Terminal dilapidations – checklist

 
  1. 1. First start with considering extent of liability to repair under the Lease.
    • What are the precise terms of the repairing, decorating, alterations, yielding up, statutory compliance covenants.
    • What was the length of Lease and what is the age and nature of the Premises?
    • Is there any Schedule of Condition or exclusion of inherent defects.
    • What is extent of actual demise and what repairs fall outside it?
    • Is there actual disrepair from a previous better state?
    • Remember a covenant to keep in repair requires a tenant to first put the premises in repair.
    • A tenant is not liable for preventative work- just because something is old or out of date, it is not in disrepair.
  2. 2. Essentially, the extent of repairs is governed by what works would make the premises reasonably fit for occupation by the sort of tenant who would have taken a Lease on these terms at Lease commencement.
  3. 3. Replacement of an item, rather than repair, is only justified where necessary or a cheaper option. Damages for disrepair are based on what works the tenant could have done to satisfy the covenants and the tenant would do the minimum works to achieve this. However, where a landlord chooses to replace an item rather than repair, it can still recover the repair costs if it would not have replaced the item if it had been left in repair.
  4. 4. Then consider whether, if the Lease is still running, is the Tenant likely to do any of the repairs and, if not, what are the Landlord’s actual intentions re repairs and re the Property generally.
  5. 5. Consider if a re-instatement notice needs to be served prior to Lease expiry and, if so, which alterations need to be re-instated?
  6. 6. Remember that an initial Schedule of Dilapidations produced when the Tenant is still in occupation is not going to pick up all defects, particularly re anything beneath the surface or relating to the services. So an early settlement of claims runs the risk it won’t cover all defects. In a claim of any size, a landlord needs an M&E expert and/or a lift expert to test all the services and it needs to inspect the drains etc.
  7. 7. Advise a landlord to tender the works to obtain accurate costings for any settlement and to show intent to do the works.
  8. 8. Remember that the diminution in value cap applied by S.18 (1) of the 1927 Act is aimed at eliminating those works which, if the premises had been left in repair, would have been superseded – so would not have been worth doing.
  9. 9. Do not consider supersession based on how the premises were left in disrepair. A landlord left with premises in disrepair need not simply do the repair works. It can take the opportunity to do other works if it wishes. The important question is what works would the landlord have done even if the premises were left in repair.
  10. 10. Loss of rent can be recovered if:
    • The premises could have been re-let quicker if left in repair; and
    • The premises would have been re-let quicker if left in repair.

    If the landlord would have made some improvements or changes anyway, the time to do these works has to be taken into account when calculating any loss of rent.

Why are Dilapidations claims so prevalent?

Whilst substantial dilapidations claims on lease expiry (“terminal dilapidations claims”) are extremely commonplace these days, and take up a large element of a property litigator’s workload, these claims rarely proceed to trial and reported Judgments are, therefore, somewhat rare and far apart. The last Judgment of note prior to this year being PGF II SA-v- Royal & Sun Alliance PLC which was decided in 2010.

However, 2013 has been a bumper year for Judgments in terminal dilapidations claims with 3 cases so far having been fought all the way in the Technology and Construction Court and decided within the space of 3 months. This article seeks to examine the following:

  1. Why terminal dilapidations claims are so common?
  2. Why, particularly in the current era of Mediation and Alternative Dispute Resolution as an alternative to litigation, terminal dilapidations cases are reaching trial and/or proving difficult to settle early on.
  3. What light the three reported cases this year can shine on the practical approach approach adopted by the Technology and Construction Court to determining such claims.

