Hybrid working and lease breaks put dilapidations back in the spotlight

What to look out for when negotiating dilapidation agreements?

When the economy and property market is running smoothly, dilapidations – the costs associated with maintenance and repair of space at the end of a commercial lease – are less of a concern for landlords and tenants. 

But when the market gets more challenging, dilapidation claims get their time in the spotlight. It happened in 2008 after the financial crash, and it’s happening again in part because of hybrid working. 

With workers spending less time in the office, more businesses are reassessing their space requirements and exercising lease breaks. 

Matthew Reading, Partner, explains: “Because the market isn’t as buoyant, landlords are naturally doing everything they can to either hang onto tenants or, if they leave, get as much cash as they can from the dilapidations process.” 

The result is far more scrutiny of dilapidation deals. David Robinson, Associate Partner, sums it up saying: “Negotiating dilapidation agreements has got more difficult in the last couple of years.”

What are the most common risks in dilapidations negotiations for tenants?

There are a number of different areas for tenants and their advisors to negotiate, and these are some of the most common stumbling blocks. 

Different lease terms mean that some break clauses are trickier to exercise than others. At one end of the spectrum, space has to be returned completely stripped out, repaired and decorated, with all rent etc. paid by the date of the break. 

At the other, it might involve simply vacating and making sure the rent is paid. 

Understanding the requirements and the steps that need to be taken before the break is critical for tenants. Exercising the break has to be followed to the letter of the terms of the lease otherwise, the landlord can refuse the break or charge a premium to settle the dilapidations claim. 

“If there is a dispute, some judges may be proportionate in their rulings, but equally if it says the break notice has to be serviced on pink paper, it has to be served on pink paper,” says Reading.  

The specific timeframe to notify the landlord of the break should be adhered to. Tenants can sometimes opt to carry out any maintenance and repair work or pay the landlord an equivalent fee. But, if opting for the former, the works need to be planned and carried out before the break date of the lease.  

Space alterations, upgrade and replacement implications

A licence for alterations is another area which needs close attention. If the space has been altered, say partitions added to create different areas/meeting rooms or individual offices, the landlord may or may not require that to be removed. If the landlord has to formally notify the tenant in a prescribed timeframe and neglects to do so, they may be unable to claim for that element of work. 

Upgrades and replacements to meet part of the building regulations may be an issue for older buildings. It can be a high additional cost, for example, if roof repairs are required as part of the dilapidations work, there may be a requirement to add insulation to meet the new building standards.

Robinson says: “It can be a real head-scratcher sometimes as to whether it's a valid head of claim or not; advisers representing tenants can argue for repairs rather than more substantial work.”

A schedule of condition is important because it determines what state the space was in when it was leased. However, having a schedule of condition will not save a tenant from having to carrying out any repairs. 

“It’s a common misconception for tenants to think that if there are any parts of the property that were in disrepair at the beginning of the lease, then they don't have to pay for it,” says Reading. “If there isn't a schedule of condition, then the chances are a tenant will be liable.”

Having fewer staff using an office because of hybrid working may make it more tempting for a tenant to carry out dilapidations work themselves, as there is less disruption. If it is just an interior office, this may be more straightforward. 

But a really old building which perhaps didn’t start life as an office, for example, will be more problematic as something can be missed that a landlord can subsequently claim for. There is also a danger that a tenant will end up spending money where they might not need to.

Is it worth paying the landlord to carry out dilapidation works?

Paying the landlord rather than carrying out the work can be more straightforward, but tenants and their advisors need to be tenacious about checking what the landlord’s plans are for the building after they’ve vacated. 

“If the landlord is planning to do some significant refurbishment, repair or going to convert the building for a different use, that would negate a large majority of the dilapidations depending on the specifics,” says Robinson.

There are examples where plans to redevelop an office into a different use have been discovered, resulting in a dilapidation claim being cut by 95%.  

Exercising a break clause and negotiating the subsequent dilapidations is complex and potentially costly if not done correctly. Market conditions are such that both sides will want to get the absolute best deal they can but planning ahead and paying attention to the detail of the lease terms will put you in a good position.  

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