What a mess! - Dilapidations in the current market

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In these increasingly difficult economic conditions, it is more important than ever that a landlord is well briefed on its rights and remedies in order to preserve and enhance asset value.  Here we offer some guidance on three particularly topical issues relating to the state and condition of demised premises, commonly known as “dilapidations”.

On lease expiry

A landlord will be keen to ensure that, on lease expiry, the demised premises are left in repair and decorated in accordance with the lease covenants, and that any alterations are reinstated. However, a landlord needs to be aware that any claim for damages for dilapidations at the end of the term will be subject to a statutory cap.  This means that:

  • the damages cannot exceed the amount (if any) by which the value of the landlord’s reversion is diminished owing to the disrepair (commonly called “diminution in value”); and
  • no damages can be recovered if the demised premises - whatever state of repair they might be in - would at or shortly after lease expiry be either demolished or structurally altered in such a way that any repairs would be rendered valueless.

In today’s real estate market, the second aspect is of less relevance given that there are very few new developments taking place or planned. Rather, the focus has shifted to the first aspect.  Many tenants will now seek to argue that that there has been no diminution in the landlord’s reversion, or that the reduction is less, because the letting market is so poor that prospective tenants would choose to take newly built or refurbished space rather than the demised premises, regardless of their state of repair.  The landlord can better its position by actually carrying out the works of repair as it is established that, where a landlord has done or intends to do the works, the cost of the works prima facie represents the damage to the reversion - so long as the work is reasonable. A tenant will no doubt seek to argue that, if there is no prospect of letting the premises, any works of repair are not reasonable.  The answer as to which position is correct will depend on expert valuation evidence from a surveyor.

Mid-term

In these uncertain times, a landlord will be concerned that a tenant may not survive until the end of the term, and will accordingly be keen to ensure that the tenant complies with its repairing obligations during the term, rather than wait until lease expiry.  In this context, there are a couple of areas of which a landlord ought to be aware:

  • Jervis v Harris clauses.

    Most modern leases contain a “Jervis v Harris clause” which gives a landlord certain powers.  It enables a landlord to inspect tenanted premises, serve a repair notice on the tenant, carry out repairs when the tenant fails to do so, and to recover the cost as a debt.  Such clauses are especially welcome in the current market as the power is exercisable mid-term but does not involve forfeiture, which would terminate the rental stream.  In addition, the statutory cap on damages that has been summarised above is avoided. Having said that, the disadvantage is that the landlord will actually have to incur the expenditure itself at day one, with the consequent cashflow and liquidity consequences, plus running the risk of recovering the sum from the tenant - a process which

    is uncertain, costly, and slow.  Nevertheless, this is an important weapon in the landlord’s armoury and serving a Jervis v Harris notice often encourages a tenant to carry out at least some repairs mid-term when it would otherwise not do so.

  • Suing for damages and/or forfeiting the lease mid-term. If the lease had an original term of seven years and has more than three years unexpired, the Leasehold Property (Repairs) Act 1938 will apply.  This limits the landlord’s ability to either sue for damages or forfeit the lease without seeking the court’s permission, and this will not be granted unless the landlord proves one of the following:

(a) that the works are immediately required to prevent a substantial diminution in the value of the landlord’s reversion;

(b) that the works are immediately required to comply with legislation;

(c) that the tenant is a tenant of part and the repairs are immediately required in the interests of other occupiers of the premises;

(d) that the disrepair can be remedied at a smaller expense now in comparison with a greater expense if delayed; or

(e) special circumstances.

Generally, this is a high threshold to overcome but in serious cases of disrepair, permission will be given and the works can then be enforced pursuant to a court order.

Break clauses

In the current climate, a tenant with a break clause in its lease may very well be looking to exercise its break in order to offload excess premises that may now be surplus to its operational requirements.  Often, break clauses will be conditional on the tenant complying with its lease covenants - including those as to repair, decoration and reinstatement.  The key point here is that any conditions attached to the exercise of a break clause will be strictly construed and the tenant must comply with any such conditions to the letter in order to avoid running the risk that its break has not been validly exercised.  Case law establishes that minor breaches of the repairing covenants (for example, decorating in the penultimate year of the term rather than in the last year) can invalidate the exercise of the tenant’s break.   Here a landlord will be keen to exploit its negotiating position to the maximum given that the tenant will wish to “over repair” in order to ensure that there is no doubt whatsoever that its repairing covenants have been complied with.

This last issue will be of less relevance to landlords who have signed up to the Lease Code which stands against break clauses conditional upon compliance with lease covenants other than the payment of rents.

No doubt there will be a rash of cases relating to these issues over the coming months, as tenants and landlords seek to safeguard their positions in a rapidly falling letting market.

 

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