The Treatment of Inherent Defects in Leases 0 Comments

The Treatment of Inherent Defects in Leases

Proposition: modern leases of commercial property rarely, if ever, attempt to provide in a balanced and equitable way for the treatment of inherent defects.

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I will begin with a matter of terminology: in the rare case where a lease makes any provision at all for dealing with inherent defects, it may well be limited by the use of the expression ‘latent defects’ and thus restricted in its operation to inherent defects which are not ‘patent` i.e. apparent or (I would submit) reasonably discoverable on inspection. This post is concerned with all inherent defects. Defects would no doubt be treated as reasonably discoverable if ascertainable by professional investigation. But what degree of investigation can reasonably be expected of a prospective tenant of what may be a small part of a large new building? Is the unfortunate tenant to be expected to commission and pay for a full structural and engineering survey of the entire building? And would the landlord even allow it?

Later in this post I will refer to specific published precedents, but first I will attempt to put the proposition in context by revisiting, first, the much debated and litigated question of what defects in a building requiring repair are to be regarded as inherent defects, and secondly, the two principal kinds of inherent defects. Later in this post I will make some suggestions as to what would amount to what I have referred to in the proposition as a balanced and equitable treatment of ‘repairs’ of this nature. In stating the existing law, I will refer to Hill & Redman’s Law of Landlord and Tenant and I am indebted to the learned editors of that work for their clear exposition.

Two further preliminary points: I have referred in the proposition to commercial buildings, and that is where I will place my emphasis, but similar arguments can and do (see the cases referred to below) apply to leases of residential property; secondly, since the issues canvassed here were frequently debated in the 1980s, buildings (particularly office buildings) have become ever more complex and innovative in terms of design and materials, and this means that the treatment of inherent defects has become a matter of ever increasing importance.

Moving on to the existing law, the first and fundamental question is whether any particular defect is, or is not, within the normal meaning of the work ‘repair’. In the majority of commercial leases, repair as such is the liability of the tenant: in the case of a lease of an entire building there will be a covenant by the tenant to repair the building, and in the case of a lease of part of a building the tenant will usually pay a service charge, which will include an appropriate proportion of expenditure incurred by the landlord in carrying out repairs to the structure, exterior and common parts of the building. I note at this point that, in fact, service charge provisions in leases of part of, primarily, office buildings often go further and include in the ‘definition of services’ for which the tenants have to pay not only ‘repair’ but also ‘renewal’ and even ‘rebuilding’.

Hill & Redman’s Law of Landlord and Tenant Division G General PrecedentsHill & Redman (see above) deals with the issue of repair in Division A, Chapter 10. The meaning of ‘repair’ is dealt with in Section C.1 (a) paragraph [3267] where the learned authors note that:

‘The concept of ‘repair’ connotes the idea of making good damage so as to leave the subject matter so far as possible as though it had not been damaged. A state of disrepair connotes deterioration from some previous physical condition. As a matter of the ordinary usage of English, that which requires repair is in a condition worse than it was at some earlier time.’

And later, in paragraph [3269] :

‘Repair’ can be distinguished from ‘renewal’. ‘Repair’ will involve some work of renewal or replacement: it is restoration by renewal or replacement of subsidiary parts of a whole. ‘Renewal’, as distinguished from repair, is reconstruction of the entirety, meaning not necessarily the whole but substantially the whole of the subject matter under discussion. The obligation to repair, however, cannot be considered in vacuo and while it is possible semantically to distinguish ‘repair’ from ‘renewal’ or ‘improvement’ or ‘alteration’, to decide in any given case whether work goes beyond ‘repair’ one has to look at the particular building, the state which it was in at the date of the lease and the precise terms of the lease, and then come to the conclusion as to whether on a fair interpretation of those terms in relation to that state the requisite work can fairly be termed repair.’

The work continues with further comment on the tests to be applied, but for present purposes I will move on to a later paragraph [3270] – [3280]:

‘It follows from the above that if a building is inherently defective but has suffered no deterioration in its condition, then works to remedy the inherent defect will not amount to repair and would on the face of things be outside a covenant simply ‘to repair’. On the other hand, if premises are inherently defective and the defect causes deterioration in the condition of the premises, then works to remedy the deterioration (and cure the inherent defect) may amount to ‘repair’. Whether or not works of this sort which cure an inherent defect go beyond repair strictly so called, however, will be judged according to the principles set out in the previous paragraphs.’

I will refer to the first category in the above extract as a class 1 inherent defect, and the second as class 2.