This article does not seek to discuss in any great detail the legal principles involved in dilapidations claims. These are generally well established and confirmed in the Judgments referred to. The difficulty lies in having to adapt and apply the legal principles to the different facts of each case. It is, however, important to understand that:

  • In construing the standard of repair required, the Court has to have regard to the age, condition and nature of the premises at the time of the letting as well as the length of the lease. The longer the lease, or the newer the premises, the greater the repairing obligation will be.
  • Repair should be to a standard to make the premises fit for occupation by a reasonably minded tenant of the class who would be likely to take a letting of the premises.
  • A tenant is entitled to pursue the least onerous and cheapest repairs if they will satisfy its repairing covenant and is not obliged to upgrade to modern requirements unless there is disrepair and this is needed to meet current regulations.
  • Replacement is only justified if repair is not reasonably or sensibly possible, or current regulations so require, or replacement is the cheaper option.
  • Where there is a need for remedial works, the fact the landlord chooses to carry out more extensive works does not prevent the landlord recovering the actual cost of repairs the tenant was liable for.
  • Damages for disrepair in the common law are based on the cost of works and loss of rent/rates suffered. They are not based on actual loss suffered by the landlord save that, under the 2 limbs of S.18 (1) of the Landlord and Tenant Act 1927, damages cannot exceed the diminution in value caused to the reversion by the disrepair and cannot be awarded at all if the landlord intended at lease expiry to demolish or redevelop the building so that any disrepair would be superseded.

Before dealing with the first 2 issues referred to above, I would briefly summarise the 3 recent cases in the order that they were determined as follows:

1 – Sunlife Properties Europe Limited v Tiger Aspect Holdings Limited & Anor (7 March 2013)

In this case, 15,300 sq.ft. of offices in Soho were let in 1973 for 35 years to a leading advertising company but they were delivered up in 2008 in very substantial disrepair with, in particular, a substantial amount of the heating, ventilation and air conditioning system non-operational. Sunlife claimed a total sum of £1,573,894 in relation to the costs of works that it had undertaken together with loss of rent and fees of some £37,000 for having had to obtain validation reports in relation to the M&E before determining
the extent of repairs necessary. Sunlife made no claim for some £300,000 of other works that it conceded constituted alterations and/or improvements.

Tiger defended the claim upon the basis that a large element of the alleged repair works undertaken by Sunlife involved complete replacement of what was there originally (such as the air conditioning and heating systems) and were improvements to meet modern demands and/or went beyond the extent of Tiger’s liability under the lease as they involved alterations to the premises that Tiger could never have been liable to undertake because of the prohibition against alterations in the lease. In addition, Tiger claimed it had a much more limited liability for repairs because the covenant to repair should be based on repairing what was there originally in 1973 rather than on the actual works required in 2008/9 to repair the premises in their then condition.

The Judgment is of particular interest to dilapidations surveyors as it deals with a large variety of items and fees and illustrates how Judges in the Technology and Construction Court can often apply their own particular expertise in determining whether items are in or out of repair and the extent of works required and the costs actually recoverable in relation to repairing the same. It also illustrates the enormous importance of obtaining detailed expert evidence at the time of lease expiry, and obtaining detailed costings through tendering the works, as the experts for Tiger only became involved at a later stage and were at a disadvantage in dealing with both liability and quantum as a result.

The Judge found that this was essentially a cost of works claim as there was little or no supersession so that the diminution in value exceeded the cost of the works and the Judge awarded £1,312,076 for the costs of works together with the full sum claimed for the validation reports. Interest was awarded at 3% on the damages from the date of lease expiry. The claim for loss of rent was not pursued. Professional fees for supervising the works were agreed at 4.88% and preliminaries at 8.42% and overheads and profits at 9%. The cost of the Schedule of Dilapidations was allowed at £3,515.

Insofar as other lessons to be learned from the case are concerned, it was of considerable assistance to Sunlife that they were able to locate the original building plans for the premises to show what was there to begin with (such as carpets and trunking and suspended ceilings) and what had been removed and the fact that Tiger had so little by way of maintenance records or wiring details was another factor which assisted the case that items could not be repaired but needed to be replaced. In some cases, the actual cost of replacing an item with its modern equivalent was cheaper than the repairs that would have been required and, accordingly, the Judge was prepared to allow such costs. The liability to remove partitioning led to substantial consequential liabilities for Tiger in relation to works required to the ceilings and lighting following removal of the partitioning.

Tiger have appealed against the Judgment on the basis that the Judge’s findings as to the claim not being capped by Section 18(1) of the Law of Property Act 1927 and the Appeal is due to be heard in early November 2013.

