UK: Life With The New Protocol: The Diminution Question

Last Updated: 12 April 2013
Article by Richard Flenley

One of the key advents of the new dilapidations protocol was the formal acknowledgment for the first time of the steps that the parties to a dilapidations dispute must take to demonstrate the comparison between the cost of repairs and the diminution in value of the landlord's reversion.

As is made clear by paragraph 9.1 of the protocol:

"Prior to issuing proceedings, the landlord should quantify its loss by providing to the tenant a detailed breakdown of the issues and consequential losses based on either a formal diminution valuation or an account of the actual expenditure or, where it has carried out some but not all remedial action, a combination of both; unless, in all the circumstances, it would be unreasonable to do so".

Although the initiating events pre-dated the introduction of the new protocol, the case of Sunlife Europe Properties Limited -v- (1) Tiger Aspect Holdings Limited (2) Tiger Television Limited [2013] EWHC 463 (TCC) represented the first substantial dilapidations dispute to be considered in the new protocol world that addressed the diminution question. Accordingly, it represents a window into the likely approach to be taken by the judiciary when analysing dilapidations claims going forwards.

Key to that case was a consideration of the cap placed on dilapidations claims by section 18 of the Landlord and Tenant Act 1927 ("the 1927 Act").

Section 18(1) of the 1927 Act provides that:

"Damages for a breach of a covenant or agreement to keep or put premises in repair during the currency of a lease, or to leave or put premises in repair at the termination of a lease, whether such covenant or agreement is expressed or implied, and whether general or specific, shall in no case exceed the amount (if any) by which the value of the reversion (whether immediate or not) in the premises is diminished owing to the breach of such covenant or agreement as aforesaid; and in particular no damage shall be recovered for a breach of any such covenant or agreement to leave or put premises in repair at the termination of a lease, if it is shown that the premises, in whatever state of repair they might be, would at or shortly after the termination of the tenancy have been or be pulled down, or such structural alterations made therein as would render valueless the repairs covered by the covenant or agreement."

The Facts

In the instant case, the Claimant, Sunlife, was the owner of combined office and retail premises in London. The premises had been let by Sunlife's predecessors in title to the predecessor in title of Tiger Television Limited ("TTL") under two leases with full repairing covenants. Tiger Aspect Holdings Limited ("TAH") was the guarantor under the leases. The term of both leases was due to expire on 24 March 2008 and Sunlife purchased the reversions in May 2006. However, both tenancies were subject to request for new tenancies by TTL. However, TTL subsequently changed its mind so that those tenancies came to an end on 14 November 2008 when TTL moved out.

In early October 2006 Sunlife arranged for the preparation of an interim schedule of dilapidations by Ian Feasey ("IF") of Lambert Smith Hampton. IF inspected the premises whilst they were still occupied by TTL. The schedule he prepared at that time showed a total cost of putting the premises into repair at approximately £740,000.

IF inspected the premises again in November 2008, just after TTL had vacated them. An uncosted schedule of dilapidations followed which was then replaced by a costed version released on 6 March 2009 that contended for a cost of putting the premises back into repair of over £2.5 million.

TTL then instructed Lee Davey ("LD") of DTZ who inspected the premises on 1 April 2009 and produced a response to IF's schedule albeit only addressing the building fabric items as opposed to the mechanical and electrical installation ("M&E"). LD's schedule showed a cost of approximately £150,000.

There was then a further exchange of schedules between IF and LD which showed that the parties were still a significant distance apart. Sunlife then carried out remedial works following which it produced a further schedule indicating a claim of £2.42 million which by trial had reduced to £2.172 million plus interest.

TTL's Case

However, TTL contended that the remedial works attributable to the failure to repair equalled approximately £700,000 but that Sunlife was not entitled to recover this sum in any event. TTL contended that Sunlife's claim was capped by the amount of the diminution in value of the premises as a result of Tiger's breaches of the repairing covenants which TTL considered amounted to no more than approximately £240,000. Central to TTL's case was the proposition that, in order to let the building in 2009, Sunlife had to carry out a significant upgrade and refurbishment (which is what it did) and that, if TTL had carried out all of its obligations, Sunlife would have been left with a building that was in working order and condition but by reference to 1973/4 standards (being the time when the leases were granted).