In support of the above passage, the learned authors refer to a number of cases the principal of which are probably Post Office v Aquarius Properties Limited [1987] 1 All ER 1055, Ravenseft Properties Limited v Davstone (Holdings) Limited [1980] QB 12 and Elmscroft Developments Limited v Tankersley-Sawyer [1984] 270 EG 140, CA: there have been many others, but the judgements in those three cases would still appear to be good law.

Pic6In Aquarius,there was a defect in the structure of the basement of the building by reason of porous concrete and defective construction joints used in the construction of the building which caused water to enter the basement whenever the water table rose, as it did between 1979 and 1984 when the basement was permanently ankle deep in water. But there was no deterioration in the condition of the building as constructed: a classic class 1 inherent defect.

Ravenseft was more complex. A building erected between 1958 and 1960, consisting of a 16-storey block of maisonettes, was constructed of a reinforced concrete frame with stone claddings. Expansion joints were omitted from the structure because at the date of erection it was not standard practice to include them: it was not then realised that the expansion rates of the concrete frame and the stone cladding were different. In 1966 the tenant took an underlease of the building. The underlease contained covenants by the tenant ‘to repair’ the building including the walls, and to repay to the landlord costs incurred in executing works to remedy, inter alia, want of reparation. In 1973 part of the stone cladding on the building became loose and in danger of falling because of bowing of the stones caused principally by the defect in design of lack of expansion joints, but also because of defective workmanship in failing properly to tie in the stones.

Pic5The landlord executed the necessary remedial works, removing the cladding and reinstating it with expansion joints (which by that date, 1973, it was standard practice to insert) and proper ties. The total cost of the work was £55,000 of which only £5,000 was attributable to the work of inserting the joints. The cost of erecting the building in 1973 would have exceeded £3 million. The landlord brought an action against the tenant claiming repayment of the whole of the cost of the works carried out, under the covenants to repair and to repay the cost of repairs executed by the landlord. The tenant denied liability for the cost of inserting the joints on the grounds that it was caused by an inherent defect in the demised premises and repairs resulting from an inherent defect could not fall within the ambit of a covenant to repair; alternatively he contended that the tenant was not bound to pay for that part of the repairs which remedied an inherent defect: held there was no doctrine that want of repair due to an inherent defect in the demised premises could not fall within the ambit of a covenant to repair. It was a question of degree whether that which the tenant was asked to do, or pay for, could properly be described as repair so as to fall within a covenant to repair, or whether it involved giving back to the landlord a wholly different thing from that demised in which case the work would not fall within a covenant to repair or pay for repairs. The insertion of the joints did not amount to changing the character of the building so as to take that work out of the ambit of the covenant to repair or the covenant to pay for repairs, for the joints formed a trivial part only of the whole building, and the cost of inserting them was trivial compared to the value of the building. It followed that the landlord was entitled to repayment: a classic case of a class 2 inherent defect.

In Elmscroft, there was constructed into the walls of a residential block what was intended to be a damp-proof course, consisting of slates laid horizontally. These existed in the external and the party walls of the flat, but, owing either to a defect in design or construction or bad workmanship, this layer of slates was ineffectual because it was positioned below ground. The result was that It allowed moisture to be drawn up from the ground by capillary action, with the consequence that the flats were in a damp condition, rising damp resulting from what was described as the bridging of this damp-proof course, and parts of the interior of the main walls of the flats had been adversely affected up to a height of about 1 to 1 1/2m. The rooms in the flats were damp, and the plaster, decoration and woodwork needed repair or renewal. The court described the condition of the basement flats as `appalling`. Nonetheless, the court found that the installation of a new damp-proof course came within the landlords repairing covenant and the tenants had to pay: another class 2 inherent defect.

pic4Ravenseft and Elmscoft were both concerned with residential buildings: I noted above that the primary focus of this post is commercial (and principally office) buildings and that similar considerations apply.

Reverting to Hill & Redman, in paragraph [3282] the learned authors set out more examples of matters which have been held to come within the scope of repairing covenants and another list of matters which have been held to constitute renewal going beyond the scope of repair. This is very helpful, but need not be repeated here: as already noted, this post is concerned with both classes of inherent defect.

The issue in the case of a class 1 inherent defect is that in the absence of a specific provision in a lease it would give rise to a stalemate, as it is probable that neither the landlord nor the tenant will under the lease terms be liable to do the necessary remedial work. So, in the case of a new building (which is where the issue is of principal importance), given that the inherent defect (in whichever class) is almost certainly going to be the result of defective design of the building or defective workmanship or materials employed or used in the construction of the building or in the preparation of the site, and that the landlord is quite likely to have been the developer, what is fair?

