Introduction

These lecture notes accompany the presentation entitled: ‘Dilapidations: A Practitioner’s Guide’.
This lecture concerns dilapidations and the law of dilapidations in leasehold commercial property held
on business tenancies.

The Agenda for this lecture, and the following notes, is as follows:
1. Terminology
2. The Law
3. The Lease
4. Analysis of Lease Covenants
5. Loss
6. Case Law Update
7. Q&A

1. TERMINOLOGY

What is/are ‘dilapidations’?: The concept of dilapidations can be defined as “a state of disrepair (in property) for which there is a legal liability to remedy”.

Accordingly, three elements must exist:
i) A building
ii) A lease
iii) A breach of covenant.

The remedies available to the injured part (i.e. the Landlord) are:
i) To enforce the implementation of remedial works; or
ii) Claim damages (which can then be expended on attending to the necessary remedial works); or
iii) Instigate proceedings to forfeit the lease. This option is obviously not available if the lease has already expired and a ‘Terminal’ dilapidations claim is being pursued.

There are several types of Schedule seemingly associated with dilapidations; namely:
i) Condition Surveys
ii) Schedules of Condition
iii) Schedules of Dilapidations
However, Condition Surveys do not fit here; this is simply a generic term with no specific meaning in the field of dilapidations. A Condition Survey could mean anything from a pre-acquisition report to a planned preventative maintenance survey. The term is often confused with ‘Schedules of Condition’, which are relevant to the field of dilapidations. Schedules of Condition enable the covenanting parties to agree and record the condition of the premises at the time of lease commencement in order to identify any pre-existing disrepair so that the tenant is not later held liable to make good this repair under the usual obligations within the lease. A Schedule of Condition must be engrossed to the lease and cross-referenced in the repair covenant and will usually be signed by both covenanting parties.
This can be an extremely valuable piece of evidence for a tenant in later defending a hefty dilapidations claim in a property that may well have been dilapidated before the lease started.
Without a valid Schedule of Condition, the tenant will be expected to observe the specific express repairing obligations in the lease and the existence of any pre-lease disrepair will fall within their liability.

Understandably, Landlords do not like Schedules of Condition as they severely limit the ability to pursue a future dilapidations claim.

There are several types of dilapidations schedule:
i) Interim Schedule – generally served ‘mid term’ and will only deal with serious breaches likely to cause a diminution in the property value or a threat to health & safety. In leases of 7 years or more where there is at least 3 years remaining, the tenant may have a defence against forfeiture proceedings for failing to comply with the content of an Interim Schedule under the Leasehold Property (Repairs) Act 1938. An Interim Schedule will not usually contain costs against the listed breaches as the intention is for the tenant to implement the works rather than claim damages.
ii) Terminal Schedule – traditionally served at the end or in the last few months of a lease. To avoid a tenant’s defence against forfeiture proceedings, the Terminal Schedule should be served in the last 3 years of a lease originally granted for more than 7 years, but by virtue of being ‘terminal’ it will not usually be served until the end of the term. A Terminal Schedule will detail all breaches and will include costs for compliance on the basis settlement will usually be achieved as a damages claim. Once the lease ends, the only option for settlement is damages, whereas up until expiry of the term the tenant has the right to implement the works listed in the schedule. Terminal Schedules, their content and the conduct of the parties in agreeing damages claims, are now governed by the ‘Dilapidations Protocol’ which came in under the Civil Procedure

Rules in January 2012.
iii) Final Schedule – the same in content as a Terminal Schedule, but issued after lease expiry. This is a rarely used term.
iv) Repairs Notice – of limited use and legal enforceability, unless served pursuant to a Landlord’s ‘self-help’ clause under the lease as propounded in Jervis v Harris [1996] Ch 195 where the Landlord can enter the premises and undertake the works in the notice with their own builders and then recover the costs from the Tenant as a debt rather than damages. This can be levied by way of rental areas and is a powerful tool at the Landlord’s disposal where the lease allows.
v) Scott Schedule – this is a modified version of a Terminal/Final Schedule with additional columns to enable the parties (or their representatives) to jointly comment against the content of the schedule on an item by-item basis. Traditionally seen as a pre-litigation document on the basis it will allow a judge to clearly see the areas of agreement and disagreement to assist in narrowing the dispute and making a determination on liability.

