Breaking down the value of dilapidations claims

Alex Wright asks: does a recent case represent a willingness by the courts to embrace a new approach to section 18 valuations? The approach to assessing the sum due to a landlord when a tenant’s lease ends and they leave a property in disrepair is long established and necessitates time and expense for the parties involved. However, Peachside Ltd v Koon Yau Lee and another [2024] EWHC 921 (TCC); [2024] PLSCS 78, in which the court accepted an arguably more straightforward approach, could give landlords and tenants a quicker and cheaper route to resolving dilapidations disputes. The orthodox approach While the starting point for assessing a landlord’s dilapidations claim may be the cost of any relevant remedial works required, section 18(1) of the Landlord and Tenant Act 1927 and its potential impact on a landlord’s dilapidations claim serves to: cap the amount of a landlord’s dilapidations claim to the diminution in value (if any) suffered by the landlord to its reversionary interest in the demised premises as a result of the condition in which they are returned to them (“the first limb”); and provide that no damages are recoverable where the demised premises are to be pulled down or structural alterations are to be carried out at or shortly after the end of the term (“the second limb”). Traditionally, a section 18 assessment requires two valuations of a landlord’s reversionary interest in the premises demised to be undertaken: a valuation of such interest based on the assumption that the premises demised were returned to the landlord in the condition required under the relevant lease (Valuation A – assumed compliance); and a valuation of such interest based on the condition in which the demised premises were actually returned to the landlord (Valuation B – actual condition). The amount of the diminution in value (if any) suffered by the landlord to its reversionary interest is determined by deducting Valuation B from Valuation A. If the amount of such diminution in value is less than the cost of any relevant remedial works required, the landlord’s claim will be capped at the diminution in value amount and the landlord will be unable to recover a sum over and above this. Conversely, if the diminution in value is equal to or greater than the cost of such remedial works then section 18 will not limit the landlord’s claim. An alternative approach While this is the traditional approach, Peachside reminded many in the industry that there is an alternative route available. This alternative approach (based on identifying “value affective works” (ie works which affect the value of the premises in and out of repair) has been advocated by commentators and increasingly embraced by practitioners in recent years. This approach involves considering: (a) the disrepair items identified by the parties’ building surveyors and the works required to remedy them; and (b) whether or not any such identified items affect the value of the demised premises and, if they do, whether they will be superseded by further works which are the landlord’s responsibility or which the landlord will carry out. While the traditional approach involves undertaking two separate valuations, section 18 itself does not require this – providing for a calculation of “the amount… by which the value of the reversion… is diminished owing to the breach of [repairing] covenant”. Undertaking two separate valuations using the traditional approach presumably only increases the costs for the parties involved, and almost invariably necessitates a somewhat hypothetical valuation exercise when undertaking Valuation B – which is undertaken by making adjustments to Valuation A to reflect the condition of the premises as returned to the landlord (as it is highly unlikely that there will be transactions involving physically similar properties with the same breaches as to repair, decoration, reinstatement, etc as the demised premises). In comparison, the value affective assessment approach drives straight to the issue, identifying the items of disrepair which have diminished the value of the landlord’s reversionary interest – minimising costs and, I would suggest, narrowing the dispute between the parties (with the parties and the court better able to focus on specific items and analyse the extent to which they affect the landlord’s interest and the basis for arguing that they do or don’t). To date, this approach has not been widely adopted/approved by the courts, until now. Game-changer? Peachside may well be the catalyst for change, and a change which could be significant for landlords and tenants. The case concerned a former textile warehouse in the Chinatown area of central Manchester which the landlord had owned since 1963. The tenant had a 14-year term lease of part, expiring in February 2017 (though their tenancy continued under the Landlord and Tenant Act 1954 until 2021). Judge Stephen Davies appears to have had no issue with accepting the use of the value affective assessment approach, which both parties’ valuers adopted when considering the impact of section 18. The attractiveness of the approach is compelling and it will be interesting to see the extent to which it continues to be endorsed by the courts – many will hope it will be embraced. Sometimes all it takes is one case to kick-start a change, and perhaps this is the one which will precipitate a shift in approach for assessing section 18 valuations – with potential benefits for all sides. Alex Wright is a principal associate at Eversheds Sutherland (International) LLP Photo by Jochen Gerlach/imageBROKER/Shutterstock (7493822a)