Early consideration of Dilapidations issues can avoid lengthy delays

While the standard of obligations imposed by a repairing clause in a lease is a hot topic when the lease is being negotiated, the dilapidations claims at the end of the lease may be seen as an opportunity for some landlords to try to seek betterment in respect of the premises which they re-claim, and can come as a shock to the tenants.  In this recessionary climate we are coming across some extravagant Schedules of Dilapidations with landlords seeking to maximise their potential and the tenants fighting tooth and nail to resist.

There are a number of common themes that we can consider in ensuring how we can best protect the commercial position which our clients – be they landlords or tenants – think they are signing up to when they enter into a lease:

Premises for which the tenants are responsible

There should be a clear understanding of the extent of the premises to which the tenants' obligations apply.  Is it just the premises which they occupy, or are other common parts brought into their repairing obligation?  For example, the tenants in a short term lease in an ornate Georgian building might find that an obligation to contribute to the repair and redecoration of the entrance hall is unduly onerous.  Equally, landlords letting out individual suites have to ensure that the whole building is maintained and generally attractive to future tenants.  Factors such as the length of a lease should guide the tenants in determining the extent of repairing risk they should be assuming.  This might encourage tenants to seek an obligation which extends solely to the interior of the subjects being occupied.  Similarly if the premises are not in good condition at the onset of a lease, rather than assuming a full repairing obligation, the tenants may seek to have their maintenance obligation benchmarked against a Schedule of Condition agreed by surveyors for the landlords and the tenants – ideally photographic with some text. 

Repairing Clause

It is probably obvious but should not be forgotten that the lease obligations should be read as a whole in determining the extent of the undertaking i.e. repairing, redecoration, statutory obligations and reinstatement.  In a multi-occupancy building whether it be a large new office building or a tenement the parties should consider the potential for common costs/service charge/repairs.  A tenant should have some idea of past charges and what might be anticipated going forward.  A survey not only of the premises being let but the common parts for which the tenants would be responsible is a wise move.  In being obliged to comply with statute, for example, the tenants may also find themselves responsible for the cost of such additional requirements arising over the period of the lease e.g. an updating of the position on fire regulations. 

Alterations/Landlords carrying out Works

Any application for consent by tenants to carry out alterations at the beginning or in the course of a lease should be clearly documented in the Licence for Works with the obligations regarding reinstatement at the end of the lease spelled out. 

In some cases works are carried out to premises by the landlords for the tenants, possibly as part of a general refurbishment.  The obligations in respect of these works at the end of a lease should be dealt with in the lease documentation so that the parties' intentions are reflected.  The works might be left in place or the landlords may require the tenants to reinstate the premises if the works are tenant specific and the preference is they are removed so a new tenant can come in and fit out.  The tenants should be clear regarding the position so there is no unpleasant surprise at the end of the lease when significant items need to be removed and the premises made good. This can be dealt with in a Licence for Works or by way of a schedule in the lease determining what happens to the works and the extent of the tenants' responsibility to remove these. 

In each case both parties should be clear as to the obligations so there is less chance of a costly time consuming dispute delaying the return of the premises in a condition conducive to a smooth re-letting.  It is in neither party's interest for the area to be grey. 

Reinstatement Provisions

How much control will each party have regarding reinstatement?  Ideally the landlords would like the option to require the tenants to reinstate, or to pay the landlords a lump sum to equate to the cost of reinstatement, which tenants will seek to resist.  The tenants will wish to be clear as to what has to be removed, with reasonable timescales for the landlords issuing a Schedule of Dilapidations giving the tenants plenty of time to consider it, agree it and be in a position to carry out the works timeously.

Conclusion

Particularly with long terms leases, both parties should be monitoring that the maintenance obligations continue to be fulfilled.  If tenants "let things go" they risk the final costs being greater and the landlords should not rely on an expensive solution being presented to the tenants at the end of their lease – especially if the tenants can't afford it at this point. 

