With the rise of tenant insolvency, Chris Sullivan, Partner at Malcolm Hollis, explains how to successfully navigate through dilapidations settlements.
Most landlords spend months refurbishing, marketing and securing tenants for their properties, which is clearly a significant investment. Landlords want their properties maintained and handed back in good condition at the end of the lease and, more importantly, the rent to be paid on time.
Tragically, we are seeing a much higher incidence of tenant defaults and insolvency than we have for many years. This begs the question: If I think my tenant is going bust, what do I do?
There is a short and long answer; the short answer is get to the front of the queue. The long answer?
Every lease contains contractual terms or covenants that serve to ensure the rent is secured and reviewed, the property is repaired, and usually decorated, unaltered and legally compliant. There are a number of important steps that can be taken to ensure these terms are adhered to.
It is too late to start worrying about whether the lease will provide you protection when the tenant is on the edge, but for future deals having the lease drafted carefully is so important.
Most leases have provisions for a surety or guarantor who would take the place of the tenant in the event of insolvency but there are many pitfalls to consider and good legal advice is essential.
The best advice is to have reduced the likely impact of insolvency. From a financial perspective, a good credit control team will keep on top of late rental payments but if a tenant becomes insolvent and they haven’t looked after your property, you may be in for a significant cost burden.
As new enquires dwindle we should be protecting our assets and ensuring they are maintained and have not been altered without permission.
At Malcolm Hollis, we deal with hundreds of dilapidations claims a year and the most significant part of these claims is reinstatement, accounting for 75 per cent of the overall value. If you get that part of a claim wrong, it can destroy the whole process. The main risk is failing to place an obligation on a tenant to remove an alteration. Most leases do not oblige a tenant to remove fixtures, which could include partitioning to offices or a mezzanine floor in a warehouse for example. Other alterations can slip the net on what the lease permits or where a specific reinstatement obligation is poorly drafted.
The final point to watch out for on alterations is service of notice – some leases have specific notice provisions to request alteration be removed having given six months notice or the landlord must first be acting reasonably in giving the notice.
With defects to a property, there are steps that can be taken to force a tenant into action during the lease. The main options are; damages, specific performance, forfeiture and landlord entering and carrying out works – see Jervis v Harris. Damages are hardly used and has little tactical merit. Specific performance is a court order requiring someone to do what they promised in the case of dilapidations, to carry out the work necessary to comply with the terms as to the condition of the building. It is an entirely discretionary remedy (like an injunction) and again underused.
There are a great number of issues and complexities concerning forfeiture and relief from forfeiture so any one involved in this process should encourage the party to seek legal advice as soon as possible after a notice has been served. Essentially forfeiture is taking back the property, the tenant has an immediate defense if the lease is seven years or more and has three or more left and in that case a court order would be necessary for the action to be successful.
By far the most effective remedy is landlord’s re-entry (self-help clause) or the Jervis v Harris remedy after the leading case. Importantly, this case enabled a landlord to make a claim for a debt rather than damages, which prevented further legal complications that could reduce the amount recovered.
If the lease permits and a tenant has allowed the property to fall below the standard considered by the lease then, subject to the wording, a landlord can serve notice on the tenant to remedy the breaches.
This will normally relate to defects rather than redecoration but could also extend to compliance with statutes such as Asbestos Regulations.
If the tenant fails to deal with the notice in a prescribed period and the notice is absolutely correct, the landlord can enter the premises and recover the costs from the tenant.
If the notice is incorrect the Landlord runs the risk of a claim for breach of quiet enjoyment or trespass.
A well-prepared Jervis v Harris case is incredibly difficult (but not impossible) to defend. If the tenant is already insolvent, it is a different story.
Restrictions are imposed on the remedies available and, to navigate your way through the minefield, a working knowledge of insolvency legislation is crucial.
Once an individual is bankrupt, his assets including any leasehold interest in property vest in his trustee in bankruptcy or in the official receiver.
The trustee becomes personally liable for rent and the covenants in the lease.
However, he may disclaim onerous property including leases and the landlord may serve notice on him to elect whether to disclaim or not – if the trustee fails to disclaim within 28 days, he is deemed to have adopted the contract.
One of a landlord’s best options when faced with individual insolvency could be to cut his losses by forfeiting the lease, proving for rent in the bankruptcy and foregoing any claim for dilapidations.
An administrator is likely to refuse to pay rent and will certainly be unwilling to contribute to dilapidations. The landlord can and should put pressure on the administrator to pay rent by threatening to apply to court to forfeit and/or recover rent arrears.
The processes involved in each of these tactics are very specialised and should only be undertaken by specialist property litigation experts.