Dilapidations is not always Lease covenant orientated. A recent instruction from a head lessee with a superior landlord (freeholder) and two sub-tenants as the leases neared their end, provided a prime example of how the parties’ perspective on the level of settlement can change with time and circumstances entirely outside of the Lease covenants.
In dealing with a significant claim from a superior landlord, our client, who at one time had occupied the entirety of the premises but subsequently sublet to two individual tenants, was subject to a claim by the freeholder of initially £950,000, not all of which they would be able to reclaim from their sub-tenants.
Because of the size of the industrial unit, it was thought that the landlord’s intentions for the property were unrealistic – returning this to a single unit – as there was not much demand for that size of accommodation in the location. As it transpired our assessment was wrong, with the freeholder managing to find a single occupier for the entirety of the unit. This set the criteria for the dilapidation settlement. Our client did not have any period (other than one day) between the termination of their lease and that of their sub-tenants; there was therefore no ability for our client to undertake repair and reinstatement between the end of the sub-tenancies and the end of their own lease.
At the outset it was believed that the freeholder would take on one of the existing, well-established manufacturing tenants as a direct lessee and re-let the other accommodation. Instead, the single letting that the freeholder had identified meant that the sub-tenant was unable to negotiate a new lease and was forced to find new accommodation at short notice.
Prior to the end of the lease, the freeholder’s initial assessment of remedial work, reinstatement and repair was £950,000, which was assessed by us to be excessive. An offer to settle at circa £650,000 was rejected by the freeholder. Subsequent to the lease end the freeholder commenced work of repair and reinstatement. As part of this process they identified additional costs and advised of an increased claim of circa £1.3 million, which we believed could be lower than £900,000 under normal negotiation circumstances but possibly £950,000 if a settlement was to be achieved. Our client was keen to settle the dilapidations so they could dissolve their holding company, which was purely a shell company in place for the purposes of the headlease only. Based on the original schedule, and our ancillary advice to this, they had set aside £750,000 for dilapidations and were therefore surprised at the revised estimate of a settlement figure. Even so, in order to accommodate closing down the shell company within the tax year, they were willing to make an offer of £950,000 for associated benefits within the accounting of the broader company structure, accepting that they needed to go beyond their perceived liabilities if a settlement was likely. These offers were rejected by the landlord.
As work continued, costs for the freeholder escalated with figures being put forward prior to completion of the work of £1.65 million as the expected dilapidation claim. Again, we assessed these costs to be inappropriate, with a number of repairs and reinstatement being outside of our client’s repairing liabilities. We did assess the claim at being between £1.1 million and £1.225 million. It became apparent that the freeholder wished, for their own group company accountancy purposes, to liquidate some of their losses and were wishing to make an early settlement to the dilapidation claim. We robustly defended their costs. As year-end accounting approached for the freeholder, a settlement was achieved at just over £1 million.
The above is a classic example of needing to be aware of each of the parties’ respective circumstances and reasons for wishing to settle and the influence that they may have on the level of claim that might be accepted. Here, in both instances the wider group’s accountancy requirements/benefits were of greater importance than the minutiae of sums involved in the actual dilapidation claim and/or merits of the claim.
Other aspects arising from the claim which are often seen by us where there is a head lessee trying to manage the lease end:
- The lack of a time period between the end of the headlease and that of the sub-leases. Ideally a period of months, up to a year (and possibly more) should be left between the sub-leases and head lease coming to an end so that the head lessee has the ability to undertake remedial work at their sub-tenant’s expense, if this is appropriate and is more cost-effective than a financial settlement. Without this provision, a financial settlement is the only recourse for the head lessee, which often leaves them in an unenviable position of trying to settle the dilapidations with the freeholder prior to settling any of the dilapidation claims with their sub-tenants, putting them at risk of the sub-tenants going out of business or otherwise avoiding their liabilities. It also puts them at risk of being liable for loss of rent if the freeholder has a tenant delayed taking the premises as a consequence of disrepair.
- There is no guarantee that the claim with the freeholder, when settled by the head lessee, will be transferred in full to any sub-tenants even if the leases are back-to-back. Successful arguments agreed with the freeholder may not guarantee success with the sub-tenant.
- The manufacturing sub-tenant in the case above had undertaken significant alterations to the property that were not fully recorded. This made it difficult to argue with the freeholder where we believed alterations had not been undertaken, and that the condition was original to when the headlease was initially created by our client, and subsequently trying to argue with the sub-tenant where they had made alterations or not. Accurate lease plans are required particularly with larger, more complex properties and details of all alterations that are undertaken to be well-documented, including both existing and proposed plans. All too often we see licences for alteration with proposed plans but not what was there originally to enable easy of identification of the reinstatement requirements.
- As our client had taken a single unit and turned it into a multi-let unit, they retained responsibility for the repair and condition of the structure and exterior of the premises. This was subject to a service charge recoverable in full from the sub-tenants. Unfortunately, over the term of the leases, our client had not kept the property in repair, which, if the leases had been operated appropriately, could have been undertaken at nil cost to our client. Consequently, with a limited timeframe before the lease end, we undertook as much of the external repair of the building fabric as was possible given the time and weather constraints. Another constraining factor was the property being in occupation, which both increased the cost of repair and also limited the extent of repair that could be safely undertaken with the sub-tenant undertaking their manufacturing operations.
- The manufacturing sub-tenant had assumed that they would negotiate a new lease with the freeholder direct and had not considered the requirements to ramp down their operations. As a consequence of the surprise new tenant obtained by the freeholder, the sub-tenant continued manufacturing for as long as they were able, knowing that they would be limited in the equipment etc. that could be removed by them and transferred to new premises. As a result, the condition and amount of equipment etc. left by the sub-tenant was greater than would normally be the case. This could be reclaimed by our client as part of their breach of covenants but became a difficult exercise as a consequence of the poor information kept regarding the alterations, flues and other penetrations that were put in by the sub tenant or were pre-existing.
- The assessment of the value of a dilapidations claim is not always definitive and finite. Particularly where the landlord undertakes work, the claim will ultimately be for their cost of remedying the breaches as opposed to any budget costs that are given in preparing a schedule of dilapidations. In some instances we have seen there to be an under-estimate of the repairing costs and advised tenants to negotiate an early settlement, whereas in other instances the costs are appearing to be excessive and a review of the landlord’s actual costs would be preferable.
- When acting for a tenant waiting on what the landlord may actually do can be key, as supersession may play a large factor and limit a tenant’s costs.