Should a dispute on dilapidations arise then each party's surveyors and solicitors need to work together in advising their client of the best way forward.  In the case of prevaricating tenants the landlords still need to act as swiftly as possible to reach a satisfactory conclusion as a damages claim will be complex and requires proof of loss in terms of lost opportunity to re-let and costs.  Tenants faced with a steep dilapidations bill will require a combination of surveyor input on the terms of the Schedule and legal input on the terms of the lease. 

While disputes can never be avoided completely both landlords and tenants are best served by clear documentation at the outset of the transaction reflecting their considered and commercial agreement and an appreciation and fulfilment of their ongoing rights and obligations.

31 August 2010

Choosing procurement routes with care

It can only be hoped that the time and effort spent on "Bank bashing" and spending cuts will at a minimum be directly proportional to the benefits to be delivered from the Coalition's new Efficiency and Reform Group (ERG) within the Cabinet Office.  My prediction for this is decidedly mixed.  First is a concern that implementation of "efficiency and [positive] reform" are tainted by the inevitable mantra of the need for "cuts".  This article is not an overview but looks at two very different examples which will have both a positive and negative impact on the public and private sector: outsourcing or shared services, and the trend in construction procurement to the NEC-suite of contracts.

It is a shame that it takes a worldwide credit crunch for both public and private sector entities to focus on efficiency and to put real effort into driving waste out of their businesses and organisations, and processes and projects. A critical assessment of whether or not a "change", a new IT system or a project would (i) improve people's quality of life (whether workers or the beneficiaries of public sector services); (ii) (truly) increase productivity; or (iii) increase profitability or the "bang" achieved by the "buck" spent, has too often been lacking.  Too frequently, projects are not killed off early enough, or those conducting gateway reviews buy into the sales pitch of increased productivity, the "everyone else has one" kind of justification, or are caught up in their perceived importance of their project. 

Outsourcing and shared services

The current pressure on public sector spending is increasing the focus on "shared services" and/or outsourcing.  The structure for shared service delivery, decision making and governance will be key, and anyone who has undertaken projects with multiple clients will be keen to advise on the potential pitfalls.  These projects involve massive change management, process change and, inevitably, legal structures and contractual documentation.  It is to be hoped those involved in the initial projects, which will set the precedent, get it more right than wrong.

Outsourcings are nothing new.  A common issue is that a major outsourcing may be the first outsourcing, or other outsourcings may have been in different sectors, and that can put the public sector at a disadvantage.  The partnering ethos can result in too cosy an approach to interrogation at the outset, or policing in the initial stages.  Critically, the lessons learned in terminating an outsourcing deal or dealing with poor service provision, are not always available and are invaluable in plugging some potential holes.  Outsourcing, like all projects, increases the risks to success if the timetable is concertinaed, or the driver is perceived to be cutting costs as opposed to getting better value services or productivity.  Sometimes the advisers can lose sight of how the structure and the process changes can be used to drive continuous improvement and to introduce self-policing functions to protect the developer, but instead focus on the more boilerplate contractual issues.

There are numerous good and bad examples of outsourcing and "multiple-client" deals.  A real challenge for developers will be to climb the learning curve on all the potential issues and consider how best to, selectively, benefit from these for their project(s) and organisation before it is too late.  With so many public sector bodies looking to move forward initiatives over the next two years there is a decided danger that these projects and developers are all learning as they go and at the same time.  The prospect of an audit task force reviewing projects and decisions after the horse has bolted looms large. 

NEC suite of contracts

In the construction sector the long-term endorsement by the Office of Government Commerce, which is now part of ERG, of the NEC suite for public and private sector construction projects has started to gain traction.  The OGC itself is facing a reduced budget and cuts.  There is a vast array of information on the OGC's website to support developers and projects and that is, perhaps, one problem in that there is too much for developers to digest.  Critical to successful projects is a project champion and driver preferably from the developer's organisation and with accountability and "something to lose" from the project's success (or failure).  Arms length organisations, quangos and Government sponsored "experts" set up to assist developers on projects are rarely accountable or have something tangible to lose. 

