Trying to limit lease-end liabilities is often not as straightforward as might be expected
Dilapidations surveyors are often asked to provide an opinion on the wording of a “no dilapidations” agreement as the concept of excluding, or limiting, liability for dilapidations is not as straightforward in practice as might be expected.
When leasing buildings that are not in perfect condition, parties will often agree conceptually, in the heads of terms, to reduce the contractual liability on the tenant in relation to repairing and maintaining the building.
Often this is dealt with by way of a schedule of condition, but during the past few years tenants have had a good negotiating position and have pushed for something further – such as the right to simply vacate the premises and leave them “broom swept” clean or stipulating there will be no terminal dilapidations liability at all. This is also a common intention in agreements for surrender, whereby the parties agree the lease will end at a future date to allow the tenant to relocate, but all liabilities are agreed in advance.
While the concept of reduced liability might be agreed in the heads of terms, landlords are often unwilling to agree a true “no dilapidations” clause when they get into the detailed drafting of contracts. This is because common questions arise which need to be addressed, such as:
- What happens if the tenant causes damage beyond normal wear and tear?
- Will the tenant agree not to commit waste?
- What happens if there is wilful damage or the premises are vandalised?
- What happens if the premises are damaged via an uninsured risk?
- If the tenant alters the property, do they need to reinstate?
- Who bears any liability to third parties if the tenant doesn’t repair?
The usual answer to these questions is to start adding various provisos into the contract which undermine the limited or no dilapidations outcome that the parties, or at least the tenant, had in mind when negotiating the heads of terms.
So how can the parties address a limited dilapidations liability in their documents? In practice, there are various ways of achieving this reduced liability.
No dilapidations
For this to be effective, the lease should exclude all the usual obligations that give rise to dilapidations claims. This includes obligations relating to decoration, reinstatement of alterations, yielding up at the end of the term, compliance with statute and meeting landlord’s costs, not just repair obligations. The most effective is a simple statement that there will be no further liabilities at the termination date provided the tenant has ceased occupation and paid its rent.
This approach deals with a terminal dilapidations situation but not issues arising during the term of the lease. It is very difficult to persuade landlords that a tenant should not at least have a covenant not to commit waste or indemnify the landlord against any third-party liabilities as a result of disrepair. To completely exclude any potential liability for the tenant, the landlord has to take some risk and trust that the tenant will act responsibly. It is difficult to exclude every eventuality, so this is more about minimisation of liability rather than exclusion.
Schedule of condition
This is the most commonly used but arguably one of the least effective solutions. The cost of preparing a document sufficiently detailed to protect a tenant fully is often prohibitive. In particular, the condition of mechanical and electrical services is difficult to document and yet they are often a significant part of dilapidations claims. Many schedules of condition do not document these services, as the schedules are often just a brief description and mainly photographic record. The dilapidations negotiation then becomes a subjective matter, which leads to dispute. Schedules of condition are often used to limit repairing liability only, so the tenant receives an unexpected claim for decoration and reinstatement of alterations anyway.
Fair wear and tear
Fair wear and tear is a useful limitation but it doesn’t go very far and is open to interpretation. It also usually does not cover reinstatement of alterations.
Pre-agreed sum
This can be an effective solution where the tenant agrees to pay a fixed sum at the end of the lease or spread over the term in place of a terminal liability. The landlord may still wish to enforce obligations during the term, but at least the tenant has certainty at the end of the lease. The cap needs to apply to all the usual clauses and cover any consequential losses. The alterations clause and reinstatement obligations need to be tied in; usually the easiest way is to restrict the tenant’s rights to alter to minor alterations only, such as partitioning. Prohibiting alterations entirely is usually counterproductive for a tenant; most will want the right to alter even if they don’t think they will actually carry out any alterations.
Dilapidations cap
This operates in a similar way to a capped service charge. It gives the landlord the potential for recovery if there are breaches of covenant but at the same time gives the tenant certainty of a maximum exposé. Again, it is important to capture all relevant lease clauses under the cap. This is a more easily workable solution but of course it depends on the parties being able to agree an acceptable cap level.
Overage agreement
An overage agreement excludes liability for terminal dilapidations up to a certain level, with the tenant bearing any cost above it. This is usually linked to the landlord undertaking dilapidations works at the end of the lease and the cost exceeding an agreed budget. This is a useful mechanism for a landlord to protect their downside while having a simple mechanism to limit the tenant’s liability. What is covered by the overage arrangement needs to be clearly documented.
Agreed maintenance regime
Under this arrangement, the tenant undertakes an agreed maintenance plan to a set standard and in doing so meets its obligation during the lease with no terminal liability at the end. Again, this allows the landlord a simple way to mitigate risk of the tenant causing damage beyond what is expected.
The most common schedule of condition method of limiting liability is often the least effective and parties should consider some of the other options more frequently when faced with the task of drafting a limited dilapidations liability.
Mike McChesney is a partner at Deloitte Real Estate