2. THE LAW

What governs dilapidations? The law of dilapidations is generally governed by the following:
i) Case Law (‘Common Law’) – this draws from judge-lead decisions in the civil courts predominantly in the area of contract law, but also in tort. There is a vast body of case law in relation to leasehold property repair matters, which has shaped and advanced the modern approach to dilapidations claims and claim management.
ii) Statute – several statutes have a bearing on dilapidations practice and procedure:
a) Landlord and Tenant Act 1927, Section 18(1), limbs 1 & 2
b) Law of Property Act 1925, Sections 146 & 147
c) Leasehold Property (Repairs) Act 1938.
iii) The Dilapidations Protocol – brought in under the Civil Procedure Rules in January 2012 to encourage attentive and transparent pre-litigation correspondence between the parties in agreeing damages claims for terminal dilapidations at the end of the lease. The protocol sets out rigid timeframes for serving and responding to schedules and gives guidance on what should/should not be included in a claim with emphasis on honest and accurate claim assessment.

3. THE LEASE

It is important to distinguish between ‘licences’ and ‘tenancies’; a licence is not a lease, a tenancy is.
The definition of a tenancy was set out in the House of Lords decision in Street v Mountford [1985] AC 809 where it was held that there is a tenancy if the agreement confers a right for exclusive possession for a term at a rent. These ingredients may convert what is seemingly a licence to a tenancy. One important aspect of this is that the security of tenure protection afforded by the Landlord and Tenant
Act 1954 applies only to business tenancies and not licences.
Generally, commercial property is held on either Full Repairing and Insuring (FRI) tenancies, or Internal Repairing and Insuring (IRI) tenancies. The difference being whether the repairing and decorating obligations extend to the external envelope of the property or not. Thus, in an FRI lease the ‘demise’ usually extends to the entire property including the roof and external walls. The ‘demise’ in an IRI lease will usually extend no further than the plaster on the structural walls, and possibly only floor boards and ceilings, but not the supporting structure. However, this has been the subject of extensive interpretive case law of recent. IRI leases are more common in multi-tenanted buildings where a service charge arrangement is put in place to deal with repairs to the exterior and structure.

There is no standard form of lease. This goes a long way to explaining why there are so many cases on leasehold contractual interpretation as each lease is unique and has its own interpretive
anomalies. There has been a concerted attempt by the Law Society and other similar bodies to formulate a standard business lease. The ‘Code For Leasing Business Premises in England & Wales’ was introduced in 2007 and has been widely adopted, albeit best suited to uncomplicated lease arrangements in modern property.
However, it should be noted that there is “no law against letting a tumble-down house”. This commonly cited statement was established in Robbins v Jones (1863)15 CB. This perhaps best exemplifies the reasoning by the vast body of case law on the subject.

4. ANALYSIS OF LEASE COVENANTS

Repair
The most common breach cited in a dilapidations schedule is that of the repair covenant. Whilst seemingly straight forward in principle, the courts have clarified, over the last couple of centuries, what a breach of the repair covenant actually entails.

Firstly, there cannot be disrepair without deterioration from a previous physical condition and/or resultant damage from the alleged defect. This has been enshrined in the cases of Quick v Taff-Ely BC [1986] QB 809 and Post Office v Aquarius Properties Ltd [1987] 1 All ER 1055. Therefore, if the alleged disrepair has not worsened over the lease term and no damage has resulted as a consequence, it is not considered to be disrepair and will not, therefore, amount to a breach of the repair covenant. The consequence of this being that it should not feature in a Schedule of Dilapidations.

Confusingly, the courts have held that a ‘failure in function’ alone will not necessarily constitute disrepair if, again, there is no underlying deterioration or damage. Accordingly, a component could be failing in its primary function (i.e. a new roof that leaks), yet not be in disrepair assuming that is how it was constructed. Conversely, a component could be performing its function adequately (i.e. a timber sash window that does not leak), yet will be in disrepair by virtue of rot or general deterioration from a previous physical condition. See: Stent v Monmouth DC (1987) 19 HLR 269.

In specifying the necessary remedial action to reverse disrepair, consideration needs to be given to the ‘standard of repair’. In Proudfoot v Hart (1890) LR 25 QBD 42 CA it was stated that the standard of repair must have regard to the “age, character and locality as would make it reasonably fit for the occupation of a tenant of the class who would be likely to take it”. This illustrates the point that the repair methodology must be contextualised against the type of property, its age, where it is located and what it is being used for. Thus, a higher standard of repair will be expected in a listed office building in the better part of town than an aged warehouse located on a backwater industrial estate.