2 – Twinmar Holdings Limited v Klarius UK Limited (19 April 2013)

This case was decided by the same Judge who decided the Sunlife case. It related to a lease of a warehouse building in Hemel Hempstead that had been let in 1993 for a term of 25 years but was terminated in 2008. The case focused on the class of tenant who would have been interested in taking a lease of that type of building at the time the lease was granted and as to the appropriate standard of repair that such a tenant would have required. The Judgment makes clear that the required condition of premises, in terms of their fitness for occupation by a tenant of the class who would be likely to take them,
has to be measured as at the commencement of the lease and not on its expiry.

The major issue in dispute was the condition of the roof lights and whether they were in disrepair because they were now letting in less light due to their state and condition? Upon the basis the premises had just been constructed at lease commencement, the Judge held that the class of tenant to be considered was one interested in taking a lease of a new building and, because there had been a visible and significant reduction in the
translucence of the rooflights, they were in significant disrepair as they were not capable of letting in the same amount of light as at lease commencement. Twinmar were therefore entitled to recover the costs of £46,000 for the repairs that the Court found
were required.

The Judgment also deals with other claims and the appropriate sums to be allowed in relation to preliminaries and professional fees (being 10.65% and 12% respectively) and for the costs of preparation and service of a Schedule of Dilapidations (the amount being reduced from £5,138 to £4,000 because it included items that were not the tenant’s liability).Interest was awarded on the damages at 3% above base rate from the date of expiry of the lease.

By the time that the Judgment was delivered, the tenant had gone into liquidation and this may help explain why this case went so far as trial as the entire claim was only for cost of works of £227,000.

3 – Hammersmatch Properties (Welwyn) Limited v Saint Gobain Ceramics and Plastics Limited (14 May 2013)

These proceedings related to a lease of a large 1930s industrial office building in Welwyn Garden City. The building had been empty for some time and, although Hammersmatch sought to argue that it had an intention to carry out all repairs at a sum in excess of £5million, the Judge held that such intention was not made out and that it would not have been economical or sensible to have carried out all such repairs in relation to such an old building which had been vacant for a considerable period of time and left in disrepair. Saint Gobain contended that it made very little difference whether the building was left in or out of repair as it was so obsolete and their expert assessed the diminution in value at only £100,000. The Judge, therefore, had to consider what was the actual diminution in value resulting from the disrepair and, on the basis that the premises would have been converted into 11 small units for office and industrial use, the Judge assessed that, left in repair, the premises would have been worth about £3 million and, left in disrepair, they were only worth the site value of £2.1million. Accordingly, the Judge found that the diminution in value was in the order of £900,000 and the Judgment is of particular interest in relation to the calculation of the value of the premises if they had been left in repair as the Judge had to factor in the cost of improvements or alterations that would have been worth undertaking, together with financing and void and letting and other costs.

Interest was agreed at 4.5% per annum and, after allowing for interest and the costs of the Schedule of Dilapidations in the sum of £19,320, the total amount awarded came to approximately £1,004,000 which was just £4,000 more than the Part 36 Offer made by Saint Gobain to settle the matter. However, in an interesting subsequent Costs Judgment, the Judge held that a near miss does not count for anything under the current Rules and, accordingly, Hammersmatch was entitled to recover its costs of the proceedings save for those costs that it had unreasonably incurred in relation to its claim that it had an intention to carry out all repairs.

This case illustrates the importance of not concentrating on what a landlord may do or not do with premises left in disrepair but upon what the landlord would have done with the premises if delivered up in repair? It is the actions a landlord would have taken upon the hypothetical basis that the tenant had complied fully with its obligations, rather than the actions actually taken to deal with the premises in disrepair, that are relevant in determining what works of repair would have been worth undertaking by the tenant.