The issue in the case of a class 2 inherent defect is whether it is right that its remediation (assuming, as is usual, that the tenant is directly or indirectly responsible for carrying out or paying in part for its cost) should be the tenant’s liability.

With that background, we can look at some of the lease precedents published and commonly used by solicitors acting for landlords. The worst results that tenants are likely to suffer are in leases of parts of new office buildings (often of cutting edge design), so that is where I will look.

Model Commercial Lease MCL – Office – 02 Version 1.1

Clause 4.9.1 of this form provides (in the most likely to be used alternative) that the tenant must ‘keep the Premises and all Tenant’s Business Alterations in good and substantial repair and condition and clean and tidy’. Since the model form is based on an interior demise, this obligation is not significant for current purposes. Under clause 3.4.1, however, the Tenant must pay as rent a Service Charge due under clause 4.3 and schedule 3. Clause 4.3 is merely the covenant to pay: schedule 3 contains the substance. Part 1 of the schedule contains the administrative provisions relating to payment: what the tenant must pay for is determined by Part 3, paragraph 1, which reads:

‘Repairing (and by way of repair, renewing, rebuilding and replacing), decorating, maintaining and cleaning the foundations, roof, structure and exterior of the Building and all Common Parts and Conducting Media.’

Since the words ‘renewing, rebuilding and replacing’ are qualified by the words ‘by way of repair’, it would seem that the tenant is only obliged to pay for repairs according to the normal meaning of the word as discussed above: in other words, the tenant may be liable to pay a proportionate part of the cost of remedying class 2 inherent defects, but not class 1 (where the position would be open – see below). There is no mention anywhere in the form of inherent defects as such.

Encyclopaedia of Forms and Precedents (Butterworths) Volume 22(1) Section B.3 Precedent 12

This is described as a ‘Lease of a suite of offices forming part of a building, with parking bays and additional parking rights’. The internal repairing covenant is in clause 3.4.1. ‘The Service Charge’ is defined in clause 1.47 by reference to other definitions, the key one of which is ‘the Landlord’s Expenses’ which are exhaustively defined in clause 1.28 by reference to schedule 6, where we find that paragraph 3 defines what the tenant must pay for. Paragraph 3.1 reads:

‘repairing – and whenever the Landlord acting reasonably regards it as necessary in order to repair, replacing or renewing – and decorating the retained Parts.’

This would appear to have much the same result as the corresponding provision in the Model Form. Again, it is difficult to see what is added by the words ‘replacing or renewing’ as replacement or renewal is only permitted if the landlord acting reasonably ‘regards it as necessary in order to repair’. Again, therefore, I conclude that under this lease the tenant may be liable to pay part of the cost of remedying class 2 inherent defects, but the existence of a class 1 inherent defect would, again, create a stalemate.

Hill & Redman’s Law of Landlord and Tenant Division G General Precedents

This work no longer seems to contain a precedent for a lease of part of an office building, so I am looking only at the draft lease of whole which is Precedent L1 (intended for the whole of an office building). There is a simple repairing covenant in clause 3.1 whereby the tenant is to ‘repair and keep the Premises in good and substantial repair.’ The result is the same as for the Model Form and the Encyclopaedia of Forms and Precedents: there is no repairing covenant by the Landlord.

Ross: Commercial Property Precedents (Butterworths) Precedent 5

This precedent seems to have the same title as the form referred to above in the Encyclopaedia of Forms and Precedents, and although the layout is slightly different the result appears to be the same. ‘The Services’ to which the tenant must contribute are set out in paragraph 3 of schedule 5 and are in identical form to the corresponding provision in the Encyclopaedia precedent.

The principal question which this post addresses is whether these commonly used provisions produce a result which is fair to the tenant. This actually breaks down into two questions: is it fair that the tenant should be liable for the cost of remedying what I have described as class 2 inherent defects (which he may well be, directly or indirectly, in all cases under the lease forms referred to above and most others I have seen); and what happens in the event of a class 1 inherent defect arising, when neither the landlord nor the tenant is contractually liable to carry out the necessary work to remedy it? I submit that it is not reasonable for the tenant to bear the cost of remedying a class 2 inherent defect. A point to bear in mind here is that, in the case of a new building, the landlord will normally be the developer, and even if he is a purchaser from the developer, will usually have the right to recover remedial costs from the developer, or, if not, to have had assigned to him remedies against the contractors and the design team, and in many cases, the benefit of a Latent Defects Insurance Policy.

