Costs management is an important aspect of landlord and tenant relationships, nowhere more so than in the area of service charges and dilapidations. By Beverley Vara
In the current economic climate, tenants want to rein in their expenditure and landlords want to maximise their recovery. This tension gives rise to two potential areas for dispute: namely service charges and dilapidations.
Service charges
In order to challenge a service charge demand, a commercial tenant must consider it against the particular service charge provisions in its lease. Establishing errors in procedure and substance can help to defer and/or significantly reduce the final bill. Below are the key issues that need to be examined.
First, does the tenant owe the amounts claimed? The clause may require: (i) the service charge demand to be certified (ii) the landlord to have obtained estimates for any works and/or (iii) a certain procedure to be carried out. These may be condition precedents to the tenant’s liability to pay all or some of the items charged.
Second, can the landlord claim all the items listed? In some cases, the landlord might have included incorrect amounts, such as interest on money borrowed to finance the cost of providing the services. In others, it might seek to recover the cost of works undertaken after the end of the term or of substantial works, such as re-roofing, carried out close to the end of the term. These are open to challenge.
The tenant may also be able to challenge sums incurred by the landlord in accordance with its obligation to comply with statute, including the Disability Discrimination Act 1995 and the Carbon Reduction Commitment Energy Efficiency Scheme (CRC): see pp86 and 88.
For example, if a landlord purchases CRC allowances and channels them through the service charge, will the tenant have to pay?
Finally, the tenant should not overlook the basics. If a cap has been set, has this been exceeded? Has the landlord charged the correct percentage share? Has it forgotten to credit the service charge account with relevant sums, such as discounts on insurance premiums?
For each tenant that may have been overcharged it is possible to find another that has been undercharged. In most cases, landlords can subsequently recover additional sums, but it is preferable not to have to rely on this. They should pay close attention to the requisite lease mechanisms and adhere to them the charges may otherwise be irrecoverable.
Dilapidations issues
Under “dilapidations”, the tenant is obliged to carry out repairs as set out in the lease.
Although a landlord can require repair works to be undertaken during the term, it is more common (for commercial and legal reasons) for a schedule of dilapidations to be served at lease end. This will usually list all outstanding repair, reinstatement, maintenance and decoration works, depending on the terms of the lease and any supplemental documentation. The landlord’s claim will normally be for damages that equate to the cost of carrying out the works. In most cases, it will include a claim for loss of rent, service charge, empty business rates, professional fees and VAT (if applicable) for any period during which the property cannot be let because of disrepair.
As with service charge demands, tenants need to be clear about the sums that a landlord can claim from them. In particular, they should be aware of section 18 of the Landlord and Tenant Act 1927. This provides a cap on a tenant’s liability for damages in respect of breaches of obligations to repair and, in some cases, to redecorate.
The damages recoverable by the landlord must not exceed the sum by which the value of its reversion is reduced by the tenant’s breach the landlord has to prove that the value of the reversion has been reduced, and the amount of the reduction. For example, the tenant may have breached its covenant to ensure that carpets are clean. However, the landlord may have no claim against the tenant if it can be shown that it intends to lay parquet flooring, meaning that the cleaned carpets would not have survived in any event. Damages will also not be recoverable where a landlord intends to demolish its building or to carry out structural alterations such that the tenant’s breaches of covenant to repair become irrelevant.
When it receives a dilapidations schedule, the tenant should, while it still has access to the premises, instruct a surveyor to make a comprehensive record of the condition of the premises immediately before the end of the term, including detailed photographic and video evidence. The level of disrepair is measured as at the lease termination date, so it is important to have evidence of the state of the property at that time.
Similarly, as soon as the tenant has vacated, the landlord should gather its own evidence of the state of repair to avoid subsequent disputes.
The tenant will have to decide between carrying out the repair works or paying damages. If it chooses the former, it should try to agree with the landlord in advance the exact nature of the works to avoid any later disagreements. It will need to work together with its surveyor to determine whether: (i) the schedule of dilapidations is factually accurate (ii) the sums claimed are reasonable in the circumstances and (iii) the proposed remedy is appropriate. As part of this process, the surveyor (sometimes together with a lawyer) will conduct a detailed analysis, checking each item in the schedule against the appropriate lease and licence provisions as well as the relevant tenant covenants.
For example, if a lease obliges a landlord to give the tenant notice requiring it to reinstate the property and the landlord fails to do so, any items in the schedule relating to reinstatement may be struck out. Alternatively, a landlord may request the replacement of an item that could properly be repaired for less. Landlords should ensure that they follow the correct procedure and are not caught out.
Be realistic
Once each party has assessed the merits of the other’s case, it should consider making a Part 36 offer to settle at an appropriate level. It is important to be realistic. In 2008, a landlord was ordered to pay the tenant’s legal costs on the higher indemnity basis mainly because of the perceived initial exaggeration of the claim. The claim was for more than £400,000 the landlord eventually accepted that it was worth only £1,073.50.
Parties should be prepared and should instruct the relevant professionals at an early stage.
Beverley Vara is a partner and head of real estate litigation at Allen & Overy LLP
