Dilapidations: enforcing the bargain

In @SIPP (Pension Trustees) Ltd v Insight Travel Services Ltd [2015] CSIH 91 the pursuer was the landlord, and the defender the tenant, in a lease of commercial premises which had come to an end in May 2012. The defender had been the tenant since the 1980s.

The court required to consider two issues:

• the nature and extent of the tenant’s repairing obligation; and
• whether the landlord could enforce a provision in the lease which allowed it, at expiry, to serve a notice calling on the tenant to pay the sum which was required to remedy the dilapidations in the building. The landlord had served such a notice calling for payment in accordance with this clause.

The decision is of interest to those who specialise in commercial leases because, on the first issue, the Inner House recognised that depending on the particular wording of the lease, a repairing obligation “to keep in good and substantial repair and condition” may also impose an obligation on the tenant to put the subjects into that condition. Separately, on the notice point, it had been thought in light of Grove Investments Ltd v Cape Building Products Ltd [2014] CSIH 43 that it was unlikely that such provisions would be enforced by the courts. However, the case recognises that such clauses may be enforceable.

The decision should also be of interest to those who specialise in drafting and enforcing commercial contracts, since it appears to be the first time the Inner House has applied the approach to the interpretation of commercial contracts set out by the Supreme Court in the English appeal Arnold v Britton [2015] UKSC 36. Further, the court passed comment on the limitations on the observations made in Grove about the interpretation of commercial contracts.

The repairing obligation

The repairing obligation in the lease required the tenant: “To accept the leased subjects in their present condition and at their own cost and expense to repair and keep in good and substantial repair and maintained… and to replace or renew or rebuild whenever necessary the leased subjects… in at least as good condition as they are accepted by the Tenant all to the satisfaction of the Landlord and that regardless of the age or state of dilapidation of the buildings or others for the time being comprised in the leased subjects”.

At first instance, the Lord Ordinary highlighted that the clause had been badly drafted with the result that it was difficult to construe. However, looking at it from a commercially sensible perspective, he opined that the obligation “to repair and keep in good and substantial repair” did not include the obligation to put the leased subjects into that condition.

Reversing the Lord Ordinary’s decision, the Inner House agreed that while the drafting of the clause was not perfect, it was “clear that the natural meaning of the words used by the parties demonstrates that their intention was that the overriding – and minimum – repairing standard was to be that of ‘good and substantial repair’”: see para 20.

In reaching that view, the court was heavily influenced by that part of Lord Neuberger’s opinion in Arnold (paras 15-20) where he ultimately concluded that “although commercial common sense is very important, the court should be slow to reject the natural meaning of a provision as correct simply because it seems to be a very imprudent term for one of the parties to have agreed, the purpose of interpretation being not to identify what the court thinks the parties ought to have agreed but what they have in fact agreed”.

The Inner House’s construction produced a twofold result. First, if, at the start of the lease, any parts of the premises were in a condition which was better than good and substantial repair, that better standard was the benchmark to which they should be repaired and ultimately the condition in which they should be returned to the landlord. Secondly, if, at the start, any parts of the premises were not in good and substantial repair and condition, the tenant was required to repair those parts in a manner which ensured they achieved that standard.

Apart from following the ratio of Arnold, the Inner House also drew support for its conclusion from:

1. the balance of authority established by Credit Suisse v Beegas Nominees Ltd [1994] 4 All ER 803; Taylor Woodrow Properties Ltd v Strathclyde Regional Council, OH, Lord Penrose, 15 December 1995, unreported; Lowe v Quayle Munro Ltd 1997 SC 346; and L Batley Pet Products Ltd v North Lanarkshire Council [2014] UKSC 27;
2. the phrases used in the repairing clause, including the fact that the obligation was
“to renew, replace and rebuild as necessary”, the fact that the repairs were to be carried out “to the satisfaction of the landlord”, and the fact that the repairs were to be carried out “regardless of the age or state of the dilapidation of the buildings”;
3. the absence of a schedule or other record of condition at the start of the lease; and
4. the fact that the clause which allowed the landlord to serve a notice in respect of terminal dilapidations (on which see further below) referred to the sum to be included in that notice as “a sum equal to the amount required to put the leased subjects into good and substantial repair”.

Terminal dilapidations

The removal clause (which was otherwise in the terms generally used in such clauses) also included a provision that: “if the landlord shall so desire at the expiry or sooner termination of the foregoing Lease they may call upon the Tenant, by notice in writing (in which event the Tenant shall be bound), to pay to the Landlord at the termination date… a sum equal to the amount required to put the leased subjects into good and substantial repair… in accordance with the obligations and conditions on the part of the Tenant herein contained in lieu of requiring the Tenant himself to carry out the work”.

As part of its defence, the tenant argued that the clause was capable of two meanings: that the sum referred to in the clause was either (1) the sum that would be required on the hypothesis that the work would be done, or (2) the sum that was required if the landlord in fact intended to do the works. Since the wording was not clear, the landlord’s claim was not restricted to the cost of repair, with the result that the tenant was entitled to prove the appropriate measure of the landlord’s claim was loss in capital value. That was a significant issue for both parties since the tenant contended that the increase in the capital value of the premises, had the repairs been carried out, would have been £75,000 – an increase to which the total cost of carrying out the repairs was disproportionate.

The Lord Ordinary accepted that the clause was capable of both meanings, as the tenant contended, but in particular, the closing phrase, “in lieu of requiring the tenant himself to carry out the work”, indicated that the notice provisions could be invoked only if the landlord intended to carry out the work. He also took the view that the only commercial sensible construction was that very clear wording would be required to oblige a tenant to pay a sum of money in respect of terminal dilapidations which potentially bore no relation to the loss the landlord would actually suffer. He therefore opined that the obligation on the tenant to pay following service of a notice was conditional on the landlord intending to carry out the repair works. The question of whether the notice provision would apply if the landlord proved that it in fact intended to carry out the works regardless of the resultant increase in capital value was left open.

In reaching his conclusion, the Lord Ordinary clearly considered himself bound by the authority of Grove, which had been decided by the Inner House a few months before the debate before him.

On reversing the Lord Ordinary’s decision, the Inner House said that in this case there was no doubt about the measure to be employed in assessing the landlord’s claim, namely that the landlord was entitled to the cost of putting the leased subjects into good and substantial repair and condition. The court was firmly of the view that the notice provisions were not capable of any alternative meaning.

Comments on Grove

The court was also at pains to distinguish the current case from Grove. It distinguished Grove having regard to the terms of the clauses under consideration in both cases and the fact that the lease in Grove made no provision for service of a payment notice.

However, the court went further and made a number of observations about the general applicability of Grove to the interpretation of commercial contracts:

1. considerations of co-operation and mutuality should not be taken as applying
to all forms of commercial contract;
2. care should be taken to avoid reading anything into Grove to the effect that the court can ameliorate the effects of a “bad bargain” or an unfair bargain;
3. the court should not rewrite the parties’ agreement because it was unwise of one party to gamble on future outcomes; and
4. the observations in Grove predate the guidance provided by the Supreme Court in Arnold.

In summary

While the interpretation of any lease (or indeed commercial contract) will be
determined having regard to the actual words used, the effects of the decision in
@SIPP are:

• the obligation “to keep in good and substantial repair” may include the obligation to put the subjects into that condition; and
• the court will give effect to provisions in leases which clearly include a mechanism for determining the amount of the landlord’s claim for terminal dilapidations.

An application by the tenant for leave to appeal to the Supreme Court was refused.