The concept of the standard of repair also helps define when a particular property is technically in disrepair by reference to falling below the expected standard.
It is common for repair covenants to include instructive terms such as ‘put’, ‘keep’ or ‘leave’ in repair.
The most common and significant of these terms is ‘keep’ since it has been held to also carry an implied obligation to firstly ‘put’ in repair, and to ‘leave’ in repair upon expiry as well as to ‘keep’ in repair throughout the term. Therefore, the word ‘keep’ alone covers all three scenarios (see: Payne v Haine (1847) 16 M&W 541 and Proudfoot v Hart (1890) LR 25 QBD 42 CA).
Repair can include replacement or renewal (see: Elite Investments Ltd v TI Bainbridge Silencers (No 2) [1986] 2 EGLR 43) and may encompass improvement where this is a natural by-product of achieving the necessary repair (see: Minja Properties Ltd v Cussins Property Group Plc [1998] 2 EGLR 52). However, improvements cannot be imposed upon the tenant as part of the repair process simply because the Landlord was in a position where it was a convenient opportunity to implement certain upgrades to the premises (see: Secretary of State for the Environment v Euston Centre Investments [1994] 1 WLR 563).
In some instances, it will be clear that the only practical way of achieving the repair is to introduce an element of improvement. This was the situation in Elmcroft Developments Ltd v Tankersley-Sawyer [1984] EGLR 47 where the Landlord (who had the obligation to repair) repeatedly patched up the damp and defective plaster to a wall where there was an ineffective dpc; the court ultimately deemed that the only sensible method of repair was to introduce an effective dpc to avoid the futility of repeat repairs. See also Stent v Monmouth DC (1987) 19 HLR 269 where the court held that a timber door that required constant repair to prevent water ingress should be replaced with a self-sealing aluminium door which would cure the problem once and for all and avoid ongoing futile repairs.

The courts have also clarified that patchwork repair is generally not acceptable, albeit this must again be viewed in the context of the building (see: Shortlands Investments Ltd v Cargill Plc [1995] 1 EGLR 51). Therefore, non-uniform patch replacement of suspended ceiling tiles in a high quality modern office may not be acceptable, yet it may be acceptable in the office part of a car service garage. In Scottish Mutual Assurance Plc v Jardine Public Relations Ltd [1999] EGCS 43 it was held that only when something is “incapable of further patch repair” should it be replaced, thereby providing some definition as to the extent patch repair can be pursued before wholesale replacement must be considered as the appropriate repair method. It should also be noted that minor trivial or de minimis items of disrepair may be overlooked (see: Perry v Chotzner (1893) 9 TLR 477) and should not be included in a Schedule of Dilapidations.

The term ‘good and substantial repair’ has been held not to require the tenant to return the property in pristine condition or perfect repair (see: Commercial Union Life Assurance Co. Ltd v Label Ink Ltd
[2001] L&TR 29 Ch D).

Decoration
The decoration clause is a positive covenant meaning that if the lease states the premises must be decorated in the last year or 6 months of the term, then this must be done, regardless of whether, in the tenant’s opinion, it needs doing (see: Simmons v Dresden [2004] EWHC 993 (TCC)). The courts have also clarified that where decoration is to be carried out, it must be to a complete area, rather than in isolation (see: Commercial Union Life Assurance Co. Ltd v Label Ink Ltd [2001] L&TR 29 Ch D).

The decoration covenant will also usually define the colour scheme, or stipulate that the colour scheme, as demised, must not be varied unless with the Landlord’s prior written approval.

Reinstatement of Alterations
It is usual to find an express prohibition on tenant alterations unless with the Landlord’s prior written approval. This will usually be by way of a ‘licence to alter’. It is common for tenants to be permitted to undertake certain non-structural alterations (i.e. to erect demountable partitioning) without express Landlord’s consent, albeit there is usually a reinstatement obligation requiring the tenant to put the premises back to the layout and configuration as demised upon expiry. Where a licence to alter has been issued, this is usually a standard obligation.