Conclusion

All the 3 Judgments illustrate the very hands on approach of the Judges to these cases and I would now turn to answer the first 2 issues raised above together in the light of these 3 cases. There are a variety of reasons in my view as to why terminal dilapidations claims are proving so litigious and I believe the principal reasons are as follows:

  1. obviously, many tenants do not seek to keep their premises in repair and, accordingly, render themselves liable for dilapidations at lease expiry. In some cases, they may well hope that market circumstances will relieve them from any liability on the basis there will be no diminution in value because the premises will need either substantial upgrading to meet modern market requirements or will be suitable for redevelopment and any repairs would be rendered valueless. Often, repair is not practicable because the premises remain occupied up to lease expiry and, naturally, the tenant gives its business interests priority;
  2. landlords often do not do the repairs, preferring a cash settlement and/or to wait to see what a new tenant wants. This creates uncertainty as to what works are actually worth undertaking. Recently, many office buildings have been converted to residential with much, if not all, of any disrepair being superseded;
  3. historically, leases were often granted for long terms of some 25 or 35 years or even longer and, thereby, gave rise to substantial
    dilapidations liabilities at lease expiry which are often difficult to accurately ascertain without detailed consideration as to what the premises originally constituted and what the requisite standard of repair should be at lease expiry given the age of the premises and the type of tenant that would have been likely to have taken them at the very start. A lot of these longer leases have been coming to an end in recent years. ;
  4. because of recent market conditions tenants are not renewing their leases but vacating, thereby giving rise to a terminal dilapidations claim. Furthermore, a large number of tenants are exercising break clauses;
  5. due to a wish to wait to see what the landlord does with the premises and, in particular, whether it does carry out the repair works or not? It is, in fact, interesting to note how both landlords and tenants actually concentrate on the actions they take to deal with the premises in disrepair upon the basis that they think this will be directly relevant to a dilapidations claim and whether there has been any supersession of any disrepair whereas, in fact, as in the Hammersmatch case, it is the actions that a landlord would have taken if the premises had been left in repair that is primarily relevant to the question of supersession. As made clear in Sunlife, when premises are left in disrepair, a landlord essentially has a free hand as to the works that it wishes to undertake and is not confined to simply undertaking repairs if, given the circumstances, other works would be the sensible option. This is illustrated by the Judgment in the Hammersmatch case where, left in disrepair, it was certainly not worth doing any of the repair works but, if the premises had been left in repair, that it would have been worthwhile undertaking certain of these works;
  6. the sheer complexity involved in applying the law to the particular facts of each case. There is no denying that the law, both as to establishing the standard of repair and whether items are in repair or in disrepair, as well as the law as to how damages are to be assessed, are complex and confusing and, in some cases, somewhat out of date. Accordingly, it is often difficult to assess the extent of a tenant’s liability and, accordingly, difficult to advise as to what sum should be paid or accepted in settlement thereof. In the Sunlife case, the parties were very far apart in their assessment as to what should be payable. Having said this, the vast majority of claims do settle and the Dilapidations Protocol, if properly followed, should generally secure a resolution out of Court;
  7. a continuing failure by some parties and/or their representatives to follow the Dilapidations Protocol and, in particular, make their cases clear to each other at an early stage. In the Hammersmatch case, the Defendant was criticised for only making its arguments clear at a late stage and the Claimant for having maintained a claim that it intended to carry out all the repairs when this was not the case.
  8. an inability of a tenant to meet its liability. In the Twinmar case, the tenant went into liquidation without having paid anything.

The future for dilapidations claims

The future is somewhat uncertain. Nowadays, tenants take shorter leases and are a lot wiser to the extent of a full repairing liability. Leases are often subject to a Schedule of Condition and/or, in the case of new buildings, premises are let with the benefit of warranties from the original contractor and construction team. The Dilapidations Protocol is now part of the Court rules and, clearly important to follow. Claims should therefore be smaller and more capable of settlement.

The recent introduction into the Court rules of a provision intended to further encourage settlement by allowing claimants to recover an extra 10% of their damages (up to a limit of £75,000) if they recover more at trial than they have offered to settle at will, no doubt, provoke many tenants to settle to avoid this risk.

However, so long as tenants do not maintain premises in repair throughout a lease and/or don’t make provision for such a liability, and market conditions remain uncertain, terminal dilapidations claims will continue and there is, in fact, now a large dilapidations industry dependent upon this.

Jonathan Ross
Forsters LLP