A terminal dilapidation claim is a claim made by a landlord for financial compensation at the end of a lease.
If a tenant leaves a property in breach of its lease covenants and fails to restore it to its original state or fails to remove alterations they have made during the lease term, then a landlord is entitled to sue the tenant for the cost of restoring the property to the condition it should have been in if the tenant had complied with its lease covenants.
Once a tenant has left the property, they have no right to return and carry out repair work after they have received a terminal schedule of dilapidations from their landlord.
Terminal dilapidation claims are different from claims that a landlord might make if the lease is continuing if the tenant fails to keep the property in repair. Disrepair claims, while the lease is still running, are known as interim dilapidations claims.
It is common to find a clause in commercial leases, also known as a repairs clause or a Jervis V Harris clause (named after a famous case dealing with disrepair), which gives the landlord a right to inspect the premises and serve a notice on the tenant requiring the tenant to undertake repair works within a short period, and gives the landlord the right to go in and carry out those repair works if the tenant fails to do so.
This gives the landlord control over ensuring that the property is kept in repair and also has the advantage that the landlord is entitled to recover any costs it incurs in completing works from the tenant as a debt.
Often, commercial property leases also give the landlord a right to serve a Section 146 notice on a tenant warning that if the tenant fails to carry out repair works, the landlord can forfeit (terminate) the lease.
In some cases, a landlord may not want to end the lease but may require the tenant to pay damages equating to the cost of the required repair work.
What is the tenant liable for?
It is very common for commercial leases to include full repair obligations. It is imperative that tenants properly understand their repair obligations and the condition under which they will be required to give back the premises at the end of the lease when they take on the lease.
Leases usually require a tenant to maintain the property in good repair, which applies even if the tenant takes on a property already in disrepair.
Very often, tenants think they have no repair liability when their lease ends because they have improved the property's condition and it is in better condition than when they took it on. This is a common misunderstanding on the part of many tenants and offers them no defence at all if, in fact, their lease required them to put and keep the property in repair or keep the property in repair and give it back in repair at the end of the lease.
In addition to a covenant to keep the property in repair, commercial leases also usually include obligations on the tenant to redecorate the property throughout the lease term and an obligation to decorate the inside and outside of the property in the last year of the lease term. It is not unusual to see clauses in leases that require the tenant to agree with the paint colour that should be used with the landlord.
Tenants are also usually obliged to clean the windows throughout the lease term and give them back in a clean and tidy condition.
There are also likely to be restrictions in the lease about alterations that the tenant can make whilst they are in the property and the need for tenants to obtain the landlord's consent if they make any alterations. The landlord's consent is documented in a licence for alterations, and it is very common for the licence to include obligations on the tenant to reinstate those alterations, i.e., restore the property to the condition it was in before those works were done and before the lease comes to an end.
Common issues that are disputed
If a tenant is taking on a property in a poor condition and they want to limit their repair obligations, then they should seek to agree with their landlord that a schedule of condition limits the tenant's repair obligation and that they do not have to return it to the landlord in a better state than it was at the start of the lease. A schedule of condition is a written and photographic record of the property showing its condition at the beginning of the lease. If a tenant has a detailed schedule of condition that will give them some protection from a terminal dilapidations claim at the end of the lease.
A common reason a tenant might want a schedule of condition is that they might be taking on the lease of a property where the roof, for example, is already fairly old. In this situation, the tenant needs to make sure that they are not signing up to a lease that obliges them to give back the property's roof in a fully repaired condition at the end of their lease term.
Even if a tenant has the benefit of a limited repair obligation and a schedule of condition disputes can still arise if the landlord's surveyor believes that the property's condition is worse than when the lease started. Take the example of a schedule of condition that documented that the property's roof was already 20 years old and showing signs of disrepair. If the tenant has been in the property for a further 10 years and over that time, the condition of the roof has deteriorated significantly, the tenant may still run into difficulties if they are not able to give back the property in the condition that it was at the start of the lease. If the roof already had leaking roof lights when the lease started, but the roof leaks are now far more extensive, it may be impossible for the tenant to undertake works to restore the leaking roof lights to the condition they were in at the start of the lease. The tenant could, therefore, find that despite the schedule of condition, if they signed up to a full repair obligation, they are still liable to give back a repaired roof, and that might mean a wholesale replacement of the roof.