In some instances a tenant may consider that the alterations they have made enhance the premises and may well be of benefit to a future occupier. This is entirely at the Landlord’s discretion as a breach of the ‘not to alter’ clause is a breach nonetheless, regardless of whether it enhances or diminishes the property value. Where express permission has been granted and there is no reinstatement obligation, a tenant may be relieved from any requirement to reinstate. Upon lease expiry, any tenant alterations and fixtures become the Landlord’s, therefore if a tenant remains in occupation and renews the lease, the alterations carried out under the previous lease become part of the demise (as a Landlord’s fixture) and will therefore become subject to the repairing covenant.

Accordingly, a tenant renewing the lease may find they are responsible (under the new lease) for repairing items they brought in to the premises, which now belong to the Landlord.

Statutory Compliance
Most commercial leases contain a covenant requiring the Tenant to comply with all Acts of Parliament and Regulations imposed by the relevant authorities. This includes obligations of management such as fire safety and precautions (including detection, means of escape, lighting), asbestos control and registration and safety of gas appliances. However, this obligation also applies to statutes restricting certain acts (i.e. planning permission for external alterations).

The obligation to comply with Acts of Parliament or Regulations does not require a tenant to make alterations to the premises for DDA purposes (other than their own service provider requirements), fire and health & safety risk assessments (which are an occupier’s liability rather than an obligation imposed on the property itself) and water chlorination testing where the water supply is mains fed.

Schedules of Dilapidations should also avoid requesting tenants to undertake general testing for statutory compliance – if the Landlord/Landlord’s Surveyor is unable to identify the breach then there can be no breach. The duty to ‘test’ in order identify a breach falls upon the Landlord, not the Tenant; however, if the Landlord does initiate testing and discovers non-compliance/breach, then the testing costs may be recoverable from the tenant as part of the claim.

Yielding Up
The ‘yield up’ provision in the lease is a catch-all clause that reprises earlier covenants, as explored above, but also sets out the tenant’s instructions for properly delivering up the premises to the Landlord. This covers the matters of:
i) Vacant possession
ii) Return of keys
iii) Removal of tenant’s fixtures & chattels
iv) Removal of refuse
v) Compliance with express obligations (i.e. repair, decoration, etc.).

It should be noted that whilst the tenant may deliver up the premises at the expiry date absent personnel and chattels, they may still be deemed to have failed to give up vacant possession if certain unauthorised alterations remain in place (i.e. partitioning) or where personnel are still on site merely attending to the dilapidations works after the expiry (or break) date (see: NYK Logistics (UK) Ltd v Ibrend Estates BV [2011] EWCA Civ 683).

5. LOSS

In terminal dilapidations claims where a financial settlement is being negotiated in settlement of the claim, the outcome will be a damages payment. The concept of damages is to restore the injured party to the position they would have been in had the breach not occurred. In financial terms, this will be assessed on the principles of loss. As such, when claiming a settlement in damages one cannot claim what one has not lost.

