If you rent commercial premises in Scotland then chances are you have accepted responsibility to keep them in good condition and repair throughout the lease, and to return them to the landlord in that condition at the end of the lease.
Your repairing obligation, despite being a continuing one, will probably be enforced by your landlord only at the end of your lease. They will serve a schedule of dilapidations on you, which will list the works they consider necessary to put the premises into good condition and repair. You will be asked to either carry out those works or to pay them the total cost of the works required in compensation for your breach of the repairing obligation.
If you don’t agree with the extent of the works for which the landlord thinks you are liable – for legal or factual reasons – or their cost, then you will negotiate. Settlement is usually reached, but in the last ten years, more and more negotiations have ended up in litigation.
Dilapidations were never a particularly important issue for landlords and tenants. Very little, if any, time was spent on negotiating the dilapidations clause. When a lease came to an end a landlord would usually have another tenant keen to move into the premises. The new tenant would be prepared to pay the full market rent and accept an obligation to maintain and return the premises in good condition and repair, irrespective of the condition they were in. Because of this, landlords would be more willing to agree a quick and low settlement of their dilapidations claim with the outgoing tenant. They would look to cover any incentive they had to pay to the incoming tenant, but often, the dilapidations settlement would just be money in the landlord’s pocket.
However, things changed in 2008. When the recession hit, tenants very quickly became few and far between. Leases, however, were still coming to an end. The prospect of landlords finding new tenants to fill those empty spaces became very bleak indeed. Landlords were facing the likelihood of years of empty space after a tenant left, with no rent coming in and a host of liabilities including rates, security and maintenance costs. They had to make money somehow, and the most obvious candidate was their outgoing tenant.
Attention turned to dilapidations. If pursued fully, a landlord could often find that they had a significant claim for dilapidations. Ideally, their tenant would accept a new lease to try and postpone that dilapidations liability to another day, possibly when things had picked up. If that didn’t happen, the landlord would instruct their surveyors and lawyers to pursue dilapidations hard.
For tenants, the recession meant that they weren’t making the money that they used to. Most of them hadn’t provisioned for their dilapidations liability. Their expectation was that the dilapidations would be low. They therefore didn’t have the money to pay large dilapidation claims. This usually meant that they had no choice but to instruct their surveyors and lawyers to contest the dilapidations claims just as hard as landlords pursued them.
The inevitable consequence of these divergent positions was that many dilapidation claims ended up in court.
Since 2008, there have been significant court victories for landlords and tenants. That hasn’t gone unnoticed by the market. The potential to make or save substantial amounts of money by properly contesting dilapidations has changed the attitude towards dilapidations in Scotland. Even though the market is improving, landlords now know the value of their dilapidations claims and pursue them to their full potential. Tenants, on the other hand, know the arguments available to reduce their liability so they push back hard. While the amount of litigation has reduced, there is still a steady flow of large dilapidation cases that will be contested in court.
We have had the benefit of acting in some of the most significant dilapidations cases in the past decade. Based on our experience, we consider that the following should be borne in mind when dealing with dilapidations for a lease of commercial premises in Scotland:
Provision for dilapidations
This is being done more often by tenants now but still probably not enough. Provision should be made for your dilapidations liability at the end of your lease. The amount that should be put aside can be determined based on advice from a building surveyor. One thing to bear in mind, however, is that if you do get into a dispute with your landlord over dilapidations, they may try to review your accounts to determine how much you have put aside to pay them.
Consider whether or not you should be putting in place an ongoing maintenance scheme. This can be relatively inexpensive and is, most probably, something required to perform your repairing obligation. Often, some of the largest dilapidations could have been avoided if the premises had been maintained on a regular basis. There is, of course, a balance to be struck. The nature of the premises and the duration of the lease may mean that a maintenance contract is not required. For example, a brand new office is unlikely to need much maintenance, especially over the first five years.
Check your position before lease expires
A review of your dilapidations exposure should be undertaken probably around three years before the expiry of the lease, although that depends on the term of your lease. It would not make sense to carry out a review three years before the expiry of the lease if it was only of five years’ duration. The review should simply involve instructing a building surveyor to inspect the premises and provide advice on what they considers your dilapidations liability may be at the end of the lease. That will allow you to consider how much has been provisioned for dilapidations and increase or decrease that accordingly.
