Whilst the Covid-19 virus may not directly attack commercial lease covenants and mutate them, does it impact upon dilapidations matters?
Aside from keeping safe in the COVID Pandemic, a key consideration for property owners and occupiers is the altered usage and demand for their buildings and workspaces. The inevitable re-assessment of space requirements, re-considering layout and assessing liabilities has been brought into renewed focus in the last nine months. At Ingleton Wood we have found an enormous amount of activity in planning for and dealing with Exit Strategies and Terminal Dilapidations at the end of commercial leases and break options.
The commercial team at Ingleton Wood highlight some of the main themes that Landlords and Occupiers should be considering as well as some thoughts on future trends.
Alteration clauses within commercial leases and licenses have a variety of constructions, many of which require the Landlord to request or serve notice to trigger Tenant reinstatement obligations. In these uncertain times it is really important for Landlords and Tenants to capture these timings across their portfolios and ensure strict performance. The risk for Landlords is, if they do not serve notice in time or in the correct form, the Tenant’s reinstatement obligation may not be triggered. This would leave the Landlord responsible for removal of alterations and the consequential making good, which often make up a significant proportion of terminal dilapidations claims.
Landlords and tenants have had a fairly intense relationship over the past nine difficult months dealing with a variety of issues such as rental payment, COVID Secure use of common parts and any other shared areas, and monitoring the performance of each other’s businesses. All with the backdrop of the Pandemic restrictions and temporary legislation such as the moratorium on commercial forfeiture. Landlords may feel that their armory to recover rent and enforce lease covenants has been significantly diminished, however there are other avenues that they can potentially use to seek recourse should tenants not comply with the lease obligations in order to protect their interest.
The use of interim schedules of dilapidations and repair notices can be an early warning to tenants that remedial repairs are required. Should breaches remain outstanding then these strategies can lead to the potential for re-entry for the Landlord to complete the remedial works as in Jervis v Harris. Furthermore, interim steps can also potentially improve a Landlord’s influence in the event of the Tenant electing for a CVA (Company Voluntary Arrangement) by improved voting weighting through this pro-active management of dilapidations.
Alongside reassessing the need for space, Tenants have been reviewing their leases to ascertain potential Break Dates, notice periods and the break option conditions. Given the risk of significant void periods it should be expected that Landlords will strictly interrogate the break option conditions to maximise every opportunity to challenge the validity of a break. Break Option conditions can vary considerably, with the lightest level being payment of rent and appropriately timed notice periods, and at the more onerous end of the spectrum they can require achieving vacant possession or even full compliance with the lease covenants. It is in these more complex situations that early planning is essential from the Tenant’s perspective together with obtaining professional advice.
In addition to the above themes, we consider that there are a number of developing trends to look out for as follows:
Improvements and Supersession
The specification of offices has been changing over the last few years and the market requirements are fairly well established for what occupiers will desire in particular locations. Furthermore, Cat A+ and ‘Plug and Play’ workspaces with the flexibility that they provide will no doubt continue to grow in the new world post-COVID. In light of these requirements, there are strong arguments at lease end from a Tenant’s perspective for potential supersession under the second limb of Section 18 (1) of the Landlord and Tenant Act 1927, which may severely impact Landlord’s claims.
Diminution in Value
The first limb of section 18(1) of the Landlord and Tenant Act 1927 states the damages for a breach of a covenant to keep or put the premises in repair shall not exceed the amount by which the value of the reversion of the premises is diminished owing to the breach of covenant. This Limb effectively places a cap on the cost of the repairs whereby the claim cannot be more than the reduction in the value of the Landlord's reversionary interest. The level of diminution will depend on both the current market conditions and the potential acquirer’s stance on the disrepair in question. Arguments around this theme are still developing, although the current suppressed market conditions in the context of the Pandemic might be viewed as short sighted given the market is expected to pick up and claims for breach of covenant in a commercial lease are open for 12 years post expiry.
Oversupply and Shorter Lease Lengths
With the reassessment of workspace requirements by many tenants, the expectation is an increased supply of offices resulting in more competition and flexible terms on offer. More frequent churn and voids may lead to Landlords and Occupiers seeking financial certainty and trying to fix lease-end dilapidations at the outset. This may take the form of a confirmed figure, or rate, combined within the rent or as a form of premium payment informed by a dilapidations assessment report.
Another key element in dilapidations is timing, as many landlords and occupiers consider it to be a matter dealt with at or very close to lease end. As shown in many of the above themes there are a multitude of risks and opportunities at the start of taking a commercial lease, during the term as well as at lease end and there are real benefits in obtaining professional advice to assist in decisions.
For example, a building survey and assessment of dilapidations upon taking a lease will inform any fixed dilapidations premium and also assist to ascertain future liability. During the lease term, seeking interim dilapidations advice to plan for potential tenant default will ensure the landlord is not left with large amounts of disrepair and reinstatement of tenant alterations costs. Tax efficiency and compliance are also key considerations for occupiers by preparing dilapidations assessment for FRS102. Not to forget appointments at or close to lease end in assessing and negotiating Terminal Dilapidations.
There is also the thorny matter of loss of rent, in those rare circumstances where it is substantiated, and re-letting is protracted by the Landlord’s contractor supply chain delays caused by Covid-19 restrictions.
Similarly, a tenant intending to undertake dilapidations works at lease end may also face the risk of not completing the works on time due to supply chain delays. How do they mitigate their risk? Forward planning is key.
The Covid-19 pandemic will continue to have quite a substantial impact on dilapidations and commercial leases for some time to come.
If you or one of your clients have an issue we would be delighted to assist. Examples of our dilapidations services and expertise can be found here: https://www.ingletonwood.co.uk/dilapidations.php.
Please contact: Simon Gorst, Scott Barlow, Steven Day and Neil Henderson at firstname.lastname@example.org.