NEC has many good features: the focus on programme, project management and risk are examples.  However, these tools are often used (and should be used on any project irrespective of the form of contract) and many provisions adopted into standard form suites of contracts do not give this sufficient focus.  However, to endorse a suite of contract documents as "good" for use in public or private sector projects is dangerous – particularly for the unwary. The discussions should start with what is the optimum procurement route and how might it be delivered. Good procurement rarely stems from a discussion of which standard form suite of contract option to use.  That approach to procurement advice is generally for those looking to roll over what they have done before or are most familiar with or those with some other vested interest and, indeed, awareness of the different interests in use of NEC is a basic fact to be taken into account.  The NEC suite of contracts, whilst improved in edition 3, still contains a number of major issues for users, both contractors and clients.  As use of the NEC continues to gain traction it is likely that Banks lending on projects using NEC will need to undertake greater diligence and consider the acceptability of this at the outset.

Supporters say there is little case law on NEC, therefore, this proves it is good.  A bit like elephants are grey, mice are grey, therefore mice are big, this just draws the wrong conclusion from the existing data.  It is also likely to prove unfounded over the next five years as greater traction brings further work for those involved at the front end of the construction claims.  The problem with "disputes" is that applying the facts to NEC and seeking an answer is often very difficult.  This basic requirement for any contract was thrown out with the bath water and the desire to change behaviours and culture of claims by use of "a contract" ignores human factors and shareholder pressures. NEC fanatics have more in common with alchemists. 

Opportunities for the future

The inevitable spending cuts and impact upon the public and private sector of "austere Britain" are matters we should rightly be wary of, to say the least, but the changes in procurement bring a silver lining of opportunities to both public and private sector.  Looking back in two to five years there will be many investigations into projects and decisions initiated or undertaken over the next twelve months.  A number of clients and stakeholders will be left disappointed but where will ERG, OGC, the quangos and advisers be then? 

31 August 2010

Further Reach for Freedom of Information in Scotland?

The Scottish Government has announced the start of a formal consultation into the possible extension of the Freedom of Information (Scotland) Act 2002 (FOISA).  The consultation started on 28 July 2010, more than six months after the Scottish Government confirmed that it would hold a consultation, and will be open until 2 November 2010.

The consultation is a response to calls for an extension to the ambit of the legislation to take account of the different ways in which many public services are now provided.  The rationale is that a number of organisations that are not currently classed as public bodies under FOISA are now carrying out more and more important duties of a public nature.  The consultation seeks views on whether FOISA should be extended to organisations such as leisure and recreational trusts, PPP/PFI contractors for hospitals, schools and trunk roads, the Glasgow Housing Association, the Association of Chief Police Officers in Scotland and contractors running privately managed prisons.

This extension of FOISA could potentially cover a large range of organisations such as contractors who build and maintain hospitals, schools and trunk roads.  These types of businesses should give careful consideration to the potential consequences of having FOISA apply to them.  Local authority trusts and other bodies set up for the provision of certain facilities namely leisure, sport and cultural services receiving in excess of £100,000 per annum of public money will be also targeted.  Designation of these organisations as a public authority for the purposes of FOISA would bring not only direct obligations and responsibilities under FOISA, but also disclosure of information requirements under the Environmental Information (Scotland) Regulations 2004.

Those wishing to contribute to the consultation can do so on the Scottish Government website here. 

31 August 2010

Microgeneration - generating green income from your roofspace

Microgeneration or fuel cell technology is one of the best renewable energy sources. It is estimated that 30 - 40 % of the UK's electricity needs could be met by installing microgeneration equipment to all types of building by 2050. One type of microgeneration that is becoming increasingly popular in the UK is solar photovoltaic cells (PV cells). 