Indeed, the tenant may well have been offered and taken up third party or collateral warranties from the contractor and professional team, but why should the tenant be forced to exercise remedies which are normally weak and difficult to enforce, not to mention the very considerable costs he would incur in doing so? This is not the place to go into the difficulties which the tenant would have: suffice it to say that most tenants will probably not be in possession of all of the detailed information necessary to attribute responsibility, and the warranties would almost certainly limit liability and contain net contribution clauses confusing liability issues. I am, of course, aware that the views I have just expressed are completely contrary to the policy of most developers who, in leasing buildings, are keen to escape any further liability and in all probability are acting through a single purpose company, which will be wound up at some point in the future: but that is their (or their funder’s) choice and does not go to the issue of fairness.

At this point I must declare an interest. In the late 1980s (I am not sure when it went out of print, but in the version I have looked at it is noted that the law is up to date to 1990) I edited the then precedents section of Hill & Redman and proposed a method of dealing with inherent defects.

In the case of what I have termed class 1 inherent defects, my proposal at the time was that the lease should in effect provide that:

A  There should be a notice and counter notice procedure in order to identify and reach agreement (with a dispute resolution procedure) as the existence of a class 1 inherent defect;

In the event of the existence of the defect being confirmed, the landlord would have the option to carry out the necessary remedial works and to enter upon the premises for that purpose, or to   determine the lease on reasonable notice and retain all relevant insurance monies;

The tenant to have the right to determine the lease by not less than 3 months’ notice to the landlord at any time after service of the landlord’s notice (to protect the tenant should he find alternative premises before expiry of the landlord’s notice);

The landlord is, if he chooses to determine the lease, obliged to pay the tenant by way of compensation a sum equal to the sum which would have been payable to the tenant under Section 37 of the Landlord and Tenant Act 1954 had the tenancy been continued by virtue of Section 24, and had the landlord served notice under Section 25 stating that he would oppose an application to the court for the grant of a new tenancy on the grounds set out in S30(1)(f) and had no other ground for opposition; and

The rents payable under the lease cease to be payable during the period for which the premises cannot be occupied in whole or in part due to the carrying out of the remedial works.

This seems fair, as in the absence of such provisions, the stalemate created by the existence of a class 1 inherent defect is irresolvable, and the pressure would normally be on the tenant to resolve it by negotiating at least a contribution towards the cost of the remedial works: otherwise the tenant will continue to be liable under the terms of the lease for its duration and will receive no compensation if he is forced to leave. It should be borne in mind that class 1 inherent defects can render a building uninhabitable.

My proposal in the case of class 2 inherent defects was that:

A  Since the landlord’s repairing covenant would apply, and the remedial costs would be potentially recoverable from tenants via the service charge provisions, the landlord should covenant to use all reasonable endeavours (including the commencement and prosecution of proceedings) to recover from the persons responsible for all defective design, supervision and workmanship, and the supply, specification and incorporation of all defective materials causing or contributing to the defect, the costs and expenses incurred by the landlord in carrying out the necessary remedial works

B  The landlord to be required to take out an adequate Latent Defects Insurance Policy (if the landlord is not the developer he should take an assignment of the developer’s policy);

The landlord to be under no obligation under the covenant referred to in A above if and to the extent that the landlord decides not to seek to include the relevant costs and expenses in the service cost, or the landlord is entitled to recover the relevant costs and expenses under any Latent Defects Insurance Policy;

To protect the landlord further, the landlord to be under no obligation to commence or prosecute any proceedings unless counsel has advised that the proceedings have a reasonable chance of success;

E  The landlord to be permitted to include in the service charge any remedial costs which he fails to recover under A or B above, and the cost of any Latent Defects Insurance Policy, but not any costs incurred by him in pursuing third parties; and

The rents payable under the lease cease to be payable during the period for which the premises cannot be occupied in whole or in part due to the carrying out of the remedial works.

This does not seem too burdensome: indeed, on reviewing these provisions I would be tempted to exempt the tenant entirely from having to pay remedial costs, but I thought at the time that might be going too far, and on balance I still think so.

Cheesegrater and GherkinAs a postscript, dare I add that the problem here is that where it seems impossible to draft provisions that reconcile opposing interests, the topic tends to end up on the `too difficult` pile and be side-lined? In earlier posts on this site I have dealt with similar problems in relation to long development leases at ground rents.

In summary, I believe that the provisions outlined above are fair and reasonable (though they could be refined) and that a tenant should press for the inclusion of similar provisions in any lease of the whole or part of a building, especially where it is a new building and certainly where the new building is a state of the art modern structure with unique and innovative design features.

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