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THIS ARTICLE WAS FIRST PUBLISHED IN ESTATES GAZETTE

Dilapidations – In part 2 of their article, Dawn Reynolds and David Gilbert consider how events predominantly driven by third parties can affect a diminution in value assessment in a damages claim.

What happens when the landlord lets premises and argues that the letting crystallises the loss? This may be quantified in terms of a rent-free or other incentive or the cost of works necessary to secure the letting.

In such cases, the losses incurred are often shown as a direct deduction from the reversionary value. Although in practice this may be the case, it is important to analyse what the incentives were, what they represented and how they are causally linked with the breach of the lease terms. In this scenario, tenants should ensure that all the letting details are provided, including side agreements.

For example, a landlord claims that it offered the ingoing tenant a rent-free period in lieu of repairs and in return for taking a full repairing lease. The first line of enquiry must be to establish the extent of the repairs and compare their cost with the rent incentive. Are they equivalent and is the alleged cost of repair reasonable? If not, an element of the incentive may relate to market inducements, which should not form part of the claim. Rent-free periods are the norm, so it is unlikely, save in the strongest of markets, that a tenant would not receive some form of this incentive on the grant of a new lease. The landlord’s case may be stronger if there is a contract to carry out a schedule of works, perhaps within a specified period. This may be prima facie evidence of the new tenant’s obligation, establishing a stronger causal link between the disrepair and the loss.

Topics of Discussion

An area in which arguments often arise is the grant of a new lease on full repairing and insuring terms subject to a schedule of condition limiting the new tenant’s repairing obligation.

In establishing the loss in these circumstances, the valuer is faced with a number of questions. These include the probability of works being required during the actual term and those for which the tenant is not liable at the end of the term in order to secure another letting. In the latter case, it may be necessary to consider the likelihood of future redevelopment to establish whether the landlord is likely to incur a loss that can be deferred to the valuation date.

Another topic of discussion between valuers is a comparison between the original and the new lease demise. It may be that the premises being demised are more or less than those contained in the initial demise. In other cases, the landlord may have had to carry out improvement works to enable a new letting to take place. In such instances, it is arguable that the new letting carries little weight in establishing the losses occasioned by the tenant’s breach of repairing covenants under the old lease. The two demises may be so different as to render them incapable of being objectively compared.

This article does not cover the mechanics of valuation. However, skilled valuers can produce valuation models that account for landlord’s improvement works in assessing values in and out of repair. It would be foolhardy to show absolute disregard for the letting of a demise that is different from that being valued.

Subtenant Insolvency

A common event in recent times is a subtenant’s insolvency. With no realistic chance of recovering its loss from the subtenant, the landlord will seek to pursue a dilapidations claim against the tenant. This may be presented to the tenant several years after it has vacated the property and possibly many years after the expiry of the headlease. If the tenant’s covenants were contained in a deed, the landlord will have 12 years within which to bring a claim; if not, the limitation period is six years.

On receipt of such a claim, the tenant should consider whether, at the end of the headlease, the entire premises were occupied by the subtenant under Part II of the Landlord and Tenant Act 1954. If so, the subtenant would have become the direct tenant of the landlord when the headlease expired and be entitled to a new lease, which would be on the same terms as the existing tenancy. The tenant should consider whether this contained a repairing obligation that mirrored the headlease. The new rent would be fixed by the court without taking into account any disrepair attributable to the subtenant’s breaches of the repairing obligations in the current subtenancy. The effect may be to reduce or extinguish damage to the reversion: see Family Management v Gray (1979) 253 EG 369.

However, each case must be considered on its facts; the likelihood of the subtenant taking a new lease and its covenant strength will be relevant factors that can influence the hypothetical purchaser’s bid.

Reversionary Leases

A reversionary lease is granted for a term that starts on a future date; it may be granted to a subtenant by the head landlord with the term to commence at the end of the sublease. Alternatively, it will be granted to a new tenant at the end of an existing lease.

The advice given to head tenants often states that a reversionary lease to a subtenant (or a third party) will extinguish the head tenant’s liability if it contains a full repairing obligation. This is because the subtenant will assume responsibility for the existing disrepair once the reversionary lease term begins and the landlord has not suffered damage to its reversion.

Van Dal Footwear Ltd v Ryman Ltd [2009] EWCA Civ 1478; [2010] 1 WLR 2015 is a timely reminder of the point at which the tenant’s liability for damages arises. The court found that the reversion means the property as it reverts to the landlord and any reversionary lease, whether made before or after the term date. Whether it was made with the same tenant or a different tenant is left out of account; what is to be valued is the freehold reversion at the moment it vests in the landlord unencumbered by the old or any new lease.

The existence of a reversionary lease will not necessarily allow a tenant to avoid or limit liability for breaches of the repairing covenant at the end of the headlease.

Rating and Management

Landlords will, faced with an empty building at the end of a lease, attempt to mitigate their holding costs, one of the most significant of which is empty property rates.

In a number of cases, landlords are trying to remove buildings from the rating list by carrying out decommissioning works that, they claim, form part of an overall process of refurbishment. The success of such arguments in rating terms does not alter the fact that the works may result in changes to the structure or services that supersede alleged repair items in the terminal schedule of dilapidations.

Similar arguments may be made in respect of the decommissioning of building services or the removal of asbestos. The threat of legionella in an old empty office building, for instance, may necessitate the removal of elements of hot-water or air-conditioning systems, thus avoiding both health risks and reducing ongoing maintenance costs. In the case of asbestos, the landlord may take the opportunity to remove asbestos that the tenant left in a safe and satisfactory condition in preparation for other works.

Proof that such works, having been in the mind of the actual landlord at the termination date, were also in the mind of the hypothetical purchaser may limit the landlord’s claim. It is important that tenants properly investigate all the landlord’s actions and ongoing proposals at the termination date, not merely those that relate directly to repair, refurbishment or redevelopment. Equally, landlords should be aware that action unrelated to these issues may affect their ability to substantiate dilapidations claims.

Conclusion

Varied and numerous events take place after the term date of the lease. It is necessary to consider each event to evaluate whether it is relevant to the level of damages claimed for disrepair and other breaches of covenant. The essential question is whether it would affect the hypothetical purchaser’s bid for the reversionary interest, thereby establishing a causal link between the losses claimed and the breach of covenant.

Blanket assumptions should not be made about the effect of post-lease events on the tenant’s repairing obligations when advising the parties at the beginning or end of a term. Although it may be thought that this advice rests with the tenant’s advisers, those advising the landlord should also consider the issues, to avoid leaving their client with unrealistic expectations.

Dawn Reynolds is a Senior Associate at Hill Hofstetter LLP and David Gilbert is a Director at Lambert Smith Hampton.