End of leases

19 / 07 / 2016

Leases must be read and construed as a whole. In the hurly-burly of negotiation this wider perspective can be overlooked. Not until a matter goes to court is the inter-relationship between the parties’ covenants and obligations fully understood.

However, some clauses are evidently linked, such as alterations and yielding up.  In South Essex Partnership University NHS Foundation Trust v Laiden Holdings Limited [2016] EWCA CIV 337, the Court of Appeal looked at the terms of these clauses in the context of a dilapidations settlement.

The tenant had undertaken fitting out works at the start of the lease, at its expense but using contractors nominated by the landlord.  The bulk of the work concerned the lift but carpet tiles were also lifted and (where possible) re-used.  During the lease the tenant had freedom to make internal non-structural alterations without consent.  At the end of the term the landlord could require reinstatement of those alterations if it was reasonable to do so.

Practitioners will be familiar with a commercial bargain of this nature. Fitting out works tend to be quicker if the same party carries out both Category A works (such as mechanical and electrical, raised floors and suspended ceilings) and Category B works (like partitioning for meeting rooms and offices, carpets and kitchenettes). Specifying the contractors to be used adds an element of control for the landlord in relation to important or technical works like a lift.  There’s no need for landlords to approve every minor change carried out to premises by a tenant during a lease, but equally no reason why the landlord should be stuck with those changes at the end of the term.

The tenant exercised a break option.  The tenant then wrote to the landlord advising that the carpet tiles would be replaced with carpeting of the same colour and quality, but laid in strips rather than as tiles.  The landlord did not reply. We know from Fitzroy House Epworth Street (No 1) Limited v Financial Times Limited [2006] EWCA Civ 329 that, however frustrating it might be for the tenant, the landlord is under no obligation to reply.  In this case the tenant replaced the carpets.  After the lease had ended the parties were unable to agree a figure for the tenant’s dilapidations liability.  The first instance trial turned on two key issues:  Firstly, had the re-carpeting been done in compliance with the relevant covenants in the lease?  If it had not, what was the date in which the landlord’s damages should be assessed?  The Judge held that the re-carpeting works had not been carried out in accordance with the lease terms (at a cost of £41,445) and that the landlord’s loss should be quantified at the date of the trial rather than at the end of the lease (a two month void costing £20,070) the tenant appealed.

On appeal the tenant argued that the carpet tiles were tenant’s fixtures.  Even if they had been the landlord’s property, they were still fixtures, therefore part of the demise, therefore fell within the purview of the tenant’s entitlement to make alterations under the lease.  The Court agreed; the carpet tiles had probably been glued to the floor and so should be regarded as fixtures.  The alteration to the carpet by way of a strip carpet was a permitted alteration.  The new carpet was not out of repair at the end of the lease.  Although the landlord had a qualified right to request the removal of the altered carpet before the expiry of the term, he had not made use of this.  This meant that the tenant had not been in breach of covenant in relation to the carpet.

Note that the Court did not consider that the question of who had initially paid for the carpets was relevant.  At the start of the lease term some of the carpet tiles had been recycled within the building and some were new.  No one suggested that carpeting should somehow be apportioned between the two parties to discover whether they belonged to the landlord or the tenant.  The judgment records that the tenant’s fit out was to be disregarded on rent review; one assumes that the initial rent reflects the cost of the tenant’s works.  It would be nonsense if the lease meant that alterations of landlord’s fixtures were permitted without consent but the lease was silent on landlord’s fittings (or chattels).

In terms of the date of the damages assessment, the landlord intended to carry out works once a replacement tenant could be found.  The tenant argued that once the tenant had paid compensation for the tenant’s breaches of covenants, the tenant should not need to finance any further void period.  Postponing the works was a sensible commercial decision for the landlord to take.  However, it was not caused by the tenant’s breach.  The Court agreed with the tenant. Mesne costs after the date the tenant had paid for its breaches of covenant were not a further recoverable loss.  This finding will be welcomed by tenants.  It is line with the trend to encourage parties to settle disputes promptly and, if possible, before going to court.

What does this case mean for practitioners?  The landlord may have been advised not to respond to the tenant’s request to discuss dilapidations: the case report doesn’t shed any light on whether the break right was conditional.  However, if the parties had followed best practice on terminal dilapidations, discussions about the carpet should have taken place long before lease expiry. In this case that may have avoided the need for a trial. More generally, a party who refuses to engage with recognised best practice in the form of the dilapidations protocol[1] is running the risk of being penalised on costs. That might be a risk worth taking to preserve a conditional break, as in the Financial Times case, but solicitors should make sure their clients understand the relevant risks and benefits of engaging on dilapidations versus avoiding all contact.

Not all lease expiries are so contentious. Some leases, typically those of new or newly refurbished premises, have annexed to them a refurbishment specification.  Clear wording in such a document will take precedence over a case such as this, and will make it easier to give unambiguous advice to a client. In many existing leases the effect of this case is that landlords will not be able to require outgoing tenants to pay for bespoke flooring of an incoming tenant’s choice. The outgoing tenant need only pay for new flooring of the relevant standard.  That, I think, is as it should be.

For further information please contact Suzanne Gill or a member of the Commercial Property Team.

 


[1] The Pre-Action Protocol for Claims for Damages in Relation to the Physical State of Commercial Property at Termination of a Tenancy (aka the dilapidations protocol) is available at  https://www.justice.gov.uk/courts/procedure-rules/civil/protocol/pre-action-protocol-for-claims-for-damages-in-relation-to-the-physical-state-of-commercial-property-at-termination-of-a-tenancy-the-dilapidations-protocol.