If a tenant is vacating a property, they should engage their own building surveyor up to a year before they're planning to move out and take some very early advice about what works they need to undertake to give back the property in compliance with their lease covenants. It is inevitably cheaper for a tenant to undertake repair works while still in occupation than to face a terminal dilapidations claim once the lease is ended.
Even when a tenant engages their building surveyor and carries out extensive repair works before the lease ends, disputes can still arise if the landlord's building surveyor takes a different view on what works are needed to comply with the repair covenants.
Inevitably, building surveyors form different opinions on the extent of works needed to give a building back in repair and the appropriate repair methods.
In an ideal world, a landlord's building surveyor would work collaboratively with a tenant's building surveyor before the lease has ended and agree on what work needs to be carried out and how those works will be completed to the landlord's satisfaction. However, there is no obligation on a landlord to serve a terminal schedule of dilapidations before a lease ends, nor is there any obligation on a landlord to agree on what repair works a tenant is carrying out before a lease ends.
How are damages assessed?
If a landlord thinks that the property has been vacated by the tenant and left in a state of disrepair, the first step for the landlord will be to instruct a building surveyor to inspect the property and compile a schedule of dilapidations which lists the breaches of the tenant's obligations i.e. that the roof has been left in disrepair, what works the tenant needs to do to remedy that breach and how much that work is going to cost.
Initially, the landlord is only likely to have estimated costs because they have not actually carried out the repair works themselves.
If a landlord does intend to spend its own money and carry out the repair works, it is usual for the landlord to ask its buildings surveyor to compile a specification of works and for that specification to be put out to tender so that several contractors can put in their own prices for carrying out that work.
If a landlord initially served the outgoing tenant a schedule of dilapidations with estimated costs, once the tender process has been completed and the landlord has chosen which contractor will carry out the repairs, it is usual for the landlord's building surveyor to serve an updated schedule of dilapidations that then includes actual costs for the work.
In some cases, the likely expenditure for the works is significant and can run into hundreds of thousands of pounds. A landlord may not be able to forward fund that work and pay for itself in the expectation that it will get that money back from the tenant. A landlord will, therefore, pursue its tenant in circumstances where it has not undertaken work and has not incurred any actual loss.
It is also common to find that the predicted cost of work is very high, but that cost does not reflect any decrease in the value of the building even though it has been left in disrepair.
Section 18 of the Landlord and Tenant Act 1927 was introduced to cap the amount of damages a landlord can recover in these types of claims. It's designed to safeguard tenants, so it's vital that landlords know its implications. The cap can significantly impact how much a landlord can recover, and landlords should be mindful of this from day one when they make decisions about what they do with their property.
There are two parts to section 18, which are commonly referred to as the 1st and 2nd limbs.
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 the tenant's breaches have caused.
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.
Dilapidations protocol
The courts now require parties to a dilapidation claim to follow a protocol and process before any court proceedings are issued. The protocol sets out that the landlord should send the tenant a terminal dilapidation schedule setting out the breaches of the lease, the works need to be done and if possible, the landlord's costings.
Schedules should be sent within a reasonable period of time and that can vary from case to case but the protocol indicates that it should generally be within 56 days after the end of the lease.
The schedule has to be endorsed by the landlord, or if it's being prepared by a surveyor, the landlord's surveyor. The endorsement has to confirm that in the landlord's or the landlord's surveyors' opinion, all the works set out in the schedule are reasonably required to remedy breaches, and the full account has been taken of the landlord's intentions for the property.
A quantified demand should also be sent to the tenant, which clearly sets out all aspects of the dispute and substantiates the monetary sum that the landlord is seeking as damages. It should also set out with the VAT applies and confirm that the landlord or its surveyor will attend a meeting with a tenant or its representative.
