Cap That: Dilapidations Cap Under Scrutiny

These post-recessionary times are fascinating for a number of reasons but perhaps one of the lesser talked about developments is the management of the end of the landlord and tenant relationship. We are not talking break rights or surrenders; no, the point of interest here is the question of dilapidations and where we are following both the introduction of the current (and potentially more potent) protocol and a number of key cases focussing on the damages cap imposed by section 18 (1) of the Landlord and Tenant Act 1927.

For the uninitiated (and as a refresher for those familiar with this topic) section 18(1) creates a cap on damages for dilapidations in the following terms;

"Damages for a breach of covenant or agreement to keep or put premises in repair during the currency of a lease, or to leave or put premises in repair at the termination of a lease, whether such covenant or agreement is expressed or implied, and whether general or specific, 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 beach of such covenant or agreement as aforesaid [the diminution question] ; and in particular no damage shall be recovered for a breach of any such covenant or agreement to leave or put premises in repair at the termination of a lease, if it is shown that the premises, in whatever state of repair they might be, would at or shortly after the termination of the tenancy have been or be pulled down, or such structural alterations made therein as would render valueless the repairs covered by the covenant or agreement [the supercession question]".

Casting our mind backs to prior to the credit crunch, litigation under section 18(1) was relatively rare and the fundamental aspects of the assessment of damage relatively secure until the seismic shift that was PGF II SA v (1) Royal & Sun Alliance Insurance Plc (2) London & Edinburgh Insurance Company Limited [2010] EWHC 1459 ("PGF").

PGF II SA v (1) Royal & Sun Alliance Insurance Plc (2) London & Edinburgh Insurance Company Limited

In the case of PGF, the claimant landlord of a 6 storey building in Lime Street, City of London issued two claims following the expiry of two leases. The first defendant, the headlessee, took a lease of the subject property in 2007, and with the consent of the landlord, sublet the majority of the property to the second defendant. Following the expiry of both the headlease and the underlease, the tenants vacated the property without carrying out any works and the landlord, having spent £5million refurbishing the building, sought to recover £4million plus interest (including a substantial loss of rent claim).

The landlord issued a claim for damages against the first defendant for breach of repairing, decoration and reinstatement covenants, and against the second defendant for damages for disrepair and for breach of the reinstatement covenant. The first defendant brought a claim against the second defendant for damages for disrepair and failure to reinstate the premises.

Following the expiry of the leases, a revised schedule of dilapidations was served as it had been decided that the cladding in the building needed replacing.

It was accepted that the landlord had carried out works which went beyond the scope of the works which either the headlessee or the underlessee would have been obliged to carry out in the event that they had complied with their covenants prior to the expiry of the leases. Further, the Defendants argued that (i) the building was worth more to the landlord refurbished/developed that it was in full repair (i.e. the latent development value); (ii) that the rules of supercession applied; and (iii) that they had no liability for the cladding replacement as this superceded the Defendants' obligation to repair and could have been repaired for substantially less cost.

Dealing with the more tame part of the judgment first (that of the diminution question), the Court held that in assessing damages under the Landlord and Tenant Act 1927 section 18(1), the first consideration is the common law value of the cost of putting the premises in repair (and which, in accordance with the decision in Ruxley Electronics v Forsyth (1996), needed to be reasonable and not out of proportion to the...