Shortly before the expiry of a lease, most landlords will serve on their tenant a schedule of dilapidations (defects in the condition of the property) - setting out what works must be done by the tenant, in order to comply with its lease repairing obligations, before the lease ends.
Some leases contain wording that allows the landlord to require the tenant to pay to the landlord the estimated cost of the works, as set out in such a terminal schedule of dilapidations, rather than for the tenant to do the repair works. Whilst, in many cases, the landlord will use the money to enable it to do the works itself, there are occasions where this won't be done e.g if the landlord is carrying out a major refurbishment or demolishing to redevelop or the incoming tenant does not require some or all of the work to be done.
A recent case considered the meaning of particular lease wording that purported to allow the landlord to recover the estimated cost of the dilapidations, rather than its actual demonstrated loss due to the tenant's failure to do the work.
Grove Investments Limited v Cape Building Products Limited
In this case, Grove was the landlord and Cape was the tenant.
A schedule of dilapidations was served in 2008, but the works had not been done by Cape by the time the lease expired in 2011 - so Cape was in breach of its repairing obligation.
The lease required Cape, at lease expiry, to:
- pay to Grove the total value of any schedule of dilapidations and noted that "[Grove] shall be free to expend all moneys recovered as dilapidations as they think fit" and
- make a financial settlement with Grove in lieu of Cape's repair obligations.
Grove's arguments
Grove took the view that the lease obliged Cape to pay Grove the total value set out in the schedule of dilapidations. It considered that lease showed that the parties had agreed that such value was the compensation due to Grove for damages caused by Cape's breach - and that it did not matter whether this value was an accurate reflection of Grove's true loss or would be disproportionate.
In Grove's view, the lease wording was a liquidated damages provision which was not a penalty.
Cape's arguments
Cape said that the proper interpretation of the lease was that Cape was only bound to pay Grove for its actual loss. To construe the provisions as proposed by Grove might result in a recovery by Grove that bore no relation to any loss actually suffered e.g if Grove had decided to demolish the property and redevelop or was about to re-let to a new tenant that required substantial alterations that would have negated the need for some of the dilapidations work.
Such an interpretation would not, in Cape's view, accord with business common sense. Cape said that the clause was simply intended to reflect the common law position ie that Cape would be liable for Grove's actual loss flowing from Cape's breach.
Decision
It was finely balanced - both parties' arguments had merit - but the court accepted Cape's arguments for the reason that it considered that Cape's construction best accorded with business common sense.
- The most natural remedy, for breach of a tenant obligation at lease expiry, is to provide compensation for the loss suffered by the landlord.
- If the landlord did intend to do the reinstatement works itself, then such a remedy would provide full recovery of those costs - as the claim could be made once the works had been done and the actual cost had been determined.
- If the landlord did not intend to do the works, then the landlord's construction might allow it to recover much more than its actual loss - so it could result in a level of recovery that was arbitrary and disproportionate, not related to any loss sustained. That would be contrary to commercial common sense.
- The tenant's interpretation did provide for full compensation to the landlord for any loss that was ultimately suffered - which accorded with business common sense, and satisfied the important requirements of proportionality and predictability.
Perhaps surprisingly, the court was not swayed by the wording about Grove being "free to expend all monies recovered as dilapidations as they think fit".
Avoid ambiguity to limit a court's ability to apply business common sense to your contract
The rules of contract interpretation should only be applied where there is an ambiguity.
Some might consider that there was little ambiguity in this case. There was a good argument that the lease was fairly clear in what it said, particularly the wording about the landlord being free to expend the monies as it thought fit. Many neutral commentators would think that the drafter of this lease (for the landlord) probably thought that he had done enough to allow the landlord to recover the estimated cost of the identified dilapidations regardless of whether the landlord intended to do the work.
If a landlord has agreed with a prospective tenant that the landlord should be entitled to demand cash, in lieu of the works, then this case is a warning that:
- very clear wording will be required; and
- the landlord should ensure that the provision is drafted such that it can't be struck out as a penalty.
If you would like to discuss these issues further, please contact us.
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