Following hot on the heels of the CRC Energy Efficiency Scheme (formerly known as the Carbon Reduction Commitment), on April 2010 the DECC launched the Feed-In-Tariffs Scheme (FITs Scheme) to encourage small businesses, homeowners and communities to invest in low carbon electricity generation (microgeneration) by guaranteeing them a cashback payment for the electricity they generate for their own use and for any excess electricity they export.  The FITs Scheme sets fixed tariffs at above market rates for electricity suppliers to pay for electricity generated from renewable energy sources. 

The latest generation of PV cells are freestanding and fairly thin, and therefore able to be mounted on top of, or integrated into, south facing roofs. In simple terms, they work by converting daylight (rather than sunlight) into energy which can be used to power the building on which the cells are installed and/or can be sold on to electricity suppliers via connection to the national grid.  The main disadvantages of PV cells are the initial outlay costs, the weight of them and the fact that a large unshaded roof area is required to generate a worthwhile amount of electricity.

Benefits for landlords and tenants

A proposal by PV operators to install PV cells on their properties should be seen by landlords as an opportunity to improve their green credentials.  Landlords will benefit directly as the presence of PVs will improve a building's energy performance rating and have a positive impact when measuring deliverables required under the CRC scheme (although only if the PV cells are installed after the property has had its initial rating, as the CRC scheme only rewards improvement rather than initial good ratings). In addition the inherent benefit of being seen to be "green" and complying with corporate social responsibility policies is that it will attract desirable tenants with strong CSR credentials.

In new build situations, it is for the developer to decide the "green" credentials of the build, in concert with the planning authorities and with a view to their target tenant.

What issues should be considered?

So what difficulties does a landlord/property owner need to consider in negotiations with a PV operator to install PV cells on an existing building?

Initial considerations should include whether the presence of the PV cells will negatively impact the capital or rental value of the property; whether planning consent will be granted (for example if the building is listed or within a conservation area particularly if the PV cells can be seen from street level); whether the cells can be installed in accordance with Building Regulations, CDM Regulations, and Fire Risk Assessment guidelines and whether the property will be insurable with the PV cells in situ.  In addition if there are pre-existing telecoms licences in place and tenants' satellites dishes located on the roof these may need to be relocated at additional cost.

Single-let industrial sheds will be very attractive to PV operators given the large area available and the relative ease of only having to deal with a single tenant, albeit a financial incentive is likely to be required by the tenant especially in an FRI situation where the roof is already let to the tenant.

The main concern for landlords of multi-let properties will be the maintenance issues. Institutional lenders are likely to refuse consent to a lease which makes the PV operator liable for maintaining the roof because the potential cost implications for the landlord (and resultant impact on the lender's security) could be substantial if the PV operator fails to properly maintain the roof, causing damage to other tenants' fixtures, fittings, stock etc. The PV operator will want other issues addressed such as maintaining rights to light and rights of access for installation and maintenance of the cells and connection to the national grid.

The residential market

PV operators' interest in the residential property market is likely to be limited to large-scale new builds and existing council housing, given the requirement for large roof areas for installation. However it is clear the government wants to encourage microgeneration in domestic premises as the new Part 40 of Schedule 2 to the Town and Country Planning (General Permitted Development) Order 1995 allows the installation of microgeneration including PV cells on houses or flats subject to certain criteria.

The residential landlord's chief focus will be the negative response of tenants to the works to install, or the presence of, the PV cells.  As an example, many attempts to install telecommunications apparatus on tower blocks have been thwarted by objections from residents, with local authorities and landlords often taking the view that it is preferable to pacify tenants than secure income.

Source of additional income

Overall, landlords would be well advised to consider the income generating possibilities of letting their roof space to PV operator on a turnover rent and/or with the option to use the PV cells to power their properties at reduced cost.
 

