Regulated by RICS

Current restrictions in force due to the coronavirus pandemic mean that circumstances for tenants and landlords have changed, writes our Barrister Nicholas Dowding QC.

Prior to the crisis, when a lease of commercial premises ended and the tenant was in breach of its covenants to yield up in repair, to decorate, and to reinstate alterations, landlords would, in ordinary circumstances, carry out the remedial works, re-let, and then claim damages in an amount equal to the cost of the works and loss of rent.

With different circumstances in play, what defences, or potential arguments, might the tenant have as a result of the current restrictions?

Liability

A contract will be frustrated where a supervening event occurs which makes its performance radically different to the considerations in play when it was made.

Although frustration ordinarily discharges the contract as a whole, it seems reasonably clear from the cases that there are circumstances in which supervening events may at least suspend the performance of a particular obligation, without ending the whole contract.

In John Lewis Properties v Viscount Chelsea [1993] 2 EGLR 77, leases granted in 1939 for 999 years contained covenants to pull down the existing buildings and erect new ones before 25 December 1987. The site included a listed building. The tenant was unable to obtain listed building consent (which had not been required when the lease was entered into) for demolishing it. The landlord’s claim for breach of the obligation was dismissed on the ground that the obligation had been suspended by impossibility of performance.

If a building or repairing obligation can be suspended by supervening events, it would be odd if it cannot, in an appropriate case, be discharged entirely.

In Sturcke v S W Edwards Ltd (1971) 23 P&CR 185, the demised premises were damaged by fire to the extent that they could not be repaired without planning permission. The landlord granted a
licence to assign, under which the assignee agreed to complete the repairs within six months. Planning permission was refused. The landlord determined the lease under a break clause, and claimed damages for breach of the repairing covenants in the lease, and the covenant in the licence. Goff J held that the principle of discharge by supervening events was capable of applying to a particular obligation in a lease, without the entire lease being frustrated, although he went on to hold that it did not apply on the facts.

The position arising where the obligation becomes unlawful or impossible to perform is to be distinguished from cases where the obligation has simply become more difficult or more expensive to perform; or where the terms of the lease or other circumstances show that the tenant is to be taken as having assumed the risk of unforeseen circumstances making performance impossible; or where the tenant has, by their acts or omissions, failed to take steps within their control which might have lessened the impact of the frustrating event. In none of these cases will the obligation be frustrated.

The tenant will therefore need to establish, at the least, that the COVID-19 restrictions made it legally or practically impossible for it to carry out the works in the run-up to lease expiry. That seems difficult, but even if it were to be proved, it is hard to see that the tenant would be released from liability for breaches occurring prior to the current crisis.

The tenant’s only alternative would be to argue that the effect of the current restrictions was to frustrate the entire lease at some point prior to its expiry. The circumstances in which a lease will be frustrated are rare, and the latest attempt by a tenant to argue that its lease had been frustrated by Brexit (Canary Wharf (BP4) T1 Ltd v European Medicines Agency [2019] EWHC 335 Ch; [2019] EGLR 17) did not succeed. In any event, the problem of liability for pre-existing breaches would presumably remain.

Quantum

If the tenant has no likely defence to liability for terminal dilapidations, what about quantum?

Damages for breach of the obligation to repair are capped by section 18(1) of the Landlord and Tenant Act 1927 at the amount by which the value of the landlord’s reversion has been diminished by reason of the disrepair. Conventionally, two valuations of the landlord’s interest in the premises are carried out, one on the assumption that the premises are in the physical state they ought to be in if the covenants had been complied with, and the other as they actually are. The difference, if any, is the diminution in value attributable to the disrepair. In both cases, the valuation date is the date of lease expiry.

The amount, if any, of the diminution will therefore depend on market conditions at lease expiry, and, crucially, the attitude of potential buyers to the disrepair. Would they pay less for the
premises in disrepair than they would for the premises in repair, and if so, why and by how much?

The exact date of lease expiry may be of critical importance, because the current crisis is a fast-moving one, in which matters are developing sometimes on a daily basis. The hypothetical willing buyer and seller cannot be assumed to take into account anything that was not known, or reasonably foreseeable, on the valuation date. So, it will be important to identify what were the relevant legal and practical restrictions, government guidance and medical advice on the date in question, and what, in the market conditions at the time, was known about, expected or being talked about as a possibility. All of these may have an important bearing on the extent to which the disrepair affects value.

In an uncertain market, with reducing demand and major business decisions being deferred, tenants are likely to argue that any diminution in value attributable to the disrepair is nil, or substantially less than it would have been in the pre-Coronavirus market. It will be said that buyers will not carry out the repair works where the premises cannot be re-let, nor will they suffer any loss of rent for the same reason.

Instead, they will wait and see what happens, on the basis that when the current crisis is over, market conditions and expectations may have changed, the premises may no longer be viable in their existing form or for their existing use, and/or different works may be necessary.

The future of offices has a number of implications for section 18 claims. A fall in demand for offices is likely to lead to some existing space being redeveloped or converted into other uses (although it can be argued that if social distancing remains a factor, the need for proper separation may result in more space being required). Either way, there may be a substantial impact on office layouts and design. Partitions left behind by the outgoing tenant may have less of an adverse impact on value. More space may need to be devoted to access, canteens and common areas; and existing ventilation systems may need review, particularly those that run on recirculated air.

Supersession may play less of a part. Suppose that, before the crisis, office premises would have been upgraded by the installation of new ceilings, lighting and air conditioning, and that much of the disrepair would have been superseded. A buyer during the crisis might decide that upgrading is too big a risk, and therefore it would be better and safer to budget for the carrying out of repairs only. Were that argument to find favour with a valuer, it would mean, ironically, that the COVID-19 crisis has resulted in the diminution in value being higher than it would otherwise have been.

Alterations

In the current circumstances, it may be more difficult for landlords to decide what they do or do not want reinstated. And in cases where the requirement must be reasonable, there may be increased scope for attacking a particular requirement as unreasonable. A good example may be a requirement to remove partitions, at least where an incoming tenant would, given social distancing requirements, be content to take them over.

Damages for breach of covenants to reinstate alterations are not covered by section 18(1), but by the common law. The landlord will only be entitled to the cost of the remedial works where it is reasonable to carry them out, ie where the cost would not be wholly disproportionate to any benefit to be obtained. The arguments will centre on whether, in the current circumstances, carrying out the works, now or in the future, would be reasonable in this sense. If yes, then the damages will equate to the cost of the works, but it is likely that the same answer would have been arrived at even if section 18(1) had applied. If no, then the measure of damages is the diminution in value, which is the same as section 18(1).

In conclusion, it remains to be seen how all of these different arguments will play out. But what seems certain is that one of the many changes resulting from the coronavirus crisis is likely to be the legal and commercial environment in which terminal dilapidations claims are played out.

As published in EG on 04 July 2020 – pages 82-84.