Development – a dampener on dilapidations claims?

Author: Julia Tobbell, Senior Associate, Real Estate Dispute Resolution, London

Whilst a developer is in the early stages of planning and finance, it may be happy to leave the current tenants in situ to generate a little extra income before the development starts (provided it can remove the tenants when the time comes!).  If that is the case, the parties will follow the usual end of lease procedure in the months running up to the termination date.  In practical terms, this means ensuring that the tenant is making arrangements to vacate and setting out the landlord's claim for dilapidations.  This blog entry addresses the approach developers can take to these claims for dilapidations.

The usual position, upon lease termination, is that the tenant owes the landlord damages in respect of any breaches of its repairing covenants (which can include reinstatement, redecoration, removal of fixtures and so on).  There are a complex series of rules which govern the quantum of damages payable, but in many cases the damages will equate to the actual cost that the landlord will incur in carrying out the works necessary to bring the premises back up to the required standard.  

However, a developer who is planning on demolishing the premises patently has no intention of carrying out any such works.   It would therefore be unfair to expect a tenant to pay in full for the cost of the works when they will never be carried out and, indeed, the premises may shortly cease to exist.  Parliament has long since recognised this potential injustice and addressed it in section 18(1) Landlord and Tenant Act 1927.  The provision contains two 'limbs':

1. The first limb states that the landlord's damages will be limited to the diminution in value of the landlord's reversion which has been caused by the tenant's breach. This is often referred to as the 'cap'.  The parties will ascertain the damages recoverable at common law (usually the cost of actually doing the repairs needed to comply with the covenant). Then the parties will ascertain the diminution in value of the landlord's interest resulting from the lack of repair. This may be the same figure as above: if the landlord can show that it intends to do the work and that an incoming tenant would require the repairs to be done, then the value of its reversion will be diminished by the cost of the works. However, if a hypothetical landlord would not do the works, perhaps because an incoming tenant would take the premises regardless of the works, or because the only use for the premises would be to sell them as a development site, then the diminution in value may be much lower. 

2. The second limb states that no damages at all will be recoverable where it can be shown that the property (whatever its state of disrepair) would have been demolished, or that other structural alterations are to be carried out which would render any repairs valueless.  This is known as 'supersession'.

Developers often get caught by this second limb because the tenant will be well aware of the landlord's redevelopment intentions – perhaps because the landlord has served notice pursuant to ground (f) of the Landlord and Tenant Act 1954, because its proposals have been made public, or the planning permission has already been granted.  However, the burden of proof is on the tenant and it has to show both a clearly formed subjective intention on the part of the landlord, and a reasonable prospect of the landlord carrying out that intention.  If it can show both, then the chances are that the landlord will recover very little, if anything, by way of damages.

However, there is one important caveat to the above – section 18(1) only applies to damages for breach of repair. It does not apply to breach of obligation to reinstate, redecorate, or remove tenant's items.  In some cases, particularly reinstatement, this can still leave the landlord with a high value claim, particularly if the cost of removing tenant alterations is high.

In the context of a redevelopment, seeking a large dilapidations settlement with an outgoing tenant may not be high on a developer's list of priorities.  But it is worth checking whether the development plans will even fall within the scope of section 18(1), whether the tenant might have committed breaches which are not caught by section 18(1), and seeking advice (from lawyers and specialist surveyors) on the most realistic settlement which might be achievable in all the circumstances.

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