31 August 2010

Large Grocers and the Controlled Land Order

On 12 August 2010 the Competition Commission published the final version of the Groceries Market Investigation (Controlled Land) Order 2010, which seeks to address competition issues identified as part of the CC's market investigation of the groceries sector. In broad terms the Order restricts the ability of large grocery retailers to enforce restrictive covenants and exclusivity arrangements in certain local markets as specifically identified in the CC's market investigation, or which fail a prescribed competition test. The intention is to remove barriers to other parties entering or expanding their business in previously concentrated local markets with the end consumer benefiting from the increased competition that results (through lower prices and greater choice).
 
The Order was originally published in April 2010 but was subsequently withdrawn as it did not fully reflect certain intended exemptions from the obligations and prohibitions in the Order applicable to "operational land restrictions" (restrictions that prevent land being used other than as a car park, service yard or access road). However, the central provisions of the Order remain the same and are summarised below. 
 
Restrictive Covenants
 
Under the Order large grocery retailers (as specified in the Order and which include, for example, Asda, Tesco and Sainsbury's) are to use their best endeavours, within a specified time period, to release restrictive covenants (i) as are specified in the Order; or (ii) which are determined by the Office of Fair Trading, on application by the owner of the burdened land, to have failed a competition test. The relevant time period in relation to (i) is 6 months from the date of the Order and for (ii) within a minimum period of 3, and a maximum of 6, months of the OFT's determination (as specified by the OFT).
 
The competition test applied by the OFT is specified in Schedule 4 to the Order and, in broad terms, captures the case where the total number of fascias within a 10 minute drive-time around the burdened site is 3 or less and the large grocery retailer  benefiting from the restrictive covenant has a market share of 60% plus.
 
Release of the restrictive covenant must be done by entering into a deed of release with the owner of the burdened land, and procuring the removal of the entry referring to the restrictive covenant from the relevant land register. If the grocer cannot secure the release of the covenant (and the Order specifically states that the obligation to use "best endeavours" does not include an obligation to make any payment to obtain consent from another party) then it is to execute a declaration by deed providing that it will not enforce the restrictive covenant.
 
In addition, large grocery retailers must not (subject to certain specified exceptions) enter into new restrictive covenants that may restrict grocery retailing (that is prevent the land from being used for grocery retailing).This includes agreements which have an equivalent effect, such as a covenant that limits access to properties for certain vehicles that could prevent required deliveries. 
 
Exclusivity Arrangements
 
The Order also  restricts the ability of large grocery retailers from enforcing, or entering into, exclusivity agreements the effect of which are to prevent or restrict another grocery store operating from the same site. The Order identifies a number of specific exclusivity agreements which a large grocery retailer must not enforce after a period of 5 years from the date of the Order. In addition, as with restrictive covenants, an application can be made to the OFT for a determination that the competition test (as outlined above) is failed: should the OFT find this is the case the large grocery retailer cannot enforce the exclusivity arrangement after 5 years from 30 April 2008 or 5 years from the date on which the store began trading, whichever is later.  Further, large grocery retailers must not enter into new exclusivity arrangements with a duration of more than 5 years from the date on which the store in question began trading.
 
The Controlled Land Order is one of a number of measures that has resulted from the CC's market investigation, including the revocation, as of April 2011, of the Land Agreements Exclusion Order. The Exclusion Order currently operates to largely insulate land agreements from the full force of competition law. Its revocation means that the enforceability of common provisions of land agreements, such as restrictions on the type of commercial activity that a tenant may undertake, will require to be assessed with competition law in mind. The approach of the CC to restrictive covenants and exclusivity provisions insofar as large grocery retailers are concerned, in particular the application of the competition test, offers a useful insight as to when competition law concerns may arise in other areas in the property sector.  

31 August 2010

Scottish courts consider when rent will be an administration expense

Introduction

Earlier this year the English High Court considered the issue of rent and administration expenses (for more information on the decision in Goldacre (Offices) Limited v Nortel Networks UK Limited, please click here).  This decision involved an interpretation of rule 2.67 of the Insolvency Rules 1986 which only apply in administrations of companies incorporated in England and Wales.  Given that the Scottish rules are worded differently, and given the criticism of the Nortel decision in England, there has been some uncertainty as to the position in relation to Scottish companies.

