Dilapidations: What landlords and tenants need to know

Managing dilapidations is a complex and specialist area within the commercial property sector. Dilapidations arise due to a tenant’s failure to comply with obligations concerning the state and condition of the premises. The formal contract between a landlord and tenant, known as a lease, outlines obligations and covenants that both parties enter into to ensure that the property is maintained to the standard agreed in the contract.

Dilapidations are items of disrepair or defects.  Tenants are usually obligated to rectify or pay to have items of disrepair/ defects remedied under repairing covenants contained in their lease prior to an exit, break or natural ending of a lease. This area is of particular importance during the COVID 19 pandemic as many properties lie empty and may be vulnerable to dilapidations.

Landlords can serve a schedule of dilapidations on the tenant during (interim schedule of dilapidations), towards the end or after (terminal and final schedule of dilapidations) the lease has expired. If the intention is to sell or re-let the premises, the earlier the schedule of dilapidations is served, the greater the chance that the tenant will undertake the work enabling the landlord to re-let sooner. In addition, the landlord can wait until the end of the term to serve a schedule of dilapidations to negotiate a financial settlement.

The main issues that arise from dilapidations involve certain breaches of tenants’ covenants relating to the state of repair of premises demised by a commercial lease.  There is a particular focus on damages claims for breaches of a tenant’s repairing, redecorating, reinstatement, and statutory covenants. In addition to the repairing covenants above, covenants to ‘yield up’ can be onerous on tenants and include returning the property to its original state and condition before lease commencement. This means that before tenants vacate the property, they have to undo all the alterations they have undertaken and restore the property to the condition at the beginning of the lease.

It is advisable to prepare a schedule of condition, a fair and factual assessment of the property’s condition at the beginning of the lease. This can then be used as a benchmark in any dispute in the future concerning any disrepair to the property.

The landlord or their surveyor will generally prepare a schedule of dilapidations. A schedule of dilapidations contains references to the breaches of the tenant’s lease obligations. These typically include outstanding reinstatement, repair, redecorating, reinstatement, and any statutory obligations with suggested remedial works and, in some cases, the estimated cost of these works and any loss of rent if the lease has expired. The schedule of dilapidations will allow for the basis of the landlord’s claim for compensation. A dilapidations claim is an allegation of breach of contract and, as such, is actionable in law.

What are the types of schedules, and how are they used?

Interim Schedule of Dilapidations is served upon the tenant during the lease term and can be served at any time from lease commencement. An interim schedule does not usually include costings as the intention is to allow the tenant to rectify the covenant breaches.

Terminal or Final Schedule of Dilapidations is served towards the end of the lease term. Terminal schedules intend to address all the alleged breaches of the lease and to specify the required remedies. A terminal schedule is served within the last 18 months (typically within the last 6 months). It gives the tenant the option to carry out the works contained within the landlord’s terminal schedule in good time, before lease end and in place of a financial settlement upon lease expiry. Terminal schedules will include costs, but this will depend on when the schedule is served. If the schedule is served towards the end of the lease, then costs will generally be included.

A Dilapidation Assessment can be undertaken for tenants who are aware of or concerned about dilapidations and the potential hefty costs. The assessment aims to provide the tenant with a projected financial estimate of their potential dilapidation liability under their existing leasehold agreement.

For landlords, a Dilapidation Assessment can be undertaken to assess the tenant’s potential dilapidation’s liability, repair and reinstatement provisions associated with the property.  It provides the landlord with a projected financial estimate of the tenant’s potential dilapidation liability.

A Dilapidations Assessment should be prepared three to five years before a break, exit or the end of the lease term. The format of a Dilapidation Assessment is similar in structure to an interim or terminal schedule but not as detailed and identifies the likely breaches of a tenant’s lease obligations or covenants.

Schedule of Condition at pre-lease or lease commencement is another option for a tenant. A Schedule of Condition will record the overall condition before occupancy.  It can then be attached to an agreed lease, with the tenant only being responsible for maintaining or restoring the property to the recorded standard.

The two common commercial leases types are Full Repairing and Insuring (FRI) and Internal Repairing Lease (IRL).  An Internal Repairing Lease, which commonly results in a higher rent to reflect the tenant’s lower obligations, is where the tenant is responsible for internal repairs and redecoration.  Under this lease, the landlord is responsible for external and structural repairs without reimbursement. The more common Full Repairing and Insuring lease are where the tenant has the responsibility for all internal and external repairs, maintenance, decoration and insuring liabilities for the building.  This results in the landlord having no repairing or insuring liability under an FRI lease.

ORS acts on behalf of both landlords and tenants and provides the following services:

• The preparation of interim or terminal Schedules of Dilapidations for landlords.
• Dilapidation Assessments on behalf of tenants and landlords.
• Negotiation of dilapidations settlements on behalf of landlords.
• Negotiation of dilapidations claims on behalf of tenants.
• Monitoring of works on behalf of the landlord.
• Project Management of works on behalf of the tenant or landlord.
• Pre-lease or Lease commencement Schedule of Conditions.

If you are concerned about your property, either as a landlord or tenant, contact Darren Holmes today.