We are frequently instructed to assist with end-of-lease disrepair claims, known in our field as terminal dilapidation claims. They often come out of the blue for tenants and are a nasty surprise, but they needn't be if you take early professional advice from a solicitor and an experienced building surveyor.
We know that often tenants only focus on getting into a building to start trading and that they don't pay sufficient attention to their repairing obligations, let alone what they might have to do before they move out, so in this guide, we will explain some of the fundamental concepts of these types of claims, and what you can do if you received an unexpected and hefty claim.
What is a terminal schedule of dilapidations?
The schedule of dilapidations document is often 10-20 pages long, depending on the level of disrepair that a landlord's building surveyor prepares when the lease is close to its expiry date. It is common for tenants to receive a request for the building surveyor to inspect the premises before the lease end date so the building surveyor can assess the work required to give back the property in compliance with the covenants in the lease.
A landlord does not have to serve a terminal schedule before the lease ends, but it is good practice to do so, particularly if the landlord is going to ask its tenant to reinstate the premises and perhaps remove items that have been altered during the lease term, i.e. the installation of a mezzanine floor.
If a landlord has given permission for a tenant to make alterations during the lease term, it is often the case that the Licence for Alterations will specifically include clauses relevant to what happens at the end of the lease term and for a landlord to have to give written notice to the tenant to remove alterations before the lease ends.
Therefore, tenants may receive a terminal schedule before the lease ends. Alternatively, a landlord might wait until after the lease has ended and the tenant has vacated and then send in the building surveyor to produce the schedule.
If you are a tenant of a building and intend to move out, the best thing you can do to avoid a terminal claim for damages is to engage your own surveyor at least a year before the lease ends and take your own advice on what needs to be done. Inevitably, it will be cheaper to carry out any work yourselves before you move out than to have to settle a claim after the lease end date.
Effectively, the schedule is a document that sets out the tenant's repairing and reinstatement obligations, the building surveyor's observations about the condition of the premises (for example, that the walls need repainting), and the work that the tenant is required to do to comply with its lease covenants.
Can a tenant return and carry out repair work once the lease has ended?
A common misconception is that a tenant can return to the premises with the lead ended and do the repair work. That is not the case; a tenant only has a right to do repair work while their lease continues. As soon as the lease has ended, the tenant can only settle the terminal dilapidation claim by reaching a financial settlement with their landlord.
What should a tenant do when they receive a schedule of dilapidations?
A tenant should always immediately take advice from a specialist property solicitor and a building surveyor to properly understand the extent of their liability and what defences they can argue to reduce the claim's value.
If the tenant has vacated, their building surveyor should try and inspect the premises as soon as they can after the lease expiry date so they can take their own photographic record of the condition of the premises and make an assessment of the extent of any breaches of the repair obligations set out in the lease.
The building surveyor will then look at the schedule that the landlord's building surveyor has prepared and provide advice on whether the tenant has breached all of the repair covenants listed in the schedule, whether all of the covenant breaches are valid or otherwise, and whether the repair works that the landlord's building surveyor has listed need to be done are agreed upon.
It is common for there to be disputes between the landlords' and tenants' building surveyors as to the extent of the alleged repair breaches and the works that are required to remedy those breaches. For example, the schedule might allege that the tenant had failed to properly repair the floor in the building before they vacated, even though the tenant has removed its heavy equipment and done its best to leave it in a state of repair. Building surveyors will often take different views on what needs to be done to a building to leave it in a state of repair, and a tenants' building surveyor will also be mindful of the type of building it is and the condition it was in when the tenant first took out their lease.
The first stage response from the tenants' building surveyor will be to annotate the terminal schedule with comments on whether or not the item of this repair is agreed upon and whether the proposed method of repair is agreed upon, as well as comment on the likely repair costs.
If a schedule has been served before the lease has ended, the landlord might expect the tenant to undertake some repair work before they move out, and the landlord may, therefore, only have estimated the likely repair costs. In contrast, if the lease has ended, the building surveyor can see its condition as the tenant has left it, and a prudent landlord should instruct his building surveyor to properly cost the alleged repair works by going through a tender process and serve a terminal schedule that sets out actual repair costs, not estimate amounts.
It is usual for the two building surveyors to meet to try to narrow the areas of disagreement regarding the schedule and see if any settlement of the claim can be agreed upon.
