Commercial property law can be a complex landscape at times, particularly where disputes arise, and none are more complicated than terminal dilapidation claims between commercial landlords and tenants.
These claims tend to focus on the cost of repairing the property, although there can also be huge issues about a tenant's failure to reinstate the property and remove items they might have added during their occupation, but one key element can significantly impact a landlord's recovery in terminal dilapidation claim; the diminution in value.
While the lease is still running, claims about disrepair are called interim claims, which operate differently than terminal claims. If a landlord brings a claim for a tenant's breach of repair obligations to put or keep the property in repair during the lease term, then the starting point for assessing damages (the amount the tenant has to pay) is the diminution to the property's value. Although the cost of the works may be £100,000, a landlord can only recover the decrease in the property value resulting from the tenant's breaches; let's assume here the decreased value is £50,000 and not the full costs of the works. The rationale for this is that the landlord could not spend the money the tenant pays on doing any of the repair works, because the landlord has no right to do those works whilst the tenant is in occupation.
When a lease has expired, the measure of damages is the reasonable cost of doing the work plus loss of rent until the works have been completed. This was established in the case of Joyner v Weeks in 1891. However, since then, case law has developed, and it has been recognised that many circumstances are not as straightforward as imagined in Joyner v Weeks.
Section 18 of the Landlord and Tenant Act 1927, was introduced to place a cap on the amount of damages a landlord can recover in these types of claims. It's designed to safeguard tenants, so it's vital that a landlord knows its implications because the cap can impact significantly on how much a landlord can recover, and is something a landlord should be mindful of from day one when they are making decisions about what they do with their property.
Common law damages and reasonableness
As the purpose of damages is to compensate the claimant for any loss, the level of damages will depend on the landlord's actual loss, which is in each case is a question of fact.
To demonstrate that the position might not be as straightforward as the basic position contemplated in Joyner v Weeks you only have to look at a decision made by the House of Lords in Ruxley Electronics v Forsyth in 1996. In that case, the court considered a claim for the cost of rebuilding a swimming pool that had been constructed to a depth of 6 foot 9 inches deep instead of 7 foot 6 inches, as specified by the claimant.
The House of Lords was at pains to point out that damages are not designed to provide a generous benefit to the claimant, and they recognised the need for reasonableness when assessing damages.
One factor that they thought was very relevant was the claimant's intention to do the repair work. In the Ruxley case, the court established after hearing evidence from the claimant that it had no intention of rebuilding the pool to the specified depth. As a result, the claimant's loss was limited to the difference in value as a result of the pool being constructed at 6 foot 9 inches deep instead of 7 foot 6 inches, which the court held to be nil.
Improvements
Issues can also arise in relation to improvements that might follow repair works.
In Joyner v Weeks, the court held that a deduction has to be made from the damages due to a landlord for breach of a tenant's repairing covenant, because the landlord is effectively being given back something that is "new for old". This principle is often referred to as a betterment discount.
In many instances it's impossible to carry out the repair works without some improvement. For example, in Harbutt's Plasticine Limited v Wayne Tank and Pump Co in 1970, the claimants had no other option but to build a new factory following the destruction of the existing premises from fire. Although the factory was rebuilt with a different layout and, of necessity, was modern and had new materials, there was no evidence that the factory including any extras or that the cost exceeded what would have been spent in replacing the old factory. The claimants were, therefore, entitled to the full cost of rebuilding without any deduction.
Loss of rent
A landlord might also be able to recover rent loss for the period reasonably necessary to carry out the works to put them into a state of repair. It might also be possible to claim for service charges and rates and insurance for the same period.
Loss of rent claims are notoriously difficult to succeed with, because a landlord will need to be able to demonstrate that it is solely the disrepair of the property and not some other reason that put off prospective new tenants and has meant that the landlord has been unable to re-let the property.
Landlords are not able to recover loss of rent if the premises could not have been re-let owing to market conditions or lack of demand for a certain type of property or could only have been let to a new tenant if a substantial rent free period was given.
Often landlords try and avoid these complications to ensure they can recover loss of rent, by including provisions in the lease that allow them to recover as a debt, loss of rent service charges and other days attributable to the period that it would take to undertake any repair works, if the tenant does leave the property in disrepair.
What does section 18 of the Landlord and Tenant Act 1927 say?