Acceptance of the premises
It seems trite, but make sure the condition of the premises actually reflects the condition in which you accept them under the lease. Often tenants simply accept in the lease that the premises are in good condition and repair when in fact they are not. That can often mean the tenant is required to carry out repairs to the premises that existed before their lease started and were not their fault.
Schedule of condition
Spend money on a survey before you enter the lease. This is especially so if you are not leasing a brand new building. That survey should identify any significant defects in the premises, which you will want to exclude from your repairing obligation under the lease. The normal way of excluding liability is by having a Schedule of Condition prepared by a building surveyor. The schedule describes in words and pictures the existing defects in the premises. They are then carved out from your repairing obligations. Although this is a capital outlay at the start that you would most probably rather avoid, it could save you a significant amount come the end of your lease.
Latent and inherent defects/extraordinary repairs
Latent and Inherent defects are generally defects in the construction of the premises. You should seek to exclude liability for them. Similarly, extraordinary repairs are repairs that you wouldn’t normally expect to be responsible to carry out under the lease. They are usually the most significant repairs in terms of scale of work and costs. They often include works such as completely replacing a roof. Depending on your negotiation position, it may not be possible to exclude these. More and more frequently, landlords are insisting that tenants need to accept responsibility for extraordinary repairs. Where, however, you are in a strong position, extraordinary repairs should be excluded from your liability.
If you alter the lease to accommodate your occupation – for example, fit out the premises – then you will normally be obliged to remove the alterations at the end of the lease. Some leases, however, impose a timescale within which the landlord has to give you notice that they require removal of the alterations. If the landlord misses that timescale, you will not be obliged to remove your alterations. You will be obliged to return the alterations to the landlord in good condition and repair, but the cost of doing that is often less than the cost of removing them. Where possible, a timescale for providing notice to remove alterations should be included in your lease.
Diminution in value
In England, statute provides that a tenant’s liability for dilapidations is capped by the reduction in the capital value of the premises caused by the dilapidations. So if there is £1m of dilapidations and the effect of those disrepairs is to decrease the value of the premises by £100,000, the tenant will only be liable for £100,000.
There is no statutory equivalent in Scotland. However, there has been a move in recent years towards it being a possible defence for tenants. Scottish courts will only award a landlord their true loss in damages, and if they are unlikely to spend the money on the works, or it would be unreasonable to do so, we think a court will find that the landlord’s loss should be measured by diminution in value.
There are, however, some leases that provide that, upon service of a notice, the tenant is obliged to pay a sum equivalent to the total cost of the dilapidations. These clauses are generally called payment obligations. If one exists in your lease, it removes the diminution in value argument from you and effectively obliges you to pay the landlord the full cost of the works required to put the premises into the condition required by the lease. That is the case, even if the landlord admits that they will not spend that money repairing the premises. These payment obligations have been the subject of much litigation because of the potential windfall they create for the landlord. It is not clear just now what exactly is required to create an effective payment obligation, but the mood of the court seems to be that these clauses are enforceable. You should check your lease to see if it includes a payment obligation is there. If you are negotiating a lease you should, as the tenant, resist a payment obligation being inserted.
Do the work or pay?
This often depends on a tenant’s attitude to risk and litigation. Most dilapidations claims are now back to being resolved between surveyors. You may, however, choose to do the dilapidations works yourself before lease expiry if you wish to control the cost. The benefit of a financial settlement is that the landlord takes the risk. If you agree a full and final settlement in respect of dilapidations and the landlord goes into the premises and discovers more substantial defects than they had originally been aware of, then you are not liable for the cost of fixing those defects even if that would have fallen under your obligation under your lease. In addition, a willingness to do the works often flushes out a landlord’s true intentions for the premises. If they intend to completely redesign them, for example, then the last thing they want is for you to repair the premises only for them to have to undo it all. Tactically, therefore, a willingness to do the work can help in any negotiation of a dilapidation settlement.
It would appear that dilapidations will continue to be an issue for commercial leases. The best strategy to deal with them is to be aware of the issue and have in place a plan from the outset of your lease that minimises your exposure throughout the lease and at its end.
Matthew Farrell is a partner in the property litigation team at Brodies LLP. For more information, you can contact Matthew on 0141 428 4112 or at firstname.lastname@example.org.