Key points

  • If a tenant hands back premises which include adequately maintained equipment - albeit that this equipment is dated - this will not, of itself, put the tenant in breach of his repair obligations
  • As long as the dated equipment is working, there is no obligation to replace, renew or upgrade it to modern standards (unless the lease or legislation says otherwise)

Sunlife Europe Properties Ltd v Tiger Aspect Holdings Ltd and another [2013]

A tenant occupied commercial premises under various leases. When the leases expired, the tenant stayed on for a while longer but did eventually move out. The question of terminal dilapidations arose, namely the tenant's obligation to hand the premises back to the landlord in the state and condition required by the terms of the lease. However, when it came to the fixtures and fittings at the premises (most notably, the air conditioning system), what was the standard by which the tenant's performance of that obligation should be judged?

In the early 1970s, when the premises were first let, the air conditioning system was state-of-the-art. Was the tenant therefore required to leave the premises with an equally up-to-date system, or was it sufficient to simply leave an air conditioning system that functioned?

This was just one of the issues discussed by the Technology and Construction Court (TCC) in Sunlife Europe Properties Ltd v Tiger Aspect Holdings Ltd and another. On that particular point, the TCC held that the tenant was obliged to hand back a working system; it did not matter that this was not state-of-the-art. Other issues (set out in this article) were considered, and restated, by the judge. The case therefore provides a useful reminder of some key principles relating to dilapidations.

Background

Leases of commercial premises usually place the tenant under an obligation to keep the premises in a good state of repair and condition. By virtue of long established case law, the phrase "to keep" the premises in a certain condition usually means "to put and keep" the premises in/to the standard required by the lease. The interpretation of that particular phrase was not an issue in this dispute, although the TCC still had cause to refer to the source of this principle: Proudfoot v Hart [1890].

Another background influence on the current case was section 18(1) of the Landlord and Tenant Act 1927. The relevant parts of this section distil down to the following:

  • Damages, for breach by the tenant of his covenant to put or leave premises in repair at the termination of the lease, cannot exceed the amount (if any) by which the value of the landlord's interest in the premises is reduced because of that breach; and
  • No damages shall be payable by the tenant for any such breach if his landlord is going to make "such structural alterations" to the premises as would render valueless the repairs which the tenant would need to carry out in order to comply with his obligations in the first place.

Section 18(1) of the Landlord and Tenant Act 1927 is often referred to as the "statutory cap on damages".

If a landlord thinks a tenant is in breach of the obligation to keep the premises in a good state of repair and condition, or that unauthorised alterations have been carried out, it may decide to send its surveyor to inspect the premises. Based on that inspection, the surveyor will prepare a "schedule of dilapidations". This is a list of the alleged failings by the tenant to comply with the obligations in the lease which relate to the condition of the premises (namely, the repair, decoration and alterations covenants). If the lease is still running at the time, the schedule is known as an "interim" schedule of dilapidations.

Where a schedule of dilapidations is prepared in anticipation of the lease coming to an end, or after the lease has ended, it is known as a "terminal" schedule, i.e. one which lists the alleged breaches which the landlord says the tenant is going to leave or has left behind on vacating the premises.

Schedules of dilapidation are either "costed" or "uncosted". A costed schedule is one which includes what the landlord thinks will be the cost to him of remedying each alleged breach. An uncosted schedule omits these pricings.

A "Scott Schedule" is a version of the costed schedule, but prepared with several columns. Some will be filled out by landlord, detailing what he considers to be the alleged defects, what he thinks are the required remedial works, and the cost of these works. Another set of columns will be filled out by the tenant, giving its counter-arguments to what the landlord has said. The final column will be used by the judge, if the case ends up in court. The judge will write in the figure that he ultimately awards as the cost for any item detailed in the schedule. Going through the Scott Schedule, line by line, will usually be the starting point for the negotiations between the landlord's and tenant's respective surveyors.

The facts of the case

The premises were originally let by the landlord's predecessor in title, under two leases, to the tenant's predecessor in title. By the time Tiger acquired the leases in 2000, the premises were already in a poor state of repair. Indeed, the outgoing tenant had to pay a premium to Tiger to take on the leases, even though the letting market was reasonably strong at that time, meaning that any payment would usually go in the other direction. Tiger carried out some works of refurbishment and repair, but really only to make the premises suitable for its own requirements.

The landlord, Sunlife, acquired the reversion to the leases in May 2006. In October 2006, Sunlife asked a surveyor to inspect the premises and to prepare an interim schedule of dilapidations.

Both leases expired in March 2008. Tiger originally wanted to stay on in the premises, but changed its mind and moved out in November 2008. Sunlife's surveyor re-inspected the premises and prepared an uncosted, now terminal schedule of dilapidations. A few months later, a costed version of the schedule was prepared and sent to the tenant's surveyor. This showed a total claim of more than £2.5 million - representing what Sunlife's surveyor calculated to be the cost of putting the premises back into repair. The first schedule prepared by Tiger's surveyor in response suggested that the works required to put the premises into the state and condition required by the terms of the lease would cost only £150,000.

Both Sunlife's surveyor and Tiger's surveyor prepared further versions of the costed schedule. By the time the case came to court, the landlord's claim had reduced to £2.172 million. Tiger's position - having now taken more works into account than were included in its original figure - was that £700,000 would suffice. It did not, however, accept that Sunlife was actually entitled to recover this sum.

