By Greig Fenton, associate director, Thomas & Adamson
DILAPIDATIONS and schedules of dilapidations in commercial leases can be somewhat contentious, often resulting in dispute and serious financial implications for tenants and landlords alike. Referring to the condition or disrepair of a commercial property at the end of a lease, tenants often fail to appreciate the extent of this obligation and accordingly don’t allow sufficient financial provisions for this liability. This can escalate if it involves the loss of rent or ‘notional loss’ to the landlord during the period needed to carry out the works.
In England, Section 18(1) of the Landlord and Tenant Act 1927 offers slight peace of mind by placing a cap on the repairs (the landlord’s loss) based on the diminution in value to the property, however in Scotland there is no such statutory provision in place. In response to this we are starting to see an increased appetite for a commercial ‘common-sense’ approach for assessing liability, and more people are beginning to test the Scottish courts: Mapeley Acquisition Co v City of Edinburgh Council (2015); Grove Investments Ltd v Cape Building Products Ltd (2014); @SIPP (Pension Trustees) Ltd v Insight Travel Services Ltd (2014).
We were able to utilise the diminution in value principle as part of our wider dilapidations’ negotiation strategy, on behalf of a major supermarket operator, who appointed Thomas & Adamson to establish the potential dilapidations liability on their tenancy within a 62,000 sq. ft. unit set over two floors in a town centre location.
The subject lease contained repairing covenants (agreements) stipulating various maintenance and repair elements, along with standard decoration clauses requiring works within the final 12 months of the lease. Our initial assessment outlined a likely dilapidations (disrepair) figure of approximately £350,000, which was significantly below the landlord’s assessment of over £1 million.
To best ensure the tenant’s dilapidation liabilities were minimised at lease expiry, we tendered the works scope defined within our assessment value and carried out the site works prior to lease expiry for the total sum of approximately £235,000. At lease expiry and taking account of the works carried out (stripping out of internal fixtures and fittings, services and ceiling/wall/floor finishes), the landlord reviewed their Schedule of Dilapidations and consequently reduced the cost to £670,000.
In our professional opinion, this figure was deemed excessive, therefore we instructed independent verification to provide an indication of the subject’s value in two scenarios: 1) as stood at lease expiry, and 2) on the basis that the landlord’s proposed works were undertaken in full.
The Diminution Valuation Report argued that ‘the value of the property as a single entity is considerably less than if it were sub divided, which would incur additional costs’ and that ‘even if the property was in good condition, I consider the letting market… for premises of this size, even if sub divided, and in this location, to be considerably weak’.
The Diminution Valuation Report concluded that ‘the hypothetical landlord/purchaser for the subject property would have bid for the property, on the basis of sub-dividing the premise’, and that ‘the dilapidations would not have had an adverse effect on value as it is my opinion the property is almost unlettable even if the premises had been left in good repair’.
Whilst we did not utilise the Diminution Valuation Report on any legal basis, its findings did reinforce our opinion that the landlord’s actual loss was covered to an appropriate level by the works undertaken by the tenant prior to lease expiry. The report’s conclusions supported our argument that any incoming tenant would necessarily sub-divide the unit and, therefore, that the open-plan shell works already undertaken by the tenant were sufficient to comply with lease obligations.
Having undertaken a significant degree of works to leave the unit in a condition which was suitable for the likely usage of the next tenant (i.e. allowing for sub-division without additional dilapidation-related costs being incurred by the landlord), a settlement figure of £150,000 was agreed between the landlord and tenant in order to underline the claim. Accounting for works undertaken by the tenant, this represented a total tenant’s outlay of approximately £430,000; a reduction of approximately £770,000 over the landlord’s initial dilapidations claim.
Whilst it does not appear that dilapidations negotiations in Scotland will depart from the time-tested methods of lease interpretation, schedules of dilapidations and associated negotiations overnight, it is important that Scottish tenants, and their representatives, are aware that in certain circumstances an alternative measure of loss is now deemed appropriate.
With increasing economic challenges, the last thing a business wants is to be tied into repair and decorating obligations as part of a lease agreement, therefore it’s important that tenants take steps to limit their dilapidations liabilities at the commencement of a lease or at the very least, comprehend the notion of dilapidations.
Thinking ahead in this way means that any necessary works can be planned, or negotiations conducted, which could considerably reduce the landlord’s claim.