Is the terminal dilapidations process too tenant friendly?

Some landlords understandably believe that when they enter a Full Repairing and Insuring (FRI) lease with a tenant, to protect their building/asset, that the lease provides them with robust protection given the covenants to repair, maintain and redecorate etc. that appear with a standard lease.

As is common practice, a Schedule of Dilapidations is prepared by the Landlords surveyor at or near lease end to identify any breaches of covenant; to either provide the tenant with the opportunity to complete the works or to leave the building without undertaking the works and use as a tool to enable negotiations, followed by a cash sum to be paid as damages in lieu, giving the Landlord the flexibility to utilise the cash as they see fit.

In reality, what can occur, is that the tenant (if advised properly such as by AG) can potentially walk away with a far reduced liability than expected………How can this be possible? Is this legally correct? Is this morally right?

How is this possible?

It is common for tenants at lease end to do little to ensure compliance with their lease covenants. Some Landlords prefer this as they prefer the flexibility of a cash settlement. However, the risk here is that in order for the Landlord to secure that cash settlement, they may be required to demonstrate loss and without that demonstration of loss it is difficult for a Landlords surveyor to pursue a damages claim on the Landlords behalf.

Loss by the landlord can be demonstrated in one of two ways;

by spending the money on undertaking the repairs, reinstatement and redecoration that the tenant should have undertaken and reclaiming as damages, or, by obtaining valuation advice, to demonstrate a reduction in the value of the building due to the lack of compliance by the tenant.

In either scenario the Landlord must spend money (at risk), either several thousand pounds on a valuation exercise, or tens or hundreds of thousands on building works.

And until one of these actions takes place, the tenant is in a position where they can sit and wait. The longer this goes on the greater the potential for a ‘No Claim’ outcome, should the Landlord re-let on similar terms or sell.

The reality is that sometimes the landlord may not have the funds to either pay for valuation advice or more likely insufficient funds to forward fund the required works, so nothing happens…….is this legally correct or, morally right?

Is this legally correct?

Sure, both parties have signed a lease (an agreement) and the tenant has not complied with the agreed lease covenants, so why is this just not enough?

Effectively what is happening (by the tenant not complying with the lease covenants) is that there is a breach of contract. Post lease end, any claim for breach of contract made by the Tenant results in a claim for damages; therefore, the overriding legal principles that preside are principals of loss, which were briefly outlined above in terms of demonstrating loss through a cost of works or a valuation exercise. So legally, there is protection, but the legal position seems to place the burden with the Landlord, despite the agreed lease position.

There are also numerous typical defences available to a tenant, a few examples are outlined below:-

Standard of repair of a reasonably minded tenant – As would be expected, the landlord and tenants view of what constitutes an appropriate repair standard to comply with the lease repairing covenant will differ; the landlord often requiring a Rolls Royce approach, whilst the tenant believes a patch repair will suffice. What needs to be carefully considered is the construction of the repair covenant, whilst considering what would a reasonably minded tenant be expected to do………as you would expect this can open up lots of debate.

Replacement goes beyond repair – linking to the above, the landlord may push for replacement of wholesale components, such as flat roof coverings or hand-standings, if they have been patch repaired previously and may be approaching the end of their economical lifespan; what needs to be considered carefully is whether replacement goes beyond the standard expected by the repairing covenant. Can the component be repaired by patching and meet the standard required by the repairing covenant?

Supersession – Where a component is requested to be repaired, but it is clear that undertaking a repair would be rendered abortive/valueless by the need to upgrade to meet market demands and will therefore be superseded by incoming tenants, landlord’s or hypothetical purchaser intentions.

Is this morally right?

Possibly not……it certainly seems that from a landlords perspective, that they have a lease in place which places certain obligations on the tenant; why should they be allowed to breach and place further burden upon the landlord……it doesn’t seem right does it……?

What can Landlords do to Protect themselves?

Before entering into a lease

Ensure the lease is well worded with more express provisions that describe clearly and specifically what the tenant must do at lease end, such as – “Tenant must replace carpets”. Ensure an accurate demise plan / schedule of fixtures and fittings is attached to the lease, so that any tenants alterations undertaken that have not formed part of an agreed Licence to Alter, can be clearly identified and notice can be provided at lease end to reinstate back to the former layout.

At/approaching lease end

Start to work with the tenant in agreeing lease end obligations and works within good time prior to lease end; indicating the standard of repair expected and extent of any reinstatement……this is all assuming the tenant wants to play ball. If the tenant has vacated without undertaking any lease end works, the landlord can undertake the necessary works in order to re-let and maintain income; this places them in a stronger position with regards to a damages claim against the tenant.

What you should do next

One of our Directors Jonathan Shaw BSc (Hons) FRICS is the only northern member of the RICS Dilapidations Steering Group.

We at AG are well placed to advise upon tenant and landlord pre-lease and post-lease strategies. We ensure a commercial approach always………we start with the end in mind to ensure the best strategic outcome for you and your assets.