In the first of a series of features on dilapidations, we provide an overview of the main issues affecting landlords and tenants of commercial property, including liability for repairs
Tenants require their liability for repairs to be fair, reflecting factors such as the nature, size, value, age, character, condition, and use of the property, having regard also to the length of lease term.
Landlords wish to optimise the investment value of their interest, and will generally aim to secure a clear income by placing the responsibility for repairs on the tenant, but avoid causing rental value to be depressed as a result of the tenant’s responsibilities being unduly onerous.
Landlords and tenants may need to give consideration to the issues covered below but, with such a general overview, there may be qualifications, exceptions, related legislation, case law and particular lease terms which warrant the need for more detailed advice to be taken. Future features will consider some of the points in more detail.
Issues at lease commencement
Tenants should ensure that they are not responsible for any disrepair which exists at the commencement of the lease, without such a liability being reflected elsewhere in the transaction. Where there is disrepair, tenants will require this to be recorded in a schedule of condition in order to avoid liability.
An obligation to keep a property in repair generally includes an obligation to put the property into repair. Therefore, if the tenant does not include a schedule of condition in the lease, the tenant can be held responsible for any disrepair which existed at the commencement of the lease.
Also, the level of rent which is determined at rent review and lease renewal can assume that the tenant is in compliance with repairing obligations, and if a schedule of condition is not included, the rent could reflect a superior condition of repair than that which existed at lease commencement.
At lease commencement, tenants may sometimes also wish to commission a full structural survey and may also check for contamination, asbestos, difficulties with air conditioning systems, high alumina cement, defective cladding and the like.
Requirement to undertake works
Rather than include a schedule of condition in the lease, the landlord or the new tenant may require works to be undertaken. Because new tenants will usually require the property to be in good condition, the landlord may undertake works as soon as the current tenant departs, thus making the property more attractive when marketed, and also sometimes helping works to be undertaken during a void period, rather than granting a new tenant a rent-free period or other allowance when a full rent could otherwise be immediately secured. However, where tenants are likely to have specific requirements in respect of facilities, condition and design, the landlord may rather wait, and grant an allowance to the new tenant to undertake the work themselves.
In order to help optimise the investment profile of a property, and therefore its capital value, the landlord needs to achieve a market rent which reflects a property in good condition and repair (rather than making allowance at rent review for initial disrepair), and obliges the tenant to keep the property in full repair. Means of achieving this include giving the tenant a capital contribution to undertake works, or granting a rent-free period or other allowance/incentive as part of the transaction.
The landlord may, alternatively, prefer to pay the tenant upon the satisfactory completion of the works and, particularly at the lower end of the market, could take a bond from the tenant on the grant of the lease, which is returned once the works are complete – thus helping ensure that the works are actually undertaken.
The repair covenant
Repair covenants within leases vary widely and could, for example, include “to keep in wind and water tight condition”, “to keep in structural repair” and “to keep in good and substantial repair and condition”. These are sufficiently distinct to create a different liability, but there are many finer variations in terminology within repair covenants which may or may not create differential liability depending on the nature, age and character of the property.
A tenant’s liability for repair does not generally involve making improvements, or modernising the property.
In longer leases particularly, the repair provisions may incorporate potentially onerous obligations, such as the requirement to “‘re-build”, “renew” or “replace”.
The repair covenant may also require specific actions to be undertaken, such as the periodic redecoration of the property.
At the expiry of the lease, tenants are usually required to “leave”, “deliver” or “yield up” the premises to a required standard. Alterations may also have to be reinstated, with consent usually having been granted initially by way of a “licence to alter”.
The repair covenant generally applies to alterations and improvements undertaken at the tenant’s expense, and to landlord’s fixtures.
Inherent defects do not generally constitute disrepair, but defects could still be the cause of certain items of disrepair for which the tenant is liable.
Failure to repair could also be a breach of the Building Acts, resulting in the service, for example, of a dangerous structures notice by the local authority.
