Sunday, September 21, 2014

Commercial Leases - Dilapidations Liability – Tenants beware!

Once a lease is signed a legal contractual relationship is formed.  It is no defence for a tenant to claim that they were not aware of what they were signing as ignorance is no defence in law! 

A tenant occupier of a commercial building has a legally binding contractual obligation through their lease to return a building to the landlord in a state of repair that is stipulated within the lease, when the tenancy ends.  Now it may seem obvious that a landlord would expect to have a building returned to them in such a condition so that they can re-let the building immediately, however in reality this very rarely is the case.  This can then lead to protracted dilapidations claims where the costs to the tenant can start to escalate due to a landlord’s a claim for loss of rent and service charge and additional professional fees in addition to the costs of repairs, reinstatement and decorations that are associated with the lease covenants.

In my professional career I spent many years negotiating dilapidation claims (acting on behalf of both landlords and tenants) in the whole spectrum of the different commercial sectors, such as office, industrial, retail, leisure etc.  During this time I have encountered many tenants who did not understand the significance of meeting their lease obligations and in fact entered into a lease arrangement without seeking professional advice or indeed reading the lease in any detail before signing!  The gravity of the situation did not dawn onto these types of tenants until they were served with a schedule of dilapidations accompanied by a summary of claim which often ran into tens of thousands of pounds and sometimes even more. 

Once a lease is signed a legal contractual relationship is formed.  It is no defence for a tenant to claim that they were not aware of what they were signing as ignorance is no defence in law!  Therefore a tenant should be aware of what they are entering into and in particular their repairing and other obligations BEFORE they sign the lease.  Although there would be a fee involved it would always be advisable for a tenant to seek professional advice to enable them to understand the lease and in particular their likely dilapidations liability once the lease comes to an end.  Good professional advice may identify obligations and clauses in a lease that may be particularly onerous to a tenant and negotiations may be possible to have clauses removed or at least re-worded.  Also, a professional advisor may recommend that a schedule of condition is taken prior to occupation which can later be used to help limit liability when the lease comes to an end.  In my experience I have found that many tenants are reluctant to pay professional fees for some of the services/advice previously discussed because they do not have the foresight to appreciate the benefits and especially the amount of money it could save them in the future.   Avoiding professional fees, particularly in relation to a tenant entering into a commercial lease arrangement really is a false economy.

A few of years ago I was asked to carry out a dilapidations liability assessment on a number of branches of a mid-sized DIY retailer’s stores which had been put up for sale.  I was acting as Consultant for the prospective purchaser.  The stores were located in many parts of the UK for which each one was occupied under a commercial lease arrangement.  Basically, my Client was considering acquisition of the business, however before being in a position to negotiate a fair price for the business it was necessary for them to understand the likely financial impact (their dilapidations liability), to them when each of the leases came to an end.  Each of the leases were unique, with a variety of remaining terms, (some had a few years remaining and some were much longer). There were also a variety of different repairing, re-instatement and decorations covenants within the leases. 

Prior to undertaking any type of dilapidations inspection it is important to read and understand the lease, which is what I did, and on completion of each inspection I was able to prepare a schedule of dilapidations for each branch.  The difference with dilapidations liability inspections compared to interim or terminal dilapidations inspections is that you need to have an eye on the future.  So I therefore had to take account of the length of term remaining on each lease and to make an assessment of the likely dilapidations that would occur at that point (the end of the term) and not just in the here and know.  I was then able to cost/quantify the lease obligations which would also factor in likely future inflationary cost increases.  I cannot remember the exact overall dilapidations liability however I do remember this totalling in excess of £1 million.  Not exactly the type of money you want to ignore if you are proposing to purchase a business!  My Client then went onto to use this to help negotiate a purchase price.

Not all dilapidations liability will be as costly as the example I give above, however it is worth educating tenants about the benefits of seeking and paying for professional advice before they enter into a commercial lease arrangement.  In most cases larger companies will have there own professional advisers so the pitfalls discussed above are much more likely to be avoided.  In my experience it is the medium and particularly the smaller size companies or even individuals who are less familiar with commercial lease arrangements and worse are much more willing to avoid paying professional fees.  Perhaps it is to these companies/individuals that we need to focus our education?

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1 comment:

  1. Totally agree with you Gary. I am interested in how the Energy Efficiency Regs (2018) will influence the lease negotiations. Perhaps it will be the status quo for those who currently don't take any advice because they either haven't budgeted foitr or don't see the value in it. Jonathan Murton