Section 18 limits the damages available for breach of repairing covenants or a covenant to leave the premises in repair at the end of a lease. There are two parts to section 18, which are commonly referred to as the 1st and 2nd limb.
The first limb (section 18 (1)) limits the amount a landlord can recover, to the diminution in the value of the landlord's reversionary interest in the property which has been caused by the tenant's breaches.
In order to assess the potential diminution in value, a specialist valuer needs to be used who will look at the value of the property as it has been left (in disrepair) and attribute a value and then do the same exercise and look at what the property would have been worth if it had been given back in compliance with the lease covenants and in full repair.
If the value of the property in repair was £1,000,000 and the value of the property as it's been left in a disrepaired state is only £750,000 then the landlord will have suffered a loss of £250,000 and section 18 (1) limits the landlord from recovering more than that sum.
If the landlord has employed a building surveyor who had drawn up a schedule of dilapidations which shows that £500,000 worth of works are needed but none of that work has been done, then if the diminution valuation shows that the loss is only £250,000 then that is the maximum amount that the landlord would be able to recover.
Sometimes, there is no difference in value resulting from the disrepair, and in that instance, the landlord will not be able to recover any damages.
It is important to note that section 18 (1) only applies to covenants to repair. However, it might apply to the breach of a decoration covenant if that breach also constitutes a breach of the covenant to repair. It is common for dilapidations claims to also include tenant breaches such as a failure to decorate the property at the end of the lease, comply with the statute and remove alterations and fixtures, but damages for those breaches are not limited by section 18 (1) and will be assessed using usual common law principles.
The second limb means a landlord cannot recover damages if it can be shown that the property, in whatever state it has been left, is going to be pulled down or structural alterations are to be carried out at the end of or shortly after the end of the lease, meaning any repairs would actually be valueless. This is also known as the supersession defence.
Purpose of diminution valuations
Section 18 valuations are usually relied on by a landlord to show that the cost of works is the same as any diminution and to justify why they should be able to recover the cost of works.
Tenants rely on section 18 valuations to try and limit the amount of any claim, particularly where a landlord has not undertaken repairs, and to argue that their liability is limited.
Section 18 valuations are more common where the amount of the claim is very significant and where the level of disrepair is very high.
Section 18 valuation is a very specialist field that involves complex assumptions and considerations. This is because different scenarios can exist, which makes the valuation complicated.
For example, a scenario where the tenant is moved out of the property and left in disrepair, but a subtenant who has renewal rights under the Landlord and Tenant Act 1954 remains in occupation. In that situation, the new lease granted to the subtenant would generally contain the same repairing covenants as the outgoing lease, and there may be no diminution to the landlord's interest at all. There could, however, be a diminution in value if the subtenant was not required to repair to the same standard as the outgoing tenant.
What is the date of valuation?
For valuation purposes, the relevant date is the date on which the outgoing tenant's lease expires.
Normally, events that occur after the lease expiry date are not relevant to the valuation exercise. However, that is not always the case, and some later events can serve as evidence of diminution. The courts have decided that the following events might be relevant to considering the value of the reversionary interest:
- Reverse premium given to a new tenant to take a lease of the premises, which reflected the former tenant's breach of covenant
- A sale of the premises shortly after the expiry of the term at a price below the market value based on the premises in the current state of repair.
In Hammersmatch Properties v Saint Gobain Ceramics and Plastics Limited in 2013, the court assessed the cost of works that the tenant should have carried out under the lease as more than £3,000,000, including fees and finance costs. As this was more than the value of the property in repair the court calculated the diminution in value as the difference between the in repair value and the site's development value of 2.1 million. This meant the diminution was £900,000, and section 18(1) capped the damages to this amount.
Supersession
The burden of proving that the 2nd limb applies falls on the tenant.
Again the relevant date for determining the landlord's intention is the date on which the lease ended. The evidence is subjective and therefore depends on what the landlord actually intended. If the landlord intended to demolish the premises when the lease ended the tenant can still rely on the second limb even if the landlord subsequently changes its mind.
The test for determining the landlord's intention was considered in Cunliffe V Goodman in 1950 and requires:
- The landlord to have reached a firm decision and have a clearly formed intention. It is not enough for the landlord to be merely be contemplating demolishing the premises or carrying out alterations.
- A reasonable prospect of the landlord carrying that intention into effect. Intention will not be established of there are too many hurdles for the landlord to overcome.