As far as Tiger was concerned, the statutory cap would apply, limiting its liability to Sunlife to something in the region of £240,000. This was on the basis that Sunlife would have to carry out upgrading or refurbishment works in order to let the premises in the then-prevailing market. In doing such "additional" works, Sunlife would "supersede" the works which Tiger would have to carry out in order to comply with its dilapidations obligation (or, as in the present case, which Tiger was being asked to pay for in lieu of carrying them out). That is to say, Tiger argued that many of the works would not "survive" Sunlife's refurbishment or upgrading works, and therefore Tiger should simply not have to pay for those works in the first place.

The court's decision

The judge was faced with two parties who were very far apart in monetary terms and, to some extent, on the law relating to dilapidations and the statutory cap on damages. He therefore went through the Scott Schedule in great detail in order to calculate the level of damages payable by Tiger to Sunlife.

In addition, the judge made various statements as to the law. He clarified, for example, that the valuation exercise is to be undertaken objectively. The question does not revolve around what works the landlord in any particular case has actually carried out (or wants to carry out). Instead, the judge said, it revolves around what work was/is required in order to persuade a hypothetical tenant or buyer of the premises to take a lease or make that purchase in the market at the appropriate date. To the extent that the landlord's works will supersede those of the tenant, the tenant will not have to carry out those works (or pay for them, in lieu of carrying them out).

Both landlords and tenants will take heart from the decision. Landlords will be pleased to see the rulings that:

  • Where the tenant is in breach of its dilapidations obligations, the court will be entitled to infer (unless the tenant can prove to the contrary) that the remedial works carried out by the landlord were indeed necessary to remedy the breach.
  • Just because the landlord has carried out works that go further than the tenant's level of obligation, this does not automatically prevent the landlord from recovering the cost of the works that the tenant should have undertaken.

Tenants will be pleased with the confirmations that:

  • A tenant is entitled to perform his covenants in the manner which is least onerous to him. Therefore, the starting point for the assessment of damages is the cost of this standard of works not anything more onerous or expensive.
  • The tenant is not obliged to deliver up the premises (and the fixtures and fittings) with new equipment installed, or with equipment that has any particular life expectancy remaining. It is sufficient for any fixtures and fittings demised to the tenant (for example, the air conditioning system), to be handed back to the landlord in "merely" satisfactory working order.
  • The relevant standard by which to judge the tenant's overall performance of the dilapidations obligation is the condition of the premises at the date of the lease. It is not the condition which would be expected at the end of the lease, where times - and standards - may have moved on.
  • The same goes for the repair covenant during the existence of the lease. A tenant is obliged to replace broken down equipment only on a like-for-like basis, i.e. with something which is the nearest equivalent to the piece of machinery that has failed. He is not obliged to upgrade the equipment in line with modern standards (unless the lease, or relevant legislation, require him to do so).

Things to consider

If the landlord wishes to put the tenant under an obligation to install new equipment at the end of the lease, this can be expressly provided for in the lease. Hence the wording, in some leases, that the tenant is to "renew or replace" certain items, in addition to the obligation of keeping them "in repair".

However, even if the additional obligations are expressly included, the landlord might still not recover from the tenant the full cost of all such new or replacement fixtures and fittings etc. This is because the statutory cap on damages will come into play, together with the general rules about mitigating losses. These are that a claimant cannot recover a loss which, by acting reasonably, he could have avoided; and that he cannot recover the cost of remedial work where the cost is disproportionate to the benefit obtained.

There is, of course, also the potential issue of "supersession", as mentioned above. Will any works, or new fixtures and fittings, which the tenant carries out, installs or pays for be rendered obsolete by works which the landlord will be carrying out?

The landlord also needs to be careful, from a rent review perspective, when imposing any express obligations on the tenant which go further than what is "usual" in the repair, decoration, alterations and reinstatement covenants. For example, if the landlord imposed express obligation on the tenant to replace all existing mechanical and engineering equipment at the premises with new, modern items, this goes further than what is normally included in a lease. The clause could, therefore, have an adverse impact on rent review because the tenant's obligations under the lease will be more onerous than under a "more usual" lease of comparable premises.

Tenants, on the other hand, should be aware of their obligations at all times. Prospective tenants should carry out a thorough inspection of the premises at the time of taking a lease, and negotiate the relevant lease clauses accordingly. Equally, if taking an assignment of an existing lease, there should be a thorough inspection, with perhaps a resulting renegotiation of the purchase price. This is part and parcel of the principle which applies to property transactions in England and Wales: caveat emptor, or let the buyer beware.

If a tenant does not comply with the lease obligations relating to the state and condition of the premises, it could be "hit" with a dilapidations claim at any time during lease term, or after it has ended. There are schools of thought both ways as to whether it is better for a tenant to comply with the lease obligations at all times (putting it in charge of the level of expenditure, when that money will be spent, etc) versus not doing so, and having the opportunity to run the statutory cap argument. Reputational issues might also be a factor. A tenant might want to be known as someone who always fulfils their obligations without being pressured into doing so (for example, by the service of a schedule of dilapidations, and the potential threat of litigation).

In terms of a dilapidations claim itself, the parties should approach the question of dilapidations (whether terminal or interim) with realistic expectations. Both the landlord and the tenant need to be aware of their obligations and remedies, but also of the potential counter-arguments and limitations. One of the most crucial issues will always be - what is to happen next to the building.