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Repairing Liabilities and The Lease Code 2007

publication date: Nov 10, 2007
 | 
author/source: Michael Hare
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In this article I want to look a little deeper at the issue of break clauses, which involve something of a departure from recent issues over compliance with repairing liabilities and indeed case law.

“Material compliance with conditions precedent” is often a precondition to a tenant’s right to exercise their break. In many instances a tenant’s right to break is usually made conditional upon the tenant performing its obligations under the lease, but generally it is compliance with the obligations to repair, decorate and not make alterations which have caused the most difficulty for tenants in such material compliance.

Failure to comply fully with their repairing and decorating obligations under the lease has resulted, over recent years, in landlords winning cases and being able to refuse the tenant their break right.

It is almost impossible for a tenant to comply absolutely with their repairing and decorating obligations in a lease, which as we have mentioned, may result in them being unable to exercise their option to break. In 1992, in Bairstow Eves (Securities) Ltd v Ripley [1992] 32 EG 52, the Court of Appeal had to consider the meaning of a condition precedent requiring the tenant to “perform and observe all covenants and obligations herein on the tenant’s part contained”.

The lease actually stated that the tenant was to paint both the outside and inside of the property within the last twelve months of the lease; in reality this was carried out between twenty and seventeen months before the termination date. The trial judge held that the tenant should be allowed to exercise their break right as he considered there was no material difference between the standard of decorative work undertaken and the repairing obligation. However the Court of Appeal disagreed, indicating that if there is any breach of repairing covenant, however small, the break will not be successfully operable. This “absolute” rigidity was later reviewed in two later cases where the exercise of a break clause was also subject to a condition precedent there was to be no material breach of covenant. In the first of these, Commercial Union Life Assurance Co Ltd v Label Ink Ltd [2001] L&TR 29, Rich J set down the principle that the insertion of the word “material” mitigated the requirement for absolute compliance to the extent that it was fair to both landlord and tenant. He said “in quantifying…that the breach must be material, it is clearly intended to mitigate that rule as an otherwise trifling breach would disqualify the tenant from exercising the option even though the court might be slow to find such a breach, where it would be unfair to do so”.

The decision of Rich, J was approved by the High Court in Fitzroy House Epworth Street (No 1) Ltd v The Financial Times Ltd [2005] 46 EG 176. Here the issue was again whether the tenant had successfully operated its break - the outcome had major financial implications in that if the tenant failed in its break it would be liable for a further £2.5m of rent, unless it could dispose of the lease; and if the break was successful the landlord faced an uphill task in finding a tenant for premises they had not marketed since the tenant vacated in April 2004.

The Financial Times, as tenant, could exercise the break option if it had “materially complied with all its obligations under this lease down to the date for which notice to terminate has been given”. Following service of the break notice, the Financial Times expended in excess of £900,000 in complying with its covenant to repair, and attempted to agree with the landlord what works were needed. The landlord neither co-operated nor commented on the tenant’s proposed works and at the termination date they refused to accept the lease had been effectively broken.

The trial judge found there was a further £19,000 worth of additional works that could have been done for the tenant to have strictly complied with its repairing liabilities; but concluded that the tenant had complied with all of its repairing obligations and thus the break was effective. Given the financial implications of this case it is no surprise that Fitzroy took it to the Court of Appeal [2006] EWCA Civ 329, who held that whether a breach is material must be assessed by reference to the ability of the landlord to re-let or sell without delay or additional expense. The court did not hold with the landlord’s view that “material” was only intended to permit breaches which were trivial or trifling and considered that the words “material” and “substantial” were interchangeable, although “reasonable” connoted a different test.

This case gives very clear guidance to the more limited condition to show material or substantial compliance with the tenant’s covenants, and the principles set out by the Court of Appeal are a useful aide memoire to property practitioners in advising whether or not a tenant has complied with its lease obligations. These are:

  • Materiality must be assessed by reference to the landlord’s ability to re-let or sell without delay or additional expense
  • The evidence of building surveyors will be crucial in assessing the degree of each alleged breach of repair; BUT the evidence of agents as to the ability to sell or re-let is likely to determine the case
  • The test to be applied is objective and subjective considerations will be irrelevant
  • The FT was successful because it took early professional advice, accepted such and went to great lengths to ensure strict compliance with the conditions precedent, which included spending almost £1m on repairs, with only minor works, valued at no more than £20,000, remaining. In this case, which involved a large office building in London let at an annual rent of £595,000, such minor works were immaterial to the landlord’s ability to re-let.
  • The Court reiterated however that where a break clause is absolute, then any breach, however trivial, will preclude the exercise of that break. For example, if a lease requires three coats of paint to be applied in the last year of the term, and only two are applied, the lease will not be able to be broken.

In practical terms it is difficult, if not well nigh impossible, to satisfactorily achieve compliance with conditions precedent regarding the physical condition of a building, but to some extent any problems of compliance can be mitigated by giving early attention to the issues, erring on the side of caution in defining repairs and seeking an early dialogue with the landlord as to what they are expecting from the tenant in terms of repairs. Whilst landlords are under no obligation to assist, the courts will be more supportive of a tenant if there are only small discrepancies and it can be shown the landlord did not co-operate.

The new Lease Code represents therefore somewhat of a move away from previous practice (and litigation) in that under recommendation 3 it states:

“The only preconditions to tenants exercising any break clauses should be that they are up to date with the main rent, give up occupation and leave behind no continuing subleases. Disputes about the state of the premises, or what has been left behind or removed, should be settled later (as with a normal lease expiry)”.

Similarly under recommendation 9 it is stated:

“A right to break should allow you to walk away from the lease at a given time after informing the landlord in writing. This should be conditional only upon having paid the rent due under the lease and giving up occupation, leaving behind no continuing subleases. You may have other liabilities to fulfil, but these should not be used to invalidate the right to break.

When your lease ends, whether by expiry or by exercise of a break option, you will be liable to the landlord for any sums due and for any repairs you should have carried out during the lease (dilapidations)”.

It is this recommendation that outstanding repairs should be subject to separate negotiation that is a major departure from current legal practice and case law.

Whilst the Appeal Court has now set out the test for “material” or “substantial” compliance the recommendations within the 2007 Code have gone further than this in that the treatment of (dis)repair at the time of the lease break should be the same as at expiry by effluxion of time – i.e. subject to a dilapidations claim as opposed to the landlord being able to frustrate the exercise of the break.

It remains to be seen how many landlords will wish to follow the new Code; after all non compliance with repairing obligations has, as we have seen from case law, frustrated a tenant’s ability to exercise their break option, which in times of a depressed market and few hopes of any early re-let, has helped owners to keep tenants in-situ by their failure to absolutely or materially comply with their covenant to repair at the time of the break.

In conclusion, Eleanor, in her article asked if the new Code would work, and suggested it should. For my part, as a commercial agent and not a lawyer, my opinion is that it probably still has limited “teeth” and will continue to have limitations whilst it is completely voluntary.

If landlords can use the power of law and precedent to assist in frustrating break clauses, particularly if the market continues to slow down, then are they likely to want to “sign up” to a voluntary Code that recommends a tenant should be able to exercise that break provided only that they have paid the rent in full and have surrendered possession and more importantly any claim for repairs should be now a completely separate issue? Is this not a case of turkeys voting for Christmas?

However the fondness of this Labour Government in legislating for the sake of it and interfering with the natural balance of market forces may just result in the Code becoming mandatory. Only time will tell!

by Michael Hare BSc FRICS FNAEA FICBA