A Storm Brewing For Landlords And Tenants Alike

Courts and practitioners have long grappled with the distinction between repair and improvement and the related issue of when an item which is in disrepair may legitimately (or, indeed, must) be replaced. Two recent cases have brought the perennial question before the courts again and will be of interest to landlords in the context of the Minimum Energy Efficiency Standards (MEES).  This article focuses principally on the situation where a landlord assumes responsibility for repair via a service charge, but the questions will be equally pertinent in those cases where a tenant is directly responsible for repair.

MEES – A recap

Subject to some prescribed exemptions, Part 3 of The Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015 provides that a landlord of a non-domestic private rented property must not:

• Grant a new tenancy (including a renewal tenancy) of a property after 1st April 2018; nor
• Continue to let the property after 1st April 2023,

where the property has an Energy Performance Certificate rating of either F or G.

It is estimated that there are some 200,000 commercial properties which will consequently require refurbishment and a debate has been rumbling for some time as to whether landlords or tenants should expect to foot the bill. In most cases, tenants will not want to bear the costs of such works, whether directly or indirectly, and landlords will naturally take the opposite view. Questions may also arise around a landlord’s ability to access let property to carry out works of improvement and a tenant’s ability to improve property where this is necessary to secure a subletting. There may also be uncertainty around rent review where the hypothetical premises would be illegal to let by virtue of being either F or G rated.

Whilst the starting point will always be the construction of the individual lease, it is easy to see why the elasticity of the concept of repair will be relevant. For example, in a standard FRI lease subject to a service charge, the landlord will be obliged to repair the common parts and structure of the property and will be entitled to recoup the cost of so doing via the service charge. If the windows of the property are in disrepair, the landlord may well be in favour of replacing the windows at the tenant’s cost. Where antiquated windows are replaced with their modern equivalents the energy consumption of a property is typically improved. In contrast, a tenant may not occupy the premises long enough to see any pay back from the more efficient new windows and may prefer the landlord to merely carry out some patching-up works at a lower cost. Normally, a landlord will only be able to recover the cost of repairing a building and not the cost of improving it. However, where there is disrepair, replacement may be possible. Replacement with a modern equivalent will often be desirable, in so far as energy efficiency is concerned.

The recent cases

These cases both concerned residential property and the courts were therefore considering the landlords’ works in the light of the Landlord and Tenant Act 1985. Nonetheless, the decisions are of general interest:

The first case, Waaler v Hounslow LBC [2017] EWCA Civ 45, considered whether it was reasonable for a landlord to incur substantial costs in replacing windows, which in turn necessitated the replacement of exterior cladding and the removal of asbestos. Perhaps unsurprisingly, the Court of Appeal did not agree that the works carried out were reasonable. The Court commented that there was no bright line difference between repairs and improvements. This was relevant because the landlord had an obligation to carry out repairs but only a discretion to carry out improvements. Inevitably, it all turned on the individual facts, but the Court did confirm that the exercise of discretion must be rational and that the rationality test applies both to a choice as between different methods of repair and also to a decision whether to carry out optional improvements. Assuming the landlord had acted rationally in deciding to improve, s19 of the LTA 1985 then added a higher objective standard of reasonableness. Whether costs have been reasonably incurred was not simply a question of process, but also a question of outcome.

In the second case, De Havilland Studios Ltd v Peries and anr [2017] 322 (LC), the landlord actually opted to repair windows and it was the tenants who argued that replacement would have been the better option. The Upper Tribunal concluded that both replacement and repair were reasonable options and that it was not therefore for the court to interfere in the landlord’s decision. Broadly, a landlord may choose from a number of reasonable options. The Upper Tribunal reiterated the findings in Waaler that reasonableness is not just a question of process but also of outcomes achieved.

Practical points for Landlords operating a service charge

For most existing commercial leases, the starting point for a landlord seeking to upgrade its building is that there must be an element of disrepair. Unless the service charge is drafted very permissively, improvement is not allowed in a vacuum. Assuming disrepair, a landlord will then need to analyse the lease terms closely to see what is permitted. If MEES makes replacement the more desirable option, landlords will need to ensure that that is a reasonable choice having regard to the outcome (which requires a landlord to consider the impact on the tenants, both financially and in terms of what is in the tenants’ best interests over the life of their leases). Where there is an element of landlord’s discretion, this must be exercised rationally (which is a lower threshold than reasonableness).

Where a landlord is granting a new lease and wishes attempt some element of future-proofing with regard to MEES, it could attempt to incorporate drafting into the service charge which expressly allows energy efficient improvements. A well-advised tenant is likely to approach such drafting with circumspection. Also, this is a nascent area and it remains to be seen what impact such provisions might have upon rent review.

There is another side to this particular coin and landlords will also be concerned that tenants’ alterations should not have a negative impact upon the EPC rating of a building. The BPP Green Lease Toolkit offers some suggested drafting on this point. Landlords will have to face up to these issues in the coming months and years and we are certain to see further commentary from the courts as the disputes arise.

This article first appeared in Estates Gazette on 2 December 2017.