The underlying emphasis in damages settlements for dilapidation claims, certainly since the introduction of the Dilapidations Protocol in 2012, is to establish what the loss is, to enable a fair assessment of damages. This may take several forms:
i) Cost of Works – the obvious starting point is the cost of the remedial works. This may be adduced from Surveyor’s estimates or Contractor’s prices following a competitive tender exercise. This is known as the ‘common law approach to loss’, but may still be limited by the imposition of the statutory cap on the claim by virtue of Section 18(1) of the Landlord and Tenant Act 1927 (see below).
ii) Diminution in Value – Whilst the amount a landlord can claim in damages for breach of the repair covenant is capped by the diminution in the reversionary value resulting from the breach under Section 18(1) of the Landlord and Tenant Act 1927, the concept of ‘diminution in value’ has a wider application in evidencing the Landlord’s loss. It is conceivable that a claim in damages for diminution in value due to all tenant breaches will equip the landlord with enough evidence to show his investment has suffered even without obtaining a cost for the remedial works. Regrettably, the quality of diminution valuations varies wildly meaning both parties may commission their own independent Surveyor to provide a diminution valuation, yet the outcome is still that there is a vast disparity between the respective parties’ positions.
iii) Loss based on Inducements - In some situations a tenant may take on premises in an unrepaired state (as left by the previous tenant), but with the benefit of certain inducements to compensate the liability they are taking on. This can include reduced rent, extended rent-free periods, a reverse premium from the Landlord to cover the cost of the repair works, or a Schedule of Condition to protect the tenant from being liable for the inherited repairs at the end of their term. These factors may assist the Landlord in proving a loss attributable to the outgoing tenant’s breaches.
iv) Other Losses – The Landlord may be entitled to claim for other losses as part of the damages claim. This may include loss of rent, service charge contributions and rates for the period in which the property has to be taken off the market to allow the Landlord to implement the works the outgoing tenant was obligated to do but didn’t. The claim would be for the period in which the Landlord is denied a rental income whilst the works are being undertaken and will therefore generally be the duration of the works. To succeed in such a claim, however, the Landlord will need to demonstrate that there was another tenant ready, willing and able to take a new lease immediately the outgoing tenant’s lease expired, but was prevented from doing so owing to the condition.
v) VAT – VAT may be an actionable loss to the Landlord if the elected status of the property means VAT on any subsequent works expenditure cannot be recovered from HMRC by offsetting input tax against output tax. Thus, if the property is unelected, the Landlord will not file VAT returns as there will be no VAT on the rent; accordingly, any VAT expenditure on physically undertaking the works becomes a loss that cannot otherwise be recovered; as such, this will form part of the damages claim. Conversely, if the building is elected (and VAT is charged on rent) the Landlord will have the ability to offset any VAT on works expenditure, so the VAT element of the works does not represent an irrecoverable loss; as such the VAT element of the works cannot be included in the claim or any subsequent damages payment. However, it should be noted that HMRC have declared damages payments are outside the scope of VAT (damages payments do not stem from supply of goods and services) so when VAT is discussed as part of a dilapidations claim, it is strictly speaking ‘compensation in lieu of VAT’.

6. CASE LAW UPDATE

The following cases have recently been reported and are discussed in the lecture in more detail:
i) Twinmar Holdings Ltd v Klarius UK Ltd [2013] EWHC 944 (TCC)
ii) Sunlife Europe Properties Ltd v Tiger Aspect Holdings Ltd [2013] EWHC 463 (TCC)
iii) Peel Land & Property (Ports No. 3) Ltd v TS Sheerness Steel Ltd [2013] EWHC 1658 (Ch)
iv) Baroque Investments Ltd v Heis [aka Teathers Ltd (in liquidation), Re] [2012] EWHC 2886 (Ch)
v) Marks & Spencers Plc v BNP Paribas Securities Service Trust Co (Jersey) Ltd [2013] EWHC 1279 (Ch)
vi) NYK Logistics (UK) Ltd v Ibrend Estates BV [2011] EWCA Civ 683
vii) Hammersmatch Properties (Welwyn) Ltd v Saint-Gobain Ceramics & Plastics Ltd [2013] EWHC 1161 (TCC).

James McAllister LL.M BSc(Hons) MRICS MCIArb FFPWS

Director The Dilapidations Consultancy Ltd
36 Glebe Road
Bristol
BS41 9LH

Biog: James McAllister
James is a Chartered Building Surveyor and Certified Commercial Mediator. He is a professional member of the Royal Institution of Chartered Surveyors and the Chartered Institute of Arbitrators. He is also a Fellow of the Faculty of Party Wall Surveyors and an individual member of the Civil Mediation Council. He has a wealth of experience in the preparation, negotiation and settlement of commercial dilapidation claims and has been involved in more than 1200 cases without once having to pursue or defend his clients’ claims in court. James’ recognised ability to conclude contentious claims without recourse to
litigation has prompted him to qualify as a Commercial Mediator specialising in dilapidation claim settlement.
James has acted for a wide range of corporate and public bodies as well as private individuals and regularly acts as a consultant to other Chartered Surveyors. James’ work has covered all property types through the UK and Channel Islands. He has appeared on BBC Radio 4 in the context of neighbourly disputes and regularly lectures on the subject of dilapidations to the National School of Government, University of West England (Bristol) and professional training providers.
James has recently attained a distinction in his Master of Laws degree in Advanced Commercial Property Law at Northumbria University coming top of the course. His thesis
was entitled: ‘In Need of Repair? A critical review of the law concerning the interpretation ofrepairing obligations in business leases’.

More information can be found at http://www.jamesmcallister.com.
Tel: 0844 3510885
Mobile: 07866 092885
Email: jm@dilapidationsconsultancy.com
www.dilapidationsconsultancy.com