Dilapidations insurance: reducing uncertainty about costs

One less thing to worry about

26 March 2018

Dilapidations insurance should significantly reduce uncertainty about costs for occupiers at lease

Uncertainty is the bane of most businesses: it deters investment, obstructs forward planning and plays havoc with the balance sheet. Consequently, a number of insurance products in recent years have been designed to make matters more certain. One of these more recent products concerns dilapidations.


Parties may find themselves in a lengthy legal wrangle

Dilapidations are a particular bugbear for businesses. The issue often arises after a company has decided to move, but is left with an ongoing headache over whether repairs and reinstatement of alterations have been completed in accordance with the commercial lease. If no cash settlement is agreed, the parties may find themselves in a lengthy legal wrangle, with the costs often exceeding the sums at stake.

Critical costs

Traditionally, this prolonged period of uncertainty favours the party that has the deepest pockets. Landlords usually have more experience of dealing with such claims, while tenants tend to shy away from having a potential liability hanging over them for years – whatever their surveyors may say about the case. The tenant’s only advantage may be that it holds the funds, although that will not be the case if the landlord retains a substantial rent deposit.

Contributing to this concern is PGF II SA v OMFS Company 1 Ltd [2013] EWCA Civ. 1288, where a landlord claimed £1.9m for breach of repairing covenants. Further lower offers were subsequently made that the tenant rejected, together with 2 offers of mediation. The day before the trial, the landlord accepted the tenant’s formal settlement offer of £700,000, but the trial judge decided that the tenant should face a costs sanction for unreasonable failure to mediate, depriving it of its costs for the relevant period. On appeal, the decision was upheld on the grounds that the mediation had a reasonable prospect of success when offered and the tenant’s silence was itself unreasonable conduct.

Another factor that has ratcheted up levels of uncertainty in recent years is the length of the lease – the old, standard 25-year lease has now shrunk to 10 years, often with an option to terminate after 5, so lease-end issues are now more frequent. Tenants should consider their dilapidations position about 2 years before their lease ends, whether they are planning to leave or not, and a surveyor should be brought in to help assess its options.

A few businesses – often those with multiple leases around the country – may set aside a reserve for dilapidations from day one of a lease. In some cases, substantial capital provisions may even be made for a claim that never materialises, which is not the best use of a business’s resources.

Insurance has a good record of providing certainty against litigation exposure. The initial model for the dilapidations policy was rights of light insurance, now used in the majority of significant developments where infringements are a concern, and is widely recommended by surveyors.

Backstop

Essentially, dilapidations insurance caps the tenant’s liability by the payment of a one-off premium with an agreed deductible, which is underwritten on a case-by-case basis. The pricing is based on the quality of the surveyor’s report, the lease agreement itself and the communication that has been had with the landlord. In the case of a lease coming up to expiry, premiums usually range from 1% to 5% of the indemnity limit. A policy can also respond to an active situation where negotiations are going nowhere.

The policy is written on an 'agreed conduct' basis, so the surveyor retains complete control of negotiations with the landlord until a claim is formally notified to the insurer. This should take place if the landlord has issued a claim, or an offer is made, for more than the deductible; following this the insurer should see correspondence from, and agree correspondence to, the landlord, and be involved in discussing any