I left the building in a better state than when we moved in – am I still liable to pay damages?
This is another common misunderstanding by tenants and reiterates why it is essential to properly understand the repair obligations you are taking on when you first take on the lease. In some instances, tenants can negotiate their repair liabilities, include a schedule of condition (SOC) with the lease, and limit their obligation to only having to give back the premises in the same state of repair as at the start of the lease. A proper schedule of condition will be a complete set of photographs with a full description showing the condition of the premises at the lease start date. A poor schedule of condition is one that is referred to in the lease but never actually prepared, or a document that is brief and lacks detail.
However, in most leases that we see, tenants don't have the benefit of limited repairing obligations or a schedule of condition, and they are obliged to put and/or keep the premises in repair and give them back in full repair at the end of the lease. It, therefore, doesn't matter that the tenant may have refurbished offices or improved the state and condition whilst they have been there. If you take on an obligation to yield up the premises in repair, then that is what you are contractually obliged to do.
What is the landlord intending to refurbish the property shortly after the lease ends?
In these circumstances, a tenant may well be able to argue that even though they have technically breached the terms of the lease and failed to give the property back in the condition required by the lease, given the landlord's intended works, the tenant's liability is negated and they do not have to pay for the cost of the repairs. This is known as a supersession argument, which can be successful if a landlord intends to undertake works to the property that effectively cancel out the tenant's breach. For example, if a tenant was technically liable to remove a mezzanine floor but had not done so, but the landlord intended to refit the property into residential flats, then they would be required to remove the mezzanine floor in any event, and they may not be able to charge the tenant for the cost of doing so.
What if the landlord has not carried out the repair works but is still claiming the cost of those works from the tenant?
This is where a tenant may be able to run a section 18 defence. Section 18 of the Landlord and Tenant Act 1927 effectively caps the amount that a landlord can recover in a terminal dilapidations claim, which limits the amount to the diminution to the landlord's reversionary interest. If a tenant is going to run a section 18 defence, then in addition to a specialist building surveyor, a tenant would be well advised to take advice from a specialist expert section 18 valuer.
In some cases, a tenant may successfully rely on a section 18 defence and limit the amount they have to pay to their landlord, not simply pay the cost of the proposed works. Using an example, a section 18 valuation involves an assessment of the value of a building left by the tenant in full compliance with its repair covenants (say £500,000). Then, the same exercise is done, but this time, a valuation is used based on the value of the building as the tenant actually left it (say £400,000). In this example, if the landlord was claiming £600,000 worth of work, the tenant may be able to limit the value of the claim to £100,000 because, by virtue of section 18, the landlord is not entitled to recover more than the difference between the value of the property in repair and out of repair. This can be a very useful argument in substantial dilapidation claims.
Well advised landlords should also, wherever possible, undertake the repair works and not simply rely on likely costs. In some instances, the court will accept the actual incurred costs as the value of the loss in preference to any loss established using the section 18 method.
My landlord re-let the premises immediately after we left and got a new tenant – am I still liable?
This is another potential strong line of defence. If, despite the repair works not being done, a landlord can find a new tenant and the new tenant can move in without any repair works being done, and the new tenant takes on a new repairing obligation, the landlord may not be able to establish any loss.
What are value affective works in this context?
This is a new and emerging concept in dilapidation claims. A section 18 defence has been a traditional defence in these types of claims, but an alternative route is available. The alternative approach is based on identifying value-effective works, i.e. works which affect the value of the premises in and out of repair. This approach involves considering :
- The disrepair items identified by the parties' building surveyors and the works needed to remedy them and,
- Whether or not any of the identified items affect the value of the premises and, if they do, whether they will be superseded by further works, which are the landlord's responsibility or which the landlord might undertake.
This approach was adopted in a recent case concerning a former textile warehouse in central Manchester, which the landlord had owned since 1965 and of which the tenant had a 14-year lease of part of the property, which ended in 2021. The judge had no issue with accepting the use of the value-effective assessment approach, which minimised costs and narrowed the dispute between the parties, where they could better focus on specific items and analyse the extent to which they affect the landlord's interest.
A landlord could issue court proceedings claiming damages. Dilapidation claims are notoriously expensive because of the number of experts that may be needed, and therefore, a settlement should be fully explored at every opportunity.
