Commercial Leases: Recent developments in dilapidations

  • Insight

03 February 2016

There are few things more likely to lead to a dispute between a landlord and tenant than the tenant’s dilapidations liability at the end of a lease.

What is most likely to upset a tenant facing a hefty schedule of dilapidations is that generally speaking, a landlord’s recovery under that schedule may well exceed, and often considerably so, the actual loss incurred.

As the landlord’s claim is ultimately a claim for breach of contract (i.e. damages) the tenant can, and always has had, the ability under the common law to try to prove that the landlord’s loss should be quantified by reference to a different standard than that suggested by the landlord. The tenant could try to argue that the landlord’s true loss is the diminution in capital value of the premises as a result of the tenant’s failure to return the premises in accordance with their obligations under the lease.

Grove Investments Ltd v Cape Building Products Limited [2014] CSIH 43

In the case of Grove Investments Ltd, (“the Landlord”) claimed that Cape Building Products Limited (“the Tenant") could not argue that the value of dilapidations under the lease should be equivalent to the diminution in capital value of the property.

The Landlord sought to rely on a clause in their lease that stated that the Tenant had to pay “the total value of the schedule of dilapidations” that had been prepared by the Landlord. The Landlord argued that this was a payment obligation, which obliged the Tenant to pay the total cost of works in the schedule of dilapidations, irrespective of what the landlord's loss might actually be.

The Landlord argued that by accepting this payment obligation in the lease, the parties had, in effect, created a debt that was due for payment in the normal way and so had displaced the common law. The Tenant’s counter argument was that the phrase “value of the schedule of dilapidations” was capable of being interpreted in more than one way. Thus, the Tenant  argued that the Landlord’s true loss should be measured by the diminution in value of property as opposed to total cost of the works contained in the schedule of dilapidations.

The Landlord contended that the reference to the schedule was only capable of meaning the total cost of the works. An Extra Division of the Inner House agreed with the Tenant. In arriving at that decision the court was persuaded that construction of the clause in this case provided the Landlord with the ability to make full recovery of the costs actually expended in reinstatement.

The court highlighted examples where this clause would produce a result that did not accord with commercial common sense such as where a landlord desires to undertake a complete refit of the property or where he intends to demolish the property or part of it.

In these cases, were the landlord to recover the full costs of the works in the schedule of dilapidations without actually doing the work, the landlord would be overcompensated  a sensible commercial approach would neither overcompensate nor undercompensate the landlord. The court did not however rule out the possibility of parties displacing the common law with express wording to that effect.

@SIPP Pension Trustees v Insight Travel Services Limited [2015] CSIH 91

The facts of this case were very similar to those in Grove. There were two issues before the court in this case:
1.Whether the tenant’s obligations on termination of the lease were limited to putting the premises in the condition in which they were accepted by it at the beginning of the lease; and
 
2.Whether the landlord was entitled to payment of a sum equal to the costs of putting the premises into the relevant state of repair, irrespective of whether it intended to carry out the work.

In the Outer House, the Lord Ordinary decided that the obligation to keep premises in good and substantial repair did not imply that the tenant had to put them in that condition irrespective of the condition of the premises at the start of the lease.

 On the dilapidations point, the Lord Ordinary decided that whether or not the tenant actually had to pay the cost of works in the schedule of dilapidations depended on whether or not the landlord actually intended to complete the repairs. Therefore, the clause was not a liquidate damages clause (or payment obligation).

The Lord Ordinary was persuaded that the interpretation which made commercial common sense was not one that obliged the tenant to pay the landlord a sum that was not commensurate with its loss. Again, the Lord Ordinary indicated that that if the parties intended to do so, this would require very clear wording.

 The Inner House has now given its view. On appeal, it has disagreed with the Lord Ordinary and decided that the natural meaning of the words demonstrated that the parties overriding and, thus, minimum repairing standard was “good and substantial repair”.

The tenant, when performing their obligation “to repair and keep in good and substantial repair” also has an obligation to put the premises in at least “good and substantial repair” irrespective of their condition at the beginning of the lease.  If there was no obligation to “renew, replace and rebuild” then a different conclusion may have been drawn, but this was not the case here.

Dilapidations

The lease contained a provision stating that, at the end of the lease, the tenant had to carry out repairs and give up the premises in a state that fulfilled its repairing obligation. It also contained the following wording:

“Provided Always that if the Landlord shall so desire at the expiry or sooner termination of the foregoing Lease they may call upon the Tenant, by notice in writing (in which event the Tenant shall be bound), to pay to the Landlord at the determination date... a sum equal to the amount required to put the leased subjects into good and substantial repair… in accordance with the obligations and conditions on the part of the Tenant herein contained in lieu of requiring the Tenant himself to carry out the work.”

The Inner House, again, disagreed with the Lord Ordinary saying that the only natural and ordinary meaning of this clause was that the clause amounted to a payment clause (and not a damages clause).

The court said that the words clearly indicated that the parties intended that if the subjects were not, at termination, in the condition in which they would have been if the tenant had complied with its repairing obligations then the landlord was to be entitled to payment of a sum equal to the cost of bringing them up to that standard whether or not the Landlord actually intended to carry out the work.

Conclusion

The court stated in @SIPP that “it is important to note that Grove decision did not lay down any general rule that the landlord in a commercial lease is, at termination, only entitled to be compensated for capital loss actually suffered”.

Where the parties expressly state that, at the end of the lease, the tenant must pay a sum equivalent to putting the premises into a state commensurate with its repairing obligations under the lease it would seem, at least from @SIPP, that the courts will interpret this as contractual payment obligation (or liquidate damages clause).

 In order to avoid any ambiguity it will be vital for landlords, when drafting dilapidations clauses in commercial leases, to ensure that the obligation on the tenant to reinstate and comply with its repairing obligation is tied to a contractual obligation to pay to the landlord at the end of the lease, the total cost of the works shown in any Schedule of Dilapidations served on the tenant. 

 This will avoid the landlord having to rely on a common law action for damages and the resulting quantification issues which will inevitably arise.

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