Dilapidations: reinstating the law

During the economic downturn, when times were tough and new tenants were few and far between, many landlords turned to dilapidations to generate income from their soon-to-be empty properties. Sometimes, the money recovered from the outgoing tenant for dilapidations would be spent on the property to make it more attractive to prospective tenants. Often, the landlord would simply keep the money and market the premises at a reduced rent. This could have the effect of creating a windfall for the landlord, by compensating it for a loss it had not and would not suffer.

The Court of Session, in two recent decisions, Grove Investments Ltd v Cape Building Products Ltd [2014] CSIH 43 and @SIPP (Pension Trustees) Ltd v Insight Travel Services Ltd [2014] CSOH 137, appears to have put paid to that practice. It now seems that tenants will only have to pay dilapidations if the landlord can satisfy them, failing which the court, that it actually intends to carry out the necessary repairs.

Dilapidations in context

Before considering these decisions, we should first look at why it is that landlords and tenants fight about dilapidations.

Landlords usually transfer responsibility for repair of the property during the lease to the tenant. That responsibility can be onerous, especially where the length of the lease exceeds the expected life of many of the landlord’s fixtures and fittings, such as the lifts and the boiler. During the lease, the landlord can seek to enforce the tenant’s repairing obligations by way of an action of specific implement. That does not happen very often, because landlords are not inclined to upset their tenants if they are paying rent and service charge when they should.

Once the lease ends, however, if the obligations are still outstanding and cannot be settled through negotiation – because the parties disagree on the correct interpretation of the lease and/or on the nature and extent of the disrepair – a landlord will usually raise an action based on breach of contract, calculating its loss by the estimated cost of the repairs it considers it will have to carry out to put the premises into the condition in which the tenant should have left them. Those repairs are described as dilapidations.

Diminution in value

It should, of course, be remembered that tenants facing a claim for cost of works have always had the right under Scots common law to attempt to prove that an alternative measure of loss should be used to determine the landlord’s true loss for breach of the repairing obligations under a lease. In the right circumstances, for example, where the tenant can prove that the landlord has no intention of carrying out the works to repair the property because it is going to be demolished, the court could find that there is no loss to the landlord arising from the tenant’s breaches.

Furthermore, in England, there is enshrined in statute a cap on the landlord’s claim, calculated by reference to the reduction in the property’s capital value. While there is no statutory equivalent in Scotland, diminution in value as a measure of the landlord’s loss is, and always has been, a possibility for tenants in Scotland who wish to challenge the landlord’s claim for dilapidations. A tenant can argue that the landlord’s true loss caused by the breaches of the repairing obligations is not the cost of works, but rather the reduction in the capital value of the property caused by the disrepair. The court would then be expected to decide which of the two measures best represents the landlord’s true loss in the circumstances.

Grove v Cape

In this case, the landlord (Grove) claimed that the tenant (Cape) was not able to argue diminution in value. It relied on an obligation in the lease which provided that, at the end of the lease, Cape had to pay to Grove “the total value of the schedule of dilapidations” prepared by Grove in respect of Cape’s repairing obligations. This, Grove argued, was a payment obligation, and its effect was to oblige Cape to pay the total cost of the works contained within Grove’s schedule of dilapidations, subject to Cape being able to challenge the reasonableness of any individual cost and liability under the lease for any of the works. It did not matter what the landlord did with the money, Grove said, as a payment obligation did not have to represent the landlord’s true loss; it created a debt that was due for payment by the tenant. Grove argued further that, by agreeing to what it considered was a payment obligation, the parties had contracted out of the common law so that Cape had agreed to be bound by the cost of works, ruling out any alternative measures of loss, including diminution in value.

Cape read the lease differently. It argued that the value of the schedule of dilapidations could be determined in a number of ways, including through the diminution in the property’s value. Grove’s response was that the value of the schedule was only capable of meaning the total cost of the works. The issue therefore turned on the meaning of the words “value of the schedule of dilapidations”.

At the appeal before the Inner House, a bench of three judges agreed with the tenant’s interpretation of the lease. They accepted that “value of the schedule of dilapidations” could have more than one meaning. Following the decision in Rainy Sky SA v Kookmin Bank [2011] UKSC 50; [2011] 1 WLR 2900, the court held that the meaning that accords with commercial common sense should be adopted. In deciding which of the proposed meanings satisfied that test, it observed that commercial common sense would not ordinarily place what reasonable people would regard as an excessive or disproportionate burden on either party, or arbitrary or unpredictable benefits or burdens on either party: commercial common sense would seek to provide a landlord with a remedy which was unlikely either to over- or under-compensate it for its true loss.

Perhaps most notably, the court went on to say that the commercially sensible approach will normally be indicated by the common law that would be applicable in the absence of any express agreement on a particular subject arising out of a contract.

For all of these reasons, the court decided that the commercially sensible construction of “value” was to compensate the landlord for the true loss it had suffered as a result of the breaches of the repairing obligations, which is the common law approach to dilapidations. The “value” of the schedule of dilapidations was not restricted to the cost of works.

The court did, however, indicate that it is possible for parties, with appropriate express wording, to contract out of the common law position and include an effective payment obligation.

@SIPP v Insight

The Commercial Court of the Court of Session had to decide whether the payment obligation in the lease between the parties to this case contained appropriate express wording so as to have created an effective payment obligation. Although the terms of the claimed payment obligation were different to those found in Grove v Cape, applying the principles established in that decision, the court agreed with the tenant that the clause in question was capable of more than one construction, and that the commercially sensible construction was not one that allowed the landlord to recover a sum that bore no relation to the loss it actually sustained as a result of the tenant’s breach of its repairing obligations.

The court also observed that, in certain circumstances, the proper measure could be the diminution in capital value of the subjects as a consequence of the tenant’s breach of the terms of the lease. As with Grove v Cape, it remains to be seen after evidence whether the court will hold that to be the true measure of loss, but the fact that it has explicitly recognised it as a possibility is a step in the right direction.

For now, therefore, it seems that the Scottish courts will be more likely to take a view that, in particular, where there is any ambiguity in the lease drafting, the common law position should be preferred, which opens up alternative measures of loss for tenants. It will then be for the tenant to prove, if it can, that the landlord’s true loss should be measured by something other than the cost of works. Diminution in value is the most obvious alternative.