Many franchisees, particularly retail or office based or in commercial premises, will take a lease in order to operate their business. Aside from paying rent there are other potential financial implications for franchisee tenants to consider.
Terminal dilapidations are breaches of lease covenants that relate to the condition of the property at the end of the term. This may coincide with the expiry of the franchise agreement.
Most commonly a claim for damages will be brought by a landlord against a tenant who has departed and who has breached a repair covenant by not delivering up the property in the appropriate condition. A tenant should budget for this potential liability. Once the lease has expired, a landlord’s remedy is a claim for damages and it will be subject to a number of limitations.
Usually there is an obligation to keep the property in repair. This means that if you take a lease of a property in poor condition your responsibility for dilapidations at the expiry of the term may mean carrying out improvements to put it into repair. If there is no Schedule of Condition at the outset then depending on the wording of the lease you may have to bring it up to a condition and standard better than when you took the lease on. You can protect against this by making sure the obligation to return the premises in a condition is by reference to a Schedule of Condition.
The claim for damages will be the reasonable cost of doing the works plus loss of rent including service charges and rates for the period until the works have been completed. The purpose of damages is to compensate the innocent party for loss caused by the breach. The level of damages will depend on the landlord’s actual loss.
However, the amount a landlord can claim will be subject to a ‘statutory cap’ on the level of compensation claimed in accordance with Section 18(1) of the Landlord & Tenant Act 1927 (“the LTA”).
Any damages claimed will be limited to the diminution in the value of the landlord’s interest in the land (freehold or longer headlease) caused by the tenant’s breach.
The process of valuing diminution involves comparing the value of the property in the state of repair required by the lease and the value of the property in its actual state at the expiry date of the lease. It is therefore very important for the landlord to obtain evidence of diminution, especially if they do not intend to do the works as this may affect the level of damages a landlord can recover. It is also good practice to take photographs as evidence of disrepair as well as providing the tenant with a Schedule of Dilapidations.
Damages are not recoverable where it can be shown that a landlord is intending to demolish or carry out structural alterations to the property regardless of its state of repair, Section 18(1) of the LTA 1927 will apply and the landlord may be unable to make a claim for damages, even if the landlord subsequently changes his mind. This incorporates a subjective test of the landlord’s intention at the time of termination of the lease and is for the tenant to prove. The landlord’s intentions for the property are therefore a key consideration in any dilapidations claim.
A landlord is also entitled to claim for other breach of covenants by a tenant (including decoration, reinstatement of alterations, removal of fixtures etc.), these breaches are not limited by Section 18(1) (unless the breach also constitutes a breach of the covenant to repair) and therefore damages will be assessed based on the reasonable costs of carrying out the works.
In reality a terminal dilapidations claim is likely to include damages falling both inside and outside S.18 (1).
Advice for Franchisees
- Take photographs before you sign a lease and at termination, as they can be used as evidence for a dilapidations claim, together with a Schedule of Condition, particularly if the property is old.
- Always take legal advice on the wording of the repair covenant in the lease and the extent of your liability for the property.
- Be aware of the terms of your franchise agreement in connection with your lease. Make sure you have a right to occupy for the term of the franchise.
- If you take an assignment of a lease on a re-sale of a franchise, be aware that you are taking on the responsibility and liabilities of dilapidations. You may need to factor that liability when negotiating the price for the business.
- Don’t forget to budget for a dilapidations claim when your lease terminates
- Remember, your landlord is not obliged to serve you with a Schedule of Dilapidations before the expiry of your lease and once the lease expires you cannot carry out the works yourself (unless your landlord agrees). Therefore, you should take both legal advice and a surveyor’s advice on your potential liabilities in good time to carry out the works which are considered necessary.
- You may want to carry out the works prior to the expiry of the lease yourself to keep control of the repair costs and to avoid additional costs (like landlord’s fees). However, be aware that carrying out the repairs yourself may not necessarily eliminate the possibility of a claim for dilapidations since your landlord may not agree with either the nature of or extent of works required.
- Investigate your landlord’s likely intentions for the property. If renovation or demolition is likely, Section 18 will operate to reduce or eliminate the sums claimed by your landlord.
For further information: http://www.legislation.gov.uk/ukpga/Geo5/17-18/36/section/18