Further, this condition would not have been one in which a letting in 2009 could be concluded and, therefore, even if TTL had carried out the maintenance and repair required by its obligations, nearly all of the work carried out by Sunlife would still have been required but with no right of recourse against TTL or TAH.

Accordingly, bearing in mind the provisions of section 18(1) of the 1927 Act, the diminution of value owing to TTL's breaches of its obligations amounted to approximately £240,000.

Sunlife's Case

Sunlife's case on the other hand was remarkably more straightforward. It contended that the sum claimed, which it said was less than the sum actually spent, represented the cost of the work necessary to put the building into the condition in which TTL should have left it.

The Decision

Mr Justice Edwards-Stuart handed down his Judgment on 7 March 2013 and, at the outset (paragraph 23), noted that it was not disputed by the parties that TTL and its predecessors did not comply with the repairing obligations under the leases and he went on to conclude that the case was "all about the measure of damages".

He went on to conclude (as advanced by counsel for TTL and TAH) that the correct measure of recoverable loss in a terminal dilapidations claim is the lower of:

1 - The total of (a) the cost of remedying the defects (i.e. putting the property back into the covenanted condition, and (b) any rent actually lost and other expenses actually incurred whilst the defects are being remedied; and

2 - The diminution in the value of the landlord's reversion, as at the term date, caused by the breaches (i.e. the statutory cap referred to in section 18(1) of the 1927 Act). When analysing this measure of loss, one had to start by considering whether, if the tenant had sufficiently performed its obligations and delivered the premises up in good repair and condition at the end of the term, the landlord would have been able to let or sell the building without any significant discount on the price to reflect the actual cost of the building.

If the answer to that question was "yes" then the measure of loss is either the cost of putting the building back into the condition in which it should have been delivered up or the difference in the value of the building in its actual state and in the state in which it ought to have been delivered up, whichever is the less. Mr Justice Edwards-Stuart went on to comment (as is supported by our own experience) that theoretically the two of these should be the same but, in practice, that is often not the case.

Alternatively, if the answer to the above question was "no" then the court must consider what work would have been required at the expiry of the lease in order to put the premises (if properly maintained and put in good condition by the tenant) into a condition that would enable it to be let to the appropriate type of tenant at a fair market rent. This "no" question has two key consequences:

1 - The landlord cannot recover the cost of that additional work from the tenant; and

2 - The additional work may make worthless some of that work that would have been necessary to put the building into repair with the result that, if such work has not been done, the landlord has suffered no loss and accordingly cannot recover any damages in respect of that breach.

Further, the analysis of the cost of putting the building back into repair (which is fundamental to the assessment of all dilapidations cases) was always subject to the duty by the landlord to mitigate its losses and to also ensure that the costs claimed were not disproportionate to the benefit conferred by the repair in question. Accordingly, if the cost actually incurred by the landlord in seeking to put the building back into the condition in which it should have been left by the tenant is greater than the cost of other work which would be sufficient to put the building into that condition, the landlord is limited to recovering the costs of the latter.

Taking all of the above into account, Mr Justice Edwards-Stuart concluded that he did not agree with the argument originally advanced by TTL that the premises could not have been let in 2009 even if TTL had complied with its repairing obligations under the leases (although that position was later watered down) but did agree with TTL that the appropriate test in this regard was not whether the landlord had acted reasonably in carrying out remedial works but rather whether what the landlord has done by way of repair goes no further than was necessary to make good the tenant's breach of covenant.

Mr Justice Edwards-Stuart went on to summarise his analysis of the general legal principles affecting dilapidations claims as follows:

1) The tenant is entitled to perform his covenants in the manner that is least onerous to him and, in general, this should be the starting point for any assessment of damages.

