There are two Limbs to section 18 of the Landlord and Tenant Act that may provide a defence to a dilapidations claim.
The first limb states the damages for a breach of a covenant to keep or put the premises in repair shall not exceed the amount by which the value of the reversion of the premises is diminished owing to the breach of covenant. This Limb effectively places a cap on the cost of the repairs.
The second limb states that damages shall not be recovered for a breach of covenant to put premises in repair at the termination of the lease if it is shown that the premises could at or shortly after the termination of the tenancy be demolished or be structurally altered. Therefore, redevelopment or refurbishment works may render the cost of any repairs worthless.
THE DILAPIDATIONS PROTOCOL: The Property Litigation Association
This sets out the pre-action protocol for claims for damages in relation to the physical state of commercial property at the termination of a tenancy. The objectives of the protocol are:
- to encourage the exchange of early and full information about the prospective legal claim;
- to enable the parties to avoid litigation by agreeing a settlement before the commencement of proceedings;
- to support the efficient management of proceedings where litigation cannot be avoided.
When making their claim, the Landlord is required to quantify the loss by providing the tenant with a detailed breakdown of the issues and the consequential losses. This may be based on either a formal diminution valuation (section 18(1) valuation) or an account of the actual expenditure, or a combination of both. However, the landlord is not required to produce a formal diminution valuation if it is not reasonable to do so.
If the tenant wishes to rely on a defence of diminution, it must state its case for doing so and provide a diminution valuation to the landlord. The tenant’s diminution valuation shall be served within a reasonable time, which will vary from case to case but generally will be within 56 days after the landlord has served his quantified claim.
LANDLORD’S CLAIM, Section 18: Valuation Approach
A terminal schedule of dilapidations may be claimed by the Landlord at any stage during the last three years of the term (or following lease expiry) for breaches of covenant which have accrued during the term. The common law measure of damages for such a claim is the cost of undertaking the works to which the breaches relate; however, the common law position is modified by section 18(1) of the Landlord and Tenant Act 1927.
In order to support a terminal dilapidations claim, a landlord may provide a Section 18 (diminution) valuation. This demonstrates how the tenant’s breach of covenant is reducing the value of the property. In preparing the valuation, consideration should be given to the interpretation of the repairing and yielding up covenants, along with an assessment of the reinstatement and decoration works, which may form separate heads of claim.
A claim made by a Landlord at the end of the lease is likely to comprise the following elements:
- Breach of covenant to repair;
- Breach of covenant to decorate
- Breach of reinstatement covenant (either under the terms of the lease or any licences for alterations);
- Loss of rent (for the period required to undertake dilapidations works);
- Professional fees.
In considering the first limb of Section 18 and any potential damage to the landlord’s reversion, consideration should be given to:
- the standard of repair;
- the condition the building is left in at the end of the term;
- the extent of the diminution of the reversion to the landlord.
The Landlord’s Section 18 valuation is essentially a comparison of the value of the property in repair against its condition in dis-repair at lease termination, with reference to the assessment of the cost of putting the property into the appropriate state of repair as required by the lease covenants.
The elements of Section 18 which may assist the Tenant in the defence of any claim made by the landlord include:
- The “cap” applied to the amount claimed by the Landlord, adopting the rationale that whilst the Landlord should be compensated for the repair, they should nevertheless not profit from it;
- The second limb of Section 18 protects the tenant where the landlord is proposing to substantially alter or demolish the premises.
In considering the above, it is necessary to consider the following:
- The leasehold market
- Trends in rental levels;
- The level of demand from owner-occupiers;
- The level of demand from investors;
- The potential for redevelopment
- The potential for refurbishment or alterations which would enhance marketability and value
- The extent to which any proposed work could be deemed to be an enhancement or even an improvement.