Dilapidations: Key points for Landlords and Funders

What are dilapidations?

A commercial lease between a landlord and tenant outlines the contractual obligations and covenants that both parties enter to ensure that the premises is maintained to the standard agreed in the lease.

The term dilapidations refer to (1) breaches of tenant covenants in a lease relating to the condition of the premises; and (2) the process for remedying those breaches. The tenant covenants of concern in a dilapidations context would typically be the repairing, decorating, reinstatement, yielding up and statutory covenants. For example, when tenants vacate a premises, they would usually be contractually obligated to undo all the alterations they have undertaken and restore the premises to the condition at the beginning of the lease.

There are 2 categories of dilapidations: (1) interim dilapidations which are dilapidations arising during the term of a lease; and (2) terminal dilapidations being dilapidations arising at the end of a lease. As terminal dilapidations are more common in the market, we will focus on this category.

Why are dilapidations of concern to Landlords and Funders?

A landlord stands to make a financial gain in dilapidations claim as it is a claim for an alleged breach of contract giving rise to an action for damages (albeit there are other remedies available in relation to interim dilapidations). How a landlord approaches a dilapidations claim will depend largely on the market conditions at the time of the claim. For example, in a strong leasing market, a landlord would usually not want to vigorously pursue dilapidations claim in the courts, instead a landlord would prefer to (1) agree a financial settlement with the outgoing tenant; (2) not carry out all or much of the works priced in the settlement and (3) instead re-let the premises to a new tenant as soon as possible. Conversely, in a slow leasing market, dilapidations claims would be more likely to be litigated in the courts with a view to obtaining sizeable damages. 

Key steps in a terminal dilapidations claim

1. A landlord must decide what outcome is desired as that will inform how the claim is to be approached (ie whether they want the dilapidations works completed or instead want to obtain a financial settlement from the tenant).

2. The lease and any ancillary lease documents relevant to dilapidations matters (eg licences for works, side letters/ agreements, agreements for lease, licences to assign and all attachments to same) need to be reviewed and reported on to identify the tenant's contractual exposure for dilapidations. This should be completed in good time before the expiry of the lease to give the landlord the maximum flexibility as once the lease expires, the landlord's ability to require the tenant to carry out the works will be lost, and the landlord's sole remedy will be a claim in damages. Alternatively, if dilapidations are assessed in good time before the expiry of the lease, the landlord would have four potential remedies available being: (1) a claim for damages; (2) forfeiture; (3) specific performance; and (4) entry to undertake the works and recover the costs from the tenant. 
   
3. Inspection of the premises by reference to the tenant's contractual obligations to identify the defects and disrepair for which the tenant is liable.
   
4. Preparation of a comprehensive schedule of dilapidations itemising the nature of the alleged tenant breaches, corresponding lease clauses, and works required to remedy the breaches. The most widely used form of schedule in the market currently as endorsed by the Society of Chartered Surveyors in Ireland is known as a "Scott Schedule". Its layout is very clear and promotes negotiation between the parties as it includes columns for these details together with columns to set out the costs determined by the landlord to address each item of defect/ disrepair, and the tenant's proposed costs figure in each case. 
   
5. The schedule must be served in compliance with the service of notice provisions in the lease. If there is any doubt as to which address the tenant is operating out of where there are multiple possibilities, it is best to serve the schedule to each address. A copy should also be served on the tenant’s solicitor. Look out for a time limit specified in the lease giving a date after which the service of a schedule will be deemed invalid and unenforceable – for example sixty days after the lease term expiry date.
6. The usual response to service is that the tenant will engage to negotiate a settlement, possibly requesting a joint re-inspection of the premises. It is usually clear quickly after service, assuming the tenant engages, what the outcome for the landlord will be. Correspondence during negotiations should be marked “without prejudice”/ “subject to contract” so as not to detract from the landlord's position in the event that settlement discussions fail and the claim is pursued in the courts. 

For more information, please contact Jacinta Niland or your usual contact in our Commercial Real Estate Department.