2) The tenant is obliged to return the premises to the landlord in good and tenantable condition and with the M&E in satisfactory working order. The tenant is not however required to deliver up the premises with new equipment or with equipment that has any particular remaining life expectancy. The standard to which the building is to be repaired or kept in repair is to be judged by reference to the condition of its fabric, equipment and fittings at the time of the demise, not the condition that would be expected of an equivalent building at the expiry of the lease.

3) Where there are covenants against making alterations to the premises, the tenant is not entitled, let alone obliged, to deliver up the premises in a condition that involves any material alteration to the building or the fixtures as demised; the fact that the landlord can consent to any such alteration does not affect the basic obligation.

4) Where the requirement to put and keep the premises and fixtures in good and tenantable condition involves the replacement of plant that is beyond economic repair, the tenant is required to replace it on a like for like or nearest equivalent basis; he is not required to upgrade it in order to bring it into line with current standards (unless required to do so by law or to comply with any necessary regulations). He stressed however that, as with most obligations in commercial contracts, this obligation must be interpreted in a manner that accords with commercial common sense.

5) Any claim by the landlord for the cost of repairs is subject to the general rules that (a) he cannot recover for a loss which, by acting reasonably, he could have avoided, and (b) he cannot recover the cost of remedial work that is disproportionate to the benefit obtained.

6) Where there is a need to carry out remedial work as a result of the tenant's breach of his repairing covenants, the fact that the landlord has carried out more extensive work than was caused by the breach does not of itself prevent him from recovering the cost of such work as would have been necessary to remedy the breach.

7) Where market conditions at the expiry of the lease require upgrading or refurbishment works to be carried out in order to enable the building to be let to the appropriate type of tenant, a tenant in breach of a repairing covenant is not liable for the costs of any work to remedy the breach to the extent that such work would be rendered abortive by the need to upgrade or refurbish the building.

8) Where the tenant is in breach of his covenant, in the absence of any evidence to the contrary, the court is entitled to infer that remedial work is necessary to remedy the breach unless the tenant demonstrates the opposite to be true.

Given his earlier comments, Mr Justice Edward-Stuart considered this to be a case in which if TTL had sufficiently performed its obligations and delivered the premises up in good repair and condition at the end of the term, Sunlife would have been able to let or sell the building without any significant discount on the price to reflect the actual cost of the building. Accordingly, in his Judgment, he went on to undertake what he considered to be the primary task in assessing a claim for dilapidations; i.e. an assessment of the cost of putting the building back into the condition in which it should have been delivered up.

In doing so he determined that the allowable costs of the work amounted to £1,312,076 plus an additional £37,663 for the valuation reports and £3,515 for the cost of preparing the schedule of dilapidations resulting in a total figure of £1,353,254.

Having made that determination, he went on to consider the application of section 18(1) of the 1927 Act by reviewing the valuation evidence.

In doing so, he noted that there was a lack of detail in the calculations made by the key expert and that, in the light of this, the Court was not in a position to adjust his conclusions to reflect the Court's decision on the costs of the work. On that basis, it was left to the Court to determine the valuation question itself.

Mr Justice Edward-Stuart therefore used an alternative valuation that was not part of the expert evidence (it had been undertaken by an expert and the calculation was before the court albeit that his expert evidence more generally was not) which provided the detail that was required. On that basis he used the valuation included in that report and came up with an "in repair" valuation of £5.870 million. From that figure he deducted the actual expert's "actual condition" valuation of £4.462 million resulting in a diminution in value of £1.408 million. As this figure exceeded the already determined costs of repairs, Judgment was given for £1,353,254 plus interest at 3% per annum and costs.

This case, therefore, acts as a useful reminder of the principles of determination of dilapidations claims and reinforces the commitment of the judiciary to focus heavily on both cost of repairs and valuation issues when assessing such claims.

It also serves as a warning to occupiers who neglect their duties that to do so can have expensive consequences; the cost of the valuation reports alone in this case was a significant liability.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Richard Flenley
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