If the lease does not contain obligations for either party to repair the property, neither of the parties are generally obliged to carry out repairs, and cannot oblige the other party to do so. There is no implied condition of fitness that the landlord has to provide, and it is for the tenant to be satisfied that the property is fit for its intended use. Certain repairs may, therefore, have to be undertaken by the party with the greater need.
For properties in multiple occupation, a service charge may be administered which includes a contribution to the cost of repairs. The service charge helps avoid individual tenants having an onerous liability for the cost of major and unexpected works, typically by the administration of a sinking fund/reserve fund.
A form of lease may therefore be termed IRI (internal repairs and insurance) which may involve the tenant only painting and decorating, as against FRI (full repairs and insurance) which includes both internal and external repairs. The precise liability for insurance will also vary accordingly.
Schedules of condition and schedules of dilapidations
A “schedule of condition” records the condition of repair of the property, typically at the commencement of the lease, and comprises descriptive comment and/or photographs, and, sometimes, also videos. The schedule should be appended to the lease, and/or the lease should make express reference to the existence and purpose of a schedule held separately. The separate availability of a schedule of condition does not necessarily limit a tenant’s liability for repairs.
A “schedule of dilapidations” details the items of disrepair for which the tenant is considered to be liable. The terms “interim”, “terminal” or “final” schedule are loosely used to mean mid-lease, towards the end, and at or beyond the end of the lease respectively.
During the lease, the schedule details works requiring remedy, but where the tenant has vacated following lease expiry, the claim is for the cost of the works. Statutory continuation/holding over and interim continuation counts as being during the lease.
A “reverse” schedule involves a tenant serving a schedule on the landlord responsible for remedying disrepair.
A “Scott” schedule takes different forms, but generally comprises both the landlord’s and tenant’s claims, costs and comments within the same schedule, prepared for the purpose of the court determining a settlement.
A “repairs notice” is usually a contractual notice, that is served under the terms of the lease, which calls for specific repairs to be carried out within a given timescale.
The landlord’s remedies for disrepair
The investment value of a property is influenced by its condition of repair. External disrepair can also affect the value of a landlord’s neighbouring interests. Landlords may therefore give greater consideration to the state of repair when, for example:
” they wish to sell or raise finance on the property,
” the tenant is of poor covenant strength or is known to be in financial difficulty,
” the tenant is in breach of other covenants,
” the lease is due to expire, or
” the tenant has exercised a break facility.
Landlords also consider factors such as:
” the possibility and consequences of forcing the tenant into bankruptcy or liquidation;
” the need to preserve the right to sue former tenants and guarantors;
” the ability to relet the property – possibly on more favourable terms;
” the opportunity to re-negotiate terms with the current tenant as a result of the issue of disrepair; and
” the damage that could be caused to the landlord-and-tenant relationship.
The landlord’s principal remedies for disrepair during the term of the lease are to sue for damages or, provided the lease contains a forfeiture clause, seek to forfeit the lease. Also, a “self-help” remedy, outlined in the second part of this feature, may enable the landlord to undertake the necessary works themselves, and recover the cost from the tenant.
To seek to forfeit the lease or to sue the tenant for damages as a result of disrepair, a notice has to be served on the tenant in accordance with section 146 Law of Property Act 1925. This “section 146” notice does not have to be in a prescribed form but must state why the tenant is in breach of the repair covenant and state what needs to be done to remedy the breach. The notice should give the tenant a reasonable period of time to undertake the works. If the works are not undertaken, the landlord can seek an order for possession from the court. Restrictions placed on the landlord’s ability to forfeit the lease, owing to the Leasehold Property (Repairs) Act 1938 are outlined in the second part of this feature.
It is worth noting also that if rent is outstanding, it may be possible to gain possession by peaceable re-entry and subsequently sue the tenant for damages for disrepair – but noting that the tenant may obtain relief against forfeiture by paying outstanding rent arrears.
The tenant’s failure to repair the property is also a ground of opposition at lease expiry for the tenant’s application for a new tenancy, either as a single ground, or coupled with other grounds.
Another remedy for the landlord is to seek an order for specific performance from the court, but in practice this is very rare.
