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What price reinstatement and refurbishment?By: Simon Brown

RefurbishmentThe majority of commercial leases require tenants to repair, redecorate and reinstate alterations to premises at the end of a lease term. A tenant failing to comply with these obligations has breached its contractual obligations and may face a claim for damages through the dilapidations process.

These reinstatement conditions apply regardless of a landlord's long term refurbishment or redevelopment plans. As such, tenants are contractually obliged to carry out work, which may be entirely unnecessary.  Many would quite rightly question why this should be the case. But there would need to be a very significant culture shift in the marketing environment and in tenants’ mindsets to encourage them to take on a building with the former occupiers bespoke fit out in place.

Perhaps surprisingly, because of the legal agreements in place, there is rarely an option written into the lease for the landlord to intervene on a tenant undertaking the works to which they are obliged to carry out.

To avoid the tenant completing unnecessary works, it has become commonplace for a landlord to initiate the dilapidations and reinstatement negotiations regarding a financial settlement towards the end of a lease. However, the onset of early negotiations can see both parties strategise on how to maximise or minimise the claim. Landlords’ robust claims can still drive tenants to undertake works that, ultimately, both parties know are not in landlords’ refurbishment plans, but tenants comply as this is the most economic route of compliance and risk mitigation.

While a financial settlement for dilapidations liabilities is often reached and this avoids waste, there are plenty of occasions where the outcome is financially and environmentally inefficient. Surely reversing this trend would be welcomed by both landlords and tenants?

A potential solution to reducing waste and inefficiency is increased correlation between tenants’ obligations and landlords’ subsequent action post lease, or more obligation on landlords and tenants to go through this cycle in the most efficient manner possible. Maybe it is time that an alternative approach is considered by those drafting heads of terms or leases? Could consideration be given to adopting any of the approaches outlined below?

  • Could the lease include a covenant giving the landlord an option to demand a reinstatement payment rather than allowing tenants to carry out refurbishment works? Once the landlord has exercised this the tenant would no longer have the option to undertake the works, and the parties would agree a financial sum for the dilapidations and reinstatement work. One consideration, however, is how diminution in value is considered. Under S18 of the Landlord and Tenant Act 1927 landlords’ claim for dilapidations damages are currently capped to the loss of value in the building. Tenants will not want to move away from the protection that this statutory cap provides.
  • Would tenants welcome the option to make a reinstatement payment as part of the licensing of alterations if they knew that there was no requirement to reinstate the works at the end of the lease? Tenants could make a reinstatement payment upfront as part of licensing, requiring no work on their part at the end of the lease and the landlord addresses them as part of their refurbishment. The question in this case is whether damages for addressing disrepair can effectively be dealt with at lease-end and in isolation.
  • From time to time, usually half way through a lease term, tenants and landlords are prepared to restructure leases so that tenants pay an all-inclusive rent including the cost of repairs and reinstatement of alterations at the end of the term. Could there be a move towards such a structure at the outset of a lease? This can work well for both parties as it offers them certainty that they will not face a dilapidations dispute at the end of the lease. A potential difficulty, however, is that it could be difficult to predict the reasonably contemplated condition at the end of the term and the appropriate level of rent adjustment to compensate the landlord for this.
  • Most leases require tenants to return to an outdated Category A arrangement, which typically includes raised floors and suspended ceilings, distribution of mechanical and electrical services, internal surface finishes and blinds. Would it be preferable, though, if leases included landlords’ options to require tenants to reinstate the space to shell and core? In this case it would be relatively easy to define the obligations, which would prevent tenants needlessly reinstating elements that would ultimately be discarded. However, the sums potentially recoverable would tend to be lower than at present, so this may not appeal to landlords. Landlords may only consider such an option if there is a move towards shell and core for marketing and what they provide at the commencement of the lease.

None of these solutions are perfect, but given more careful consideration it may be possible to construct lease covenants that compel both parties to be more aligned in their actions regarding dilapidations, reinstatement and the subsequent refurbishment cycle. This would surely help this cycle from a sustainability perspective and reduce unwanted waste of resources and money.

About the author

Simon Brown, CBRESimon Brown, Director, CBRE Dilapidations team

Features October 2015

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