Real World - Spring 2013: When can tenants escape liability for terminal dilapidations?

by Dechert LLP

Most leases require the tenant to leave the property in a good state of repair at the end of the term. The amount of damages the landlord can recover if the works are not done is limited by section 18 of the Landlord and Tenant Act 1927. A recent High Court case, Sunlife Europe Properties Ltd v Tiger Aspect Holdings Ltd, clarifies how the section should be applied where the landlord carries out a major refurbishment after the tenant has vacated. In certain circumstances, this can result in the tenant escaping all liability for terminal dilapidations.

Statutory cap on damages

The starting point for the assessment of damages for breach of a tenant’s repairing obligation is usually the reasonable cost of the works plus professional fees for supervising the works and loss of any rent which would have been obtainable had the repairs been done. Section 18(1) of the Landlord and Tenant Act 1927 places a cap on the amount that can be recovered in two situations.

  • Under the first limb of the section, damages cannot exceed the diminution in the value of the landlord’s interest in the property. So, for example, if the landlord sells its interest without any reduction in the price on account of the disrepair, then no damages will be awarded.
  • Under the second limb, no damages will be awarded where the property is to be pulled down or structurally altered at, or shortly after, the end of the term so that the repairs would be valueless.

The Tiger Aspect case concerned the application of the first limb of the section in circumstances where the landlord carries out major refurbishment works, falling short of demolition or structural alteration, after the tenant has vacated.

The facts

The case concerned office and retail premises in Soho Square in London, which had been let on two 35 year leases in the early 1970s. At that time, it was the premier area in London for advertising agencies and film companies. The premises were built to state of the art standard and fitted out to a high specification. However, the building was not properly maintained and, by the time the leases expired, the premises were in a very poor state of repair and the heating and air conditioning systems did not work. It was not disputed that the tenant was in breach of the repairing obligations in the leases; the only question was how the damages should be assessed applying the first limb of section 18(1).

The landlord’s claim amounted to over £2 million, comprising the cost of extensive remedial works, related professional fees and loss of rent. By contrast, the tenant argued that the cost of the works required was about £700,000 but that the operation of the statutory cap in the first limb of section 18(1) reduced that figure to no more than £240,000.

The tenant’s argument

The tenant’s argument was based on the fact that the lease only required it to put the building into good repair and condition, but not to upgrade it to current standards. Even if it had fully complied with its obligations, the building would still have been of 1970s standard. It argued that the landlord would not have been able to let the building in that condition except at a very substantial discount. In order to let the building at a reasonable rent, the landlord would have had to carry out a significant upgrade, which is what it in fact did. Therefore, the tenant argued, most of the works that the tenant should have carried out would be worthless to the landlord, so its failure to comply with the repairing obligation would only have reduced the value of the landlord’s interest by the relatively small amount of £240,000.

The decision

The judge confirmed the following principles:

  • The tenant's obligation is to put and keep the premises in such repair as, having regard to the age, character, and locality of the building, would make it reasonably fit for the occupation of a tenant of the class who would be likely to take it.
  • The tenant can choose to perform his obligations in the way that is least onerous to him.
  • The standard to which the building is to be repaired is judged by reference to its condition at the time the lease was granted, not the condition that would be expected of an equivalent building at the expiry of the lease.
  • The tenant is not obliged to do any more than keep the original fabric of the building in good repair and condition and keep the equipment in satisfactory working order and, when it can no longer be repaired, replace it with similar equipment. The tenant is not required to leave the premises with new equipment, or to upgrade it to bring it into line with current standards (unless necessary to comply with any applicable regulations), even if the original equipment has become obsolete.
  • The landlord cannot recover for a loss which, by acting reasonably, he could have avoided, and he cannot recover the cost of remedial work that is disproportionate to the benefit obtained. Therefore the landlord cannot recover the cost of works which go beyond what is required to put the building back into the condition in which it should have been left by the tenant. However, the fact the landlord chooses to carry out more extensive work than the tenant was obliged to do does not prevent the landlord from recovering the cost of the work that would have been necessary to remedy the breach.
  • Market conditions at the expiry of the lease may mean that, even if the tenant had complied with its obligations, further upgrading or refurbishment work would be needed to enable the premises to be sold or let to an appropriate tenant without a significant discount on the price or the rent to reflect the condition of the building. If that is the case, then the landlord cannot recover the cost of that additional work and the tenant is not liable for the cost of any of the repairs it should have done that are made worthless by the landlord’s additional works, because the landlord will have suffered no loss from those repairs not having been carried out. This is known as "supersession".

In the event, in this case the expert evidence established that the building could in fact have been let without carrying out most of the additional refurbishment works. Therefore, most of the work required to remedy the tenant’s breach would have been of value to the landlord and on that basis damages of just over £1,350,000 were awarded.

However, the principles enunciated by the judge make clear the circumstances in which a tenant could escape all or nearly all liability for damages, despite extensive breaches of its repairing obligations and although the works carried out by the landlord fall short of demolition or structural alteration so that the second limb of s.18 does not apply.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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