The second part of this feature, which will appear on 25 August, includes an examination of the valuation basis upon which damages for disrepair are assessed, together with other factors influencing the approach taken by the parties to remedy disrepair.
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Repairs and the market rent |
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Rent review provisions, and also the basis of valuation at lease renewal, usually assume that the tenant is in compliance with the terms of the lease, including the repairing covenants. The tenant cannot therefore benefit from non-compliance with repairing obligations, and pay a lower rent based on poor condition. If the landlord is deemed to be in breach of their repair covenants, the rent can usually reflect the disrepair which results from the landlord’s neglect. If a tenant’s repair covenants are onerous, having regard to factors such as the nature of the property and the term of the lease, the property should command a lower rent. Disrepair at lease commencement can give landlords particular scope to construct beneficial investment profiles. This includes, for example, granting a rent-free period as a works allowance, which unlike a rent-free period granted as an incentive, would not warrant a downward adjustment to determine the true “effective”, or “day-one” market rent. As well as artificially raising the apparent market rent for the property for the benefit of sale or financing, the transaction may be structured by the landlord having regard to its favourable impact on rental levels secured for rent reviews or lease renewals on their other interests nearby. When evaluating comparable evidence, tenants must therefore be satisfied that reported works allowances are genuine, as evidenced, for example, by establishing the true extent of the works required, checking that the lease actually obliges all of the suggested works to be undertaken, quantifying the reasonable cost of the works, distinguishing between general remedial expenditure and works specifically relating to the particular tenant’s business, ensuring that landlord’s improvement works are not incorporated, contacting the previous tenant to establish the extent of disrepair and its cost/remedy (if any) that the landlord may have pursued, and being satisfied that the time allowed to undertake the works is reasonable and is not effectively a rent-free period/incentive. |
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Estate management systems |
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As well as ensuring that property inspections are made periodically, and consideration is given to tenants’ compliance with repair covenants, administrative systems must ensure that details of original tenants and their guarantors are maintained, including changes of address and company names. Under the Landlord and Tenant (Covenants) Act 1995, any original tenants, former tenants and guarantors liable for the performance of a current tenant’s covenants must be served with a “section 17” notice by the landlord, notifying them within six months of liability arising. For repairs, this will be usually from the date that damages are claimed or other proceedings commence. However, while former tenant liability can help underpin income security and property value for institutional-grade investments particularly, for smaller landlords and in the case of lower-value properties, it will often be impractical and/or inappropriate to maintain systems and pursue former tenants, not least because many lettings will be on shorter leases granted initially to the current tenant. It is worth noting that a seemingly straightforward consent which permits a tenant to undertake alterations could result in former tenants/guarantors escaping liability, because the consent effectively varies the lease. This is one illustration of the importance of seeking good-quality legal advice, and also of the need to maintain effective management systems, including checklists, for example, which make case surveyors and also administrative staff aware of the implications and financial consequences of certain, sometimes apparently innocuous, actions. The inadvertent acceptance of rent which can “waive” the ability to take action against tenants for certain, “once and for all”, breaches of covenant (such as user or alienation provisions), is a common situation to be alert to, but in the case of repairs, the breach is ongoing, enabling rent to be accepted for the duration of forfeiture proceedings or damages claims. Records also need to be maintained of deeds of variation, licences to undertake alterations, consent to undertake improvements, previous schedules of condition and dilapidations, and general correspondence – all of which may be required to help settle dilapidations claims, compensation for improvements and compensation for disturbance, and also to help determine, for example, the basis of rental valuation and therefore the market rent at rent review and lease renewal. Note, for example, that although compensation for improvements may appear to mitigate a tenant’s liability for disrepair, tenants may still have to demonstrate that their improvements were undertaken with the landlord’s consent, and will still have to serve the required notice (the time frame for which may have passed before the landlord instigates a dilapidations claim). It is also important that leases determine the extent of the demise, including responsibility for maintenance of access ways, roof space, party walls and so on. When repairs are being undertaken, regard may also be given to other legislation such as the Party Walls Act 1996 or the Access to Neighbouring Land Act 1992. |
