Key point

  • When accepting a surrender, landlords should be careful to expressly preserve their right to claim for dilapidations

Background

When a tenant becomes insolvent, the landlord may consider cutting its losses and taking a surrender from the insolvency practitioner in order that it can then begin the process of re-letting the property.

The landlord will usually, however, want to ensure that its rights to pursue the tenant for any arrears, or any existing breaches of the lease, are preserved.

Facts of Baroque Investments Ltd v Heis (1) and Bewick (2) (as joint liquidators of Teathers Ltd)

In Baroque Investments Ltd v Heis (1) and Bewick (2), a landlord agreed a surrender with the liquidators of its tenant. The surrender deed provided that the landlord and tenant released each other from all liability in respect of any breach of the lease arising on or after (but not before) the date of the surrender.

The landlord sought to claim sums representing dilapidations in the liquidation. The claim had two components: a sum representing a failure to reinstate some alterations, and a sum to take account of the fact that the premises were out of repair.

Failure to re-instate

A licence for alterations provided that "Before the end of the Lease the Tenant is to dismantle and remove the Works and reinstate the Premises ...".

The liquidators argued that, absent the words "Before the end of the Lease", the tenant would have a reasonable time after its termination to carry out the reinstatement works. The inclusion of these words was, submitted the liquidators, designed to limit the time within which the tenant might carry out the works to the term of the lease. Accordingly, they argued, there was no breach of the reinstatement obligation as at the date of the surrender because the contractual term of the lease did not expire until some time after that.

This argument was accepted by the court. It ruled that the licence for alterations gave the tenant the full period of the term created by the lease in which to reinstate. Accordingly, there was no breach before the surrender for which the landlord could claim in accordance with the terms of the surrender deed.

Failure to keep the property in repair

The repairing covenant in the lease provided that the tenant had to "keep the demised premises ... in good and substantial repair and condition ... and in such repair and condition ... to yield up the same at the expiration or sooner determination of the term".

The landlord accepted that the second part of this clause; the yielding-up obligation, had been released by the deed of surrender. This was because the liability only arose "at" the expiration of the term, and the surrender contained a release of all claims arising on (as well as after) the date of the surrender. However, the landlord argued that it was entitled to claim for the breach of the first part of the covenant; namely to keep the premises in repair during the term.

Claims for a breach of a repairing obligation are limited by section 18 of the Landlord and Tenant Act 1927. This 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, ... shall in no case exceed the amount (if any) by which the value of the reversion ... in the premises is diminished owing to the breach of such covenant or agreement as aforesaid" (emphasis added).

In order to mitigate its loss, the landlord re-let the premises following the surrender. However, due to the poor state of repair of the premises it was forced to accept a reduced rent, as well as give the incoming tenant a considerable rent-free period. The landlord sought to recover corresponding sums from the liquidators.

The court ruled that the calculation of damages for breach of an obligation to repair premises during the term (as opposed to at the end of the term) involves an assumption that the lease is still continuing. The liquidators argued that it was not, therefore, relevant to take into account the losses arising on the re-letting.

The court agreed. The landlord should have valued the reversion in each of both its actual and its repaired state in order to calculate its loss. A valuation of the reversion necessarily assumes that a purchaser will take it subject to the lease, with the benefit and burden of all the covenants it contains for the remainder of the term.

Things to consider

The court's decision on reinstatement seems surprising. Perhaps it would have been better if the licence for alterations had said: "Before the end of the Lease (however determined) ..." (akin to the wording in the repairing covenant), but one would not expect the mere absence of these words to have led to the result in this case.

It seems from other case law (not cited in Re Teathers) that there may be a difference between covenants which are expressed to take effect "on expiry of the term" (which will not apply if the term ends prematurely) and those which are simply expressed to apply "at the end of the term".

Nonetheless, it is advisable for landlords negotiating to take surrenders to agree expressly exactly what they are expecting to preserve by way of a cause of action for dilapidations. Landlords who accept a surrender by operation of law (such as by the tenant handing back the keys) should be particularly wary, as this implies a release of all liability from and including the date of surrender. This would preclude a claim in relation to a failure to yield-up in accordance with the terms of the lease.

It is submitted that, despite a suggestion by the judge to the contrary, the landlord would not in any event have been able to claim anything by way of damages for breach of the covenant to put the premises into repair during the term. This is because at the date of the surrender there were more than four years of the contractual term left to run.

The Leasehold Property (Repairs) Act 1938 provides that as long as the tenant follows certain procedures to invoke the protection of the Act, an action for damages for breach of an obligation to keep or put property in repair during the currency of a lease cannot be commenced without an order of the court. This will only be granted in certain prescribed circumstances . The Act applies to leases which, when granted, were for a term of seven years or more, and where at the time the action is sought to be commenced there are at least three years remaining.