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Dilapidations and Surrenders

30 January 2013

Be careful not to surrender your dilapidations claim by mistake!

A surrender puts an end to the lease and to the covenants and liabilities as between the landlord and tenant from the date of the surrender onwards.  Neither the landlord or tenant is therefore liable for breaches of covenant that may occur after that date.  Is it also possible to include express drafting in a deed of surrender to the effect that the landlord and tenant are released from liability for certain breaches of covenant occurring prior to the date of surrender, but this will not usually be implied.

Surrenders and their effect on dilapidations liability

So what is the dilapidations position following a straightforward surrender?  Will a surrender operate to release the tenant from its dilapidations liabilities?  The recent case of Re Teathers Ltd (In Liquidation) [2012] EWHC 2886 (Ch) is a useful reminder of the issues that must be reviewed before that question can be answered.  In that case, the lease contained the usual tenant covenants to keep the property in good repair and to yield it up in good condition at the expiration of the lease or sooner determination of the term.  There was also a licence for alterations which required reinstatement of the alterations to be carried out before the end of the lease.  The tenant went into liquidation and the liquidators surrendered the lease to the landlord.  On the same date the landlord re-let the property to a new tenant.

Some time later the landlord submitted various proofs of debt to the liquidators including a dilapidations claim for £1,212,395.  The court was asked to consider whether the separate elements of the landlord's dilapidations claim had in fact been released by the surrender. 

On what date did the dilapidations liability arise?

Reinstatement liability

Covenants expressed to arise at or upon expiry of the term do not survive a surrender.  In this case, the obligation in the licence was, "Before the end of the Lease…to dismantle and remove the Works and reinstate the Premises…".  The court held that this should be interpreted as allowing the tenant until the expiry of the lease to carry out the requisite reinstatement works.  Therefore the potential reinstatement liability occurred after and not before the date of surrender and so was released by the surrender.

The repairing liability

The tenant in this case covenanted to, "keep the premises…in good and substantial repair and condition…and in such repair and condition…to yield up the same at the expiration or sooner determination of the term".  The covenant to repair imposes two distinct obligations.  The first is to keep the demised premises in good repair during the term.  The second is to yield up the premises in good repair at the expiration or sooner determination of the term.

It was accepted by the landlord that it could not claim against the tenant pursuant to the yield up provisions.  This is because a covenant expressed to take effect "on the termination or sooner determination of the term" is not brought into effect on a surrender (Ex p. Dyke, re Morrish (1882) 22 Ch. D. 410 and Re ABC Engineering Co Ltd (No.3) [1970] 1 WLR 702).

As to the obligation to keep the premises in repair during the term of the lease, this was not released by the surrender.  In a witness statement setting out how the landlord's claim was made up, it was explained that in order to mitigate its loss the landlord had re-let the premises but due to the poor state of repair it was obliged to give the tenant a rent free period of 19 months and accept a reduced rent for the remainder of the term.  The landlord had based his claim on the value of the rent free period and the reduction in rent.

s.18(1) Landlord and Tenant Act 1927

The liquidators argued that any claim against them for breach of this obligation would be limited by s.18(1) Landlord and Tenant Act 1927.  The first limb of s.18(1) provides that, "Damages for breach of a covenant…to keep…premises in repair during the currency of the lease…shall in no case exceed the amount (if any) by which the value of the reversion (whether immediate or not) in the premises is diminished owing to the breach of such covenant or agreement as aforesaid;…".

Unfortunately the landlord's surveyor had not followed the processes required by section 18(1).  He made no attempt to value the reversion to the property in either its actual or repaired state but assumed that the difference between those valuations would be equal to the loss sustained by the landlord on re-letting the property to the new tenant.  It was therefore held in this case that there was no provable debt.

What it appears that the landlord had also failed to appreciate was that the valuation of the freehold reversion should have been a valuation of the freehold subject to the lease (despite the fact that in reality it was surrendered the next day).  According to the decision of the Court of Appeal in Hanson v Newman [1934] Ch. 298 CA, "valuing the reversion for the purposes of the section you must value the freehold subject to so much, if any, of the term of the lease as remains in existence.".

Therefore, one can see that even if a section 18 valuation report had been prepared, the landlord might still have been left with little or no provable loss.  Since the reversion is valued subject to the lease, the hypothetical purchaser of the landlord's interest will have the full benefit of the rent, the amount of which will be unaffected by the disrepair.  The purchaser will also have the benefit of the tenant's covenant to repair.

What to watch out for

In summary, when negotiating a surrender, check first whether the surrender will act as a release of some or all of the tenant's dilapidations liabilities (do the obligations arise during the term, at the expiry of the term or upon an earlier surrender?).  Include additional drafting if that is not the intention of the parties.  Bear in mind that section 18 may render valueless any residual claim that you might have against the tenant and if this is the case it should be taken into account when negotiating the surrender premium.