Background

In Cheshire West and Chester Borough Council v Springfield Retail Limited (in Administration) the Scottish courts considered for the first time the question of rent and administration expenses. 

The application was brought by the owner of an English property that had been let to Springfield Retail Limited.  Springfield had gone into administration in March 2008. The administrators initially traded the business from the property, and had paid rent in respect of the period during which they occupied it.  In May 2008 the administrators sold the business and assets of Springfield.

As part of the sale arrangements the purchaser was to receive a licence to occupy the property for a period of 6 months. Under the licence, the purchaser was to pay rent to the landlord of the property directly. Due to oversight, the licence was never executed.

Following completion of the business sale, the administrators wrote to the landlord advising that the licence had been entered into, and that the purchaser would be responsible for the payment of rent and would be looking for consent to assignment to it.  The landlord wrote to the administrators requesting further information in relation to the purchaser. No response was provided.  The purchaser failed to make any rental payments to the landlord.  When the licence came to an end in November 2008, the administrators notified the landlord that the licence had terminated and recommended that the landlord take immediate steps to recover possession.  The purchaser continued to trade from the property until April 2009.  In May 2009 the landlord changed the locks, thereby terminating the lease.

The landlord raised an action against the administrators alleging that they had caused it unfair harm, and sought an order for payment of the rent for the period between May 2008 and May 2009 as an administration expense.

Decision

The court decided the rent in respect of the period between May 2008 (when the purchaser starting to occupy the property) and November 2008 (when the licence the terminated) should be paid as an administration expense.  It was conceded by the landlord that rent falling due after the end of the licence period would not be treated as an expense. Accordingly, the Court did not have to make a decision on this point.

The court was heavily influenced by the reasoning of the English High Court in Nortel.  In particular, it agreed that the decision as to what is or is not an administration expense is not at the discretion of the court, but should be the result of the proper application of the Insolvency (Scotland) Rules 1986.  It also agreed that the "Lundy Granite" liquidation expenses principle should apply in administration.  This principle provides that, where property is used for the benefit of a liquidation, pre-liquidation liabilities that accrue during the period of that use (such as the requirement to pay rent) should be paid as liquidation expenses.

The Court decided that occupation by a third party under a licence to occupy granted by an administrator will constitute use of the property for the benefit of the administration (and so engages the "Lundy Granite" principle).

Commentary

The decision in the Springfield case appears to bring the position in Scotland into line with the current position in England and Wales, with all of the difficulties that that brings.  Two issues arise in particular.

When rent is an administration expense.
The court did not specifically address the question of whether the full amount of a rent payment which becomes payable during the use of the property is an administration expense, notwithstanding that the property is only occuped for part of the period to which that payment relates.

The fact that the order was made only in relation to the period of occupation might suggest that the it is only the portion of rental relating the period of occupation that should be treated as an administration expense.  However, given that (i) the period of the licence in this case seem very similar to the Scottish quarter dates, the dates on which rental payments normally fall due, and (ii) the Court expressly approved the reasoning in Nortel, it would be prudent for an administrator to assume that it is the full amount of rent which becomes payable when calculating the costs associated with occupation.

Licences to occupy.

It is often essential to grant licences to occupy in order to obtain the full value from the sale of the business of a company in administration.  It is therefore unlikely that administrators will cease to give them.

Administrators will, however, now have to consider licences to occupy even more carefully.  Licences on terms that provide for the purchaser not to pay any rent or other amounts under the lease which fall due during the period of the purchaser's occupation are now highly unlikely to be given.  Administrators may also be more likely to require that lease payments that will become due during the period of occupation should be paid to them up front by the purchaser at the time of the sale or that escrow arrangements should be set up.

To ensure that any potential unfunded claim of landlords for administration expenses is kept to a minimum, the length of any licence and the methods by which the purchaser can be ejected from the property if the required payments are not made will also need to be considered.

31 August 2010