The tenant should then respond to the schedule of dilapidations and quantified demand, usually within 56 days of receipt. If the landlord is seeking a monetary sum based on the cost of works then the sums need to be fully quantified and substantiated by either an invoice or a detailed estimate. The quantified demand must also provide full details of any other losses being claimed, such as rent loss.
The tenant should respond to the dilapidation schedule by adding its own comments to the document and confirming whether it accepts that it has breached the terms of the lease, whether it agrees with the landlord's proposed repair method, and whether it agrees with the costs that the landlord has included.
The protocol then encourages the landlord and tenant and their respective surveyors to meet on a without prejudice basis and seek to agree as many of the items in dispute as possible.
The parties are also strongly encouraged to consider Alternative Dispute Resolution including mediation.
Prior to issuing any court proceedings, the landlord must quantify its loss by providing the tenant with a detailed breakdown of the issues and losses based on either a formal diminution valuation or an account of the actual expenditure or, where it has carried out some of the work but not all of the work, a combination of both, unless in all circumstances it would be unreasonable to do so.
If the landlord has not carried out all of the works specified in the schedule but intends to carry out some more, the landlord has to identify which works it's going to carry out and when it intends to do them, steps that have been taken to progress the works (such as inviting contractors to tender for the project), and the scope of such proposed works.
If the landlord does not carry out the repair works in the schedule and does not intend to carry them out, then it has to provide a formal diminution valuation again unless, in all the circumstances, it will be reasonable not to do so.
If the tenant is going to rely on a defence based on section 18 (1), then it must tell the landlord that it is going to do that and provide its valuation to the landlord. That valuation should be sent to the landlord within a reasonable time but again the protocol indicates 56 days after the landlord sends the tenant its detail breakdown of issues and losses.
Once a tenant receives a terminal dilapidation claim, it should immediately engage a building surveyor to advise on whether the claim can be defended and on what basis. If a tenant is going to comply with the timescales set out in the protocol and wishes to rely on a section 18 defence, they will also need to give very early thought to instructing a specialist section 18 valuer to assist.
Landlords must also be mindful of section 18 valuations when they pursue a terminal dilapidation claim. This is particularly so if they are not intending to carry out their works and will not have any invoices showing incurred expenditure to demonstrate their losses.
Dilapidations and break clauses
Complying with repair obligations as a condition of ending a lease early is entirely clause-dependent, and no two leases are the same.
A conditional break clause may require a tenant to give back the property in full compliance with the lease repair covenants, but this type of obligation should be avoided at all costs if you are a tenant. Material or full compliance with repair obligations as a condition of breaking the lease is very onerous, and inevitably leads to much dispute and can in the worst scenario, mean that the tenant cannot end the lease early.
The role of surveyors
Employing a building surveyor is essential for both parties in a terminal dilapidations claim. A landlord cannot prepare their own schedule of dilapidation and form a view on what the tenant should have done to give them back in repair and needs an independent building surveyor to advise them properly on any tenant breaches and what works are needed to put the building back into repair.
The landlord's building surveyor usually compiles the schedule of dilapidations to be served on the tenant and in turn the tenant needs their own building surveyor to be able to respond to that schedule.
The parties' building surveyors should then meet and seek to reach agreement, if they can, on any tenant breaches, methods of repair and costs.
Ultimately if the parties cannot agree on a financial settlement the building surveyors may need to attend court and give evidence to the court on the tenant breaches proposed methods of repair and costings.
The role of lawyers
Although building surveyors play a pivotal role in dilapidations claims, it is usual for a lawyer to be instructed and for them to serve the schedule of dilapidations, and act as a conduit between the parties.
Sometimes, the tenant's obligations are unclear, as the lease may be ambiguous, and a legal opinion may be needed on interpretation.
If no settlement can be reached, lawyers may be involved in a mediation or a non-prejudice meeting to try to narrow the issue in dispute.
Ultimately, a lawyer might be needed if the amount to be paid cannot be agreed upon and court proceedings have to be issued.
