conducting improvement works.

Conclusions

If you are a tenant and answered yes to one or both of the questions posed at the outset, then we may not have assisted you other than helping to identify the issues landlord and tenants continue to fight over.

In an ideal world, landlords and tenant will agree the extent of the works that need to be carried out at the end of a lease term, so that the tenant can comply with its repairing obligations. If they cannot agree directly, they can resort to some form of alternative dispute resolution, rather than argue through the courts. Otherwise, a tenant’s best option may be not to carry out any works at all, but take its chances in resisting a damages claim.

At rent review, a landlord will always want to argue that a tenant’s improvement works include an element of repair. In that case, before any improvement works are carried out, tenants should be advised to prepare perhaps another schedule of condition, to record what is in repair and what is not. If the improvement elements can be agreed with the landlord at the time, so much the better.

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