Maintenance, Repairs, and Dilapidations in Retail Leases

Understanding Commercial Lease Repair and Maintenance Obligations

This episode provides an in-depth overview of commercial lease repairing obligations, emphasising the importance of tenants understanding their responsibilities and double-checking them against those of the landlord. It explains the differences between Full Repairing and Insuring (FRI) leases and Internal Repairing and Insuring (IRI) leases, and the expectations set for tenants regarding proactive and reactive maintenance. Host Gary Marshall also delves into issues related to lease compliance, potential conflicts, and legal notices like the section 146 notice from the 1925 Law of Property Act. The necessity of professional advice for tenants to navigate their obligations and potential disputes effectively is highlighted.

00:00 Understanding Repairing Obligations in Commercial Leases

00:16 Types of Repairing Leases: FRI vs IRI

01:07 Proactive vs Reactive Maintenance

02:03 Insurance and Repair Costs

03:22 Elasticity in Repair Obligations

06:38 Landlord's Rights and Tenant's Responsibilities

07:33 Legal Actions and Tenant's Defense

10:40 Section 146  Notice and the 1925 Law of Property Act

12:37 Schedules of Dilapidations

15:00 Privity of Contract

15:06 Reinstatement Clauses 
 
 16:11 Accounting Implications, IFRS and FRS102

17:05 Final Advice for Tenants

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IFRS/FRS102

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Transcript

0:00

Welcome to that Retail Property guy with your host, Gary Marshall. In each podcast episode, we delve into topics from the perspective of a retailer as tenant sharing stories and insights through Gary's unique lens. We hope you'll be entertained, enlightened, and may be a little inspired. All commercial tenants should be aware of their repairing obligations and should double check against the landlord's obligations in case something is excluded or maybe falls between the two points of view. Most commercial leases contain some clauses relating to repairing obligations. A retail tenant of a traditional standalone property might typically face a full repairing and insuring lease known as FRI. Where the tenant is effectively expected to keep the whole of the property in good repair throughout the duration of the lease term, and to hand it back to the landlord at expiry in good order, ready to be relet, well, subject to some elasticity and interpretation, more on that later. Meanwhile, a tenant in a retail park or another. Managed shopping center might have an internal repairing and insuring lease known as IRI, leaving the landlord to look after the repairing obligation of the main structure, the external finishes, and particularly the roof and so on to keep in repair has a different meaning than simply to repair, which suggests fixing something that's broken. To keep in repair also means to avoid anything deteriorating. In other words, this is about proactive maintenance as well as reactive maintenance. It can mean keeping up with regular painting commitments to ensure that wooden windows don't rot, and checking that the gutters don't get blocked, which then avoids damp penetration. It's like washing and servicing your car, not just waiting to fix the bits that fall off. But obviously it also means promptly and properly fixing the things that do break or fall off like a leaky roof, a damaged wall, damaged gutters, broken gates, the savvy tenant should read their lease and know two primary things, who is responsible for repairs and maintenance of any specific part of the building, and also its surrounding environment. This could include the delivery yard, the forecourt, that concrete canopy, or the shared staircase. And is there building insurance, which might help in the case of unforeseen damage, even if that damage is technically their responsibility to repair, they might still have to organize to fix it, but maybe the landlord's insurance will cover the majority of the cost. It's worth checking before committing to any large expense. The insurance part is often overlooked, whether by small business teams who haven't thought of it, or by big retailers, maintenance teams who haven't thought of it either. You'd be amazed how much maintenance and repair gets spent on stuff that could be the basis of a claim against the landlord's insurance. Damage might be the result of a storm, a flood, a break-in, or vehicle impact damage, or possibly even subsidance or damp, if that emanates from external causes, like a neighbor's neglect. But back to the plot, if a tenant has an IRI internal obligation or an FRI, full obligation, they should pay attention. They should plan activities to maintain the parts of the building that they are responsible for. They should monitor, maintain, decorate, fix, replace, upgrade, and generally wrap that building in cotton wool in order to keep it pristine and give it back to the landlord at expiry in tip top condition. Huh? Or should they? There can be an argument that all of this proactive maintenance stuff is very much elastic. Okay? Yes, if the roof leaks, stop the leak, but does that mean patch the immediate leak or recover a section of roof or replace the whole roof covering and its substructure? How far is a repair required to go? Should a landlord get a property back in better condition than when the tenant took it with a fabulous new roof that'll last another 30 years compared to the original one, which was on its last legs when the tenant signed the lease. Probably no. A more specific answer could start with read the lease, because some commercial leases actually specify that repair doesn't include improvement even when a practical repair becomes unviable. Of leases might carry a schedule of condition, often a photographic record with supporting descriptive text accurately describing just how bad or good the various elements of a building were at the date the tenant signed the repair obligation. A competent schedule of condition should be prepared by a competent building surveyor or other property professional, but an amateur version can be just as useful so long as it is signed and dated by both the tenant and the landlord, and defined as agreed to represent the condition on that date. A decent schedule of condition can really help both parties to deal with any difference of opinion about repairs either during the lease or as it expires. But with or without a schedule of condition, another elastic test of whether proactive maintenance or a reactive repair absolutely must be undertaken. Could be. What is the loss or damage to the landlord's reversion? This sounds a bit technical, so let's look at it this way. If the tenant's lease expires and the tenant hands back the keys and the property is a bit shabby, notwithstanding that the lease gave the tenant the obligation to keep it in repair proactively and reactively, so the landlord considers a claim for the costs of doing the outstanding repairs or for other damages. But if the landlord is still able to quickly relet the premises at a full market rent without having to give the new tenant any discounts or financial concessions, and without having to dilute the new tenant's repairing obligations with a schedule of condition, then what is the landlord actually lost? It looks like their investment is still a hundred percent sound, financially robust, not undermined by the outgoing tenant having done less than obliged under their lease. The same test applies if a landlord intends to demolish or substantially alter the premises. There might be no perceived loss if the tenant hasn't painted a window or repaired a roof that the landlord simply intends to rip out. This diminution test might indicate that the loss or damage to the landlord's investment, also known as their reversion is negligible. So a court might be willing to agree with the outgoing tenant that the landlord has lost nothing, so no damages have arisen. So nothing for the outgoing tenant to pay. This test is elastic. It certainly isn't watertight, but it's definitely worth the tenant and their advisors bearing in mind. But again, back to the plot, what can a landlord do if they feel that the tenant is falling behind with practical maintenance or not using quality materials in repairs or badging a job for a quick fix, not a best or permanent solution. Obviously we assume that they have read the lease and are correct in their assessment of what the tenant is supposed to do. Bear in mind that the lease should give the tenant the absolute right to exclusive possession of the premises. It shouldn't be the landlord's ongoing right to whats in and out as they wish, and certainly they shouldn't just take it upon themselves to carry out repairs and send the bill to the tenant. That might be an eventual option, but there is a journey to reach that point. It isn't step one. If the landlord is bold, brave, or maybe dumb enough to carry out repairs, which were the tenant's obligation, the tenant might even be in a position to respond with. Thanks. Very generous of you. Don't expect me to pay. So what is that journey and what are the landlord's options and how should the tenant respond? The first rule for all tenants should, of course, be read the lease. The second rule should be don't be pressured into paying up. Seek professional advice from a property professional with the relevant experience in this sector. Some landlords might go immediately for the biggest possible hammer to crack that smallest of nuts. They might consider litigation or a few other avenues, including the formal service of an interim schedule of dilapidations, or even serving a section 1 4 6 notice under the 1925 Law of Property Act. Both these options are available but can be considered excessive, and a landlord might find a judge agrees with the tenant. Once again, a tenant doesn't just have to take it on the chin. They have options too. A landlord who serves a schedule of D lapse or a section 1, 4 6 notice just to be vexacious and then expects the tenant to pay any associated costs, might just have a tenant who knows how to push back, how to avoid that action and possibly even leave the landlord. To pick up the tenant's costs. So let's consider what the best steps are for a reasonable landlord to follow. First step should be for the landlord to write politely to the tenant to remind them of their obligations and to point out anything that they feel is not up to scratch, not being complied with, and the tenant could possibly respond stating that they are aware of their obligations, that they have a plan to resolve these items in the near future, possibly even confirming a date range for works to commence. It might be that there are issues which the landlord is unaware of, like the tenant's ongoing struggle to get a scaffolding permit or to get the gas disconnected, or even the availability of suitable contractors. In theory, the landlord should then back off and give the tenant time to do as promised. But if a reasonable amount of time passes and still nothing happens, then the landlord can take the next step. Another possible response from the tenant might have been that they are aware of their obligations, but they have no plans to do those works until near the end of the lease if they are still required. An obligation could be if the lease states that the tenant will redecorate externally every three years. This is mainly to keep up appearances and to ensure that woodwork doesn't rot and so on. But if the existing state of decor is marvelous, as good as new, even if it is three years old. Then in practical terms, what does the landlord stand to gain from insisting on compliance right now? If the tenant pushed the matter to court, would the judge side favorably with the tenant? But let's say the landlord isn't happy with the passing of time or polite refusal, what's their next step? As we discussed earlier, the biggest sledgehammer could be the section 1, 4 6 notice. The 1925 Law of Property Act allows a landlord to use this protocol to step in and terminate a tenant's lease to forfeit the lease for non-compliance of practically any lease terms except payment of rent for which bailiffs are their option. To be clear, yes, this notice is intended to throw the tenant out and reclaim the premises for the landlord. And some landlords have been known to serve a 1 4 6 for the smallest of matters, completely disproportionate to the value of the overlooked repair, the size of the premises, the value of the rent, and so on. A quirk of these notices is that the landlord is then expected to completely behave like the injured party, and so they shouldn't do anything to compromise that appearance. So here's the quirk. Continuing to accept rent. Is seen as compromising that position. So a landlord who serves a section 1 4 6 notice should immediately stop demanding and accepting rent. A tenant on the receiving end of a 1 4 6 notice should immediately seek advice because even a section 1 4 6 notice isn't a fixed and unser legal device. It isn't irrefutable. It isn't absolute. Landlords should consider wisely before hitting this big red button. The notice must allow the tenant a reasonable amount of time to complete the repairs. Though the definition of reasonable is flexible if the tenant complies within that reasonable timeframe, the landlord can't proceed with forfeiting the lease, but they might still have a claim against the tenant, say for legal costs and damages. A tenant could also seek defense against a section 1 4 6 notice by challenging the validity of the notice. Was it badly served for some technical detail? Or by disputing the alleged breach on non-compliance, or even by going to court to seek relief from forfeiture so at least the landlord doesn't get the premises back. Even though the judge might make some other decision about the alleged problem itself, like ordering the tenant to paint those windows. So the section 1, 4 6 notice isn't always the best option. What else could a landlord do? Well, they could serve an interim schedule of dilapidations in this context. Interim means that the schedule is served during the term of the tenant's lease. A similar schedule could be served as the tenant approaches the expiry of the lease. And this would be known as a terminal schedule of dilas. And if the landlord serves it after the lease expires, then it would be a final schedule of DAPs. But they're all schedules of DAPs. The first response for the tenants, of course, once again, is always read the lease, get advice, and consider that diminution test. Can the landlord actually prove a loss, especially if other circumstances suggest otherwise? An interesting point, however, arises if the lease has already expired and the tenant has vacated, so the landlord would be serving a final schedule of collapses and the tenant could negotiate to try to reduce the impact. But they'd no longer be allowed to actually do the works once they've handed the keys back. The ex tenant has no right to enter their former of premises, so can't choose to save money through DIY or choosing their own contractor. They're stuck with the landlord or their agent or contractor doing the work at a commercial rate, and the landlord could also claim for the loss of a commercial rent for the period while those works are undertaken. So if the tenant doesn't comply with their repairing obligation and risks everything like on red 17 at the casino, hoping that the landlord will demolish or substantially redevelop the premises or re-let them at full market rent with no discounts. Well, if it goes wrong, they could lose out by much more than if they'd simply complied and done the work. During the term of the lease, one more point for tenants who might sell their business and assign the ongoing lease to a new occupier thinking, phew, that's the end of that. Your leasehold obligations might not go away. If the ultimate tenant at the end of the lease term hasn't complied with all the lease terms, then depending on the terms of the assignment of the lease, it's possible or even likely that a landlord could come back to you for outstanding costs and actions under a legal protocol known as privity of contract. You'll appreciate that for many ultimate occupies who are not the original tenant on a lease, this could seem an attractive or easy option to walk away and let the landlord chase the original tenant. And one final point, what if the lease also includes a requirement for the full reinstatement at the expiry of the lease? This specific requirement stretches way beyond standard repair. It sets out a clear obligation for the tenant to strip out everything and reinstate the premises to exactly the condition they were in at the start of the lease. And this is really onerous. It spells out an emphatic obligation to do a load of expensive work right at the end of the lease. But within the duration of the term of the lease, not afterwards on the tenant's clock as it were. So this could be difficult to dodge, defer or delay unless the landlord has clearly indicated an intention to demolish and so on. The tenant has limited time to make a decision. Do it now within the lease or don't do it, and then litigate. Hoping for a softer option, but risking the added pain of paying an ongoing commercial rent after expiry while the landlord gets their contractor who is more expensive than yours to do the job that you could have done. Hmm. And while we're on this point, what do the accounting standards people think about reinstatement clause? We're talking about a business's accounting obligations under International IFRS or domestic FRS 1 0 2. You might think that repairs and maintenance surely have nothing to do with lease accounting. This is all revenue expenditure. It's just the cost of doing business. Nothing for the balance sheet. But if the tenant's lease clearly requires specific adherence to certain likely costs, which includes full reinstatement at the end of the lease term. Then the accountants should acknowledge the likely cost as a liability in the IFRS or FRS calculation, even if there is a possibility that the eventual action will be negotiated, reduced, or avoided. It has to be acknowledged from day one as a potential liability, which then impacts the balance sheet. So there we have it, repairs and maintenance, and the consequences for not complying with the lease obligations, but also the best tactics for managing those obligations. This is a well-documented and litigated minefield. Many landlords expect their smaller, less advised tenants to simply yield. Maybe get taken for a ride. The best advice is to read the lease and get advice as early as possible In any scenario from a property professional, not you make down the pub or a quick search on Google. Don't underestimate the value of the advice. See the value, not the cost. Good luck. Thank you for listening to that Retail Property guy. If you enjoyed the show, please consider leaving a review. Your feedback is greatly appreciated. For more information, visit that retail property guy.com. Thanks again for tuning in.