Landlord and tenant disputes continue to rise

In the current economic downturn, there has been a lot of focus in the real estate industry on the effect of tenant insolvencies, “pre-pack” administrations and lease disclaimers. However, tenant failures are only part of the story. In a business environment where real estate investment and development opportunities are harder to come by and rents harder to maintain, a fall in the real estate market tends to encourage tighter asset management. This increases the potential for conflict between landlords and tenants.

Conditional break options
Many tenants will be looking to down-size or take advantage of a declining property market to find alternative premises. Far-sighted tenants may have anticipated a change in circumstances and negotiated break options in their leases that have conditions attached. The most common condition requires the tenant to have paid rent and other sums due up to the break date. If rent is payable quarterly (or by reference to some other period) all rent must be paid on the relevant payment date that precedes the break date, even if the break will terminate the lease part way through a rental period. Better-advised landlords may seek to ensure that future tenants’ break options fall on or shortly after a rent payment date.

Break clauses may in addition require the tenant to have complied materially with all of his lease obligations, the most onerous of which involve covenants to keep premises in repair. Even where a landlord is unlikely to find a new tenant at a decent rent or where it has no intention of carrying out any repairs, he may use such a break condition to seek a favourable financial settlement with the tenant. In these circumstances this type of break condition is a powerful tool for a landlord, since a tenant cannot seek to reduce its liability by arguing that its breach of covenant does not diminish the reversionary value of the landlord’s premises. He must simply comply with the break condition. A landlord can drive a very hard bargain in order to release the tenant from this.

On the other hand, where the tenant has the ability to break its lease but knows that it will not be leaving the premises, it may be able to negotiate with its landlord to remove its right to break the lease in return for some other concession. Removal of the break right will mean that the landlord’s reversionary interest is worth considerably more, so the landlord may be keen to enter into discussions and a tenant may be able to obtain a rent free period or convert to a turnover rent in return.

Rent reviews
With rents falling, few landlords may be inclined to activate rent reviews and many tenants simply may not be able to pay an increased rent. Nevertheless, the area remains an active one, and there are a number of issues that might be of importance to landlords and tenants.

Firstly, if a break option is co-terminus with a rent review date this could have an unforeseen effect. If it is not expressly provided for in the lease, time will not be of the essence in relation to a rent review notice: i.e. the fact that a landlord (or a tenant) fails to serve a rent review notice by a date specified in the lease will not prevent it from activating the rent review. Where there is an inter-relationship between a rent review date and a break date, this may make time of the essence. The rationale adopted by the Courts is that it must have been intended by the parties that the tenant would be able to know what its reviewed rent was going to be before deciding whether or not to break the lease.

For a landlord activating rent reviews may well not be a priority. However, if the last rent review was some time ago, checking the relevant lease provisions may well be important. Another issue that it is worthwhile checking carefully is whether, instead of fixing a rent review date, a lease provides for a “floating” valuation date that attaches to the date that the reviewed rent is agreed. Other leases may link the rent review date to the date of service of a rent review notice.

These types of leases may give both parties to the lease the ability to affect the outcome of a rent review quite significantly in a rapidly rising or falling rental market. However, parties should be wary of leases where there is ambiguity over the relevant wording. In terms of valuation, landlords desperate for favourable comparable evidence to use in rent reviews may be more inclined to seek side agreements with tenants who are either unable to pay rents or have been able to negotiate rent downwards in the knowledge that landlords are under pressure to keep premises occupied.

Conversely, there are likely to be more instances of tenants seeking disclosure of a landlord’s documents in rent review arbitrations in an effort to undermine the landlord’s comparable evidence and find the true level of the market. Where rent reviews have taken place, there may be attempts to overturn arbitrator’s decisions. One area of concern for a landlord is where a rent review valuation arose but he feels that the arbitrator’s decision may have been influenced by what has happened to the market during the period necessary for the arbitration to take place and an award to be issued. It should be remembered in this regard that the “hypothetical tenant” to be assumed in determining a particular rent review will exist whether or not there is, in reality, a market for the premises at the date of the rent review.

Dilapidations
When rents are rising investors are seeking redevelopment opportunities and tenants are short of available space – contested dilapidations claims are usually relatively rare. However, in recessionary times with landlords seeking to maximise revenue, the converse is very much the case and there are many traps that unwary parties can fall into. Perhaps the most misunderstood issue for landlords and tenants alike concerns Section 18 of the Landlord and Tenant Act 1927. This limits a landlord’s claim for repairs to the diminution in value of its reversionary interest. This diminution is calculated by assessing the value of the premises on the date of termination of the lease. It is carried out by reference to what a notional purchaser would have paid for the premises.

A tenant can sometimes relate what a landlord has actually done, or proposes to do with the premises to the notional purchaser for valuation purposes. If the landlord proposes to refurbish it is likely that at least some of the work carried out or contemplated will supercede any works necessary to address the tenant’s disrepair. Section 18 is a potent weapon in the hands of a determined tenant, and should be borne in mind by a landlord with a large potential dilapidations claim making future plans for his premises.

Conclusion
The downturn in the real estate industry has thrown many landlord and tenant issues into sharp relief and where tenants remain solvent, increased the potential for disputes to arise. A proper understanding of a statute heavy and technical area of the law is essential. But for well advised landlords and tenants the current economic circumstances can present an opportunity as well as challenge.

For more information
Contact Jones Day at 21 Tudor Street, London, EC4Y 0DJ
Tel: +44 207 039 5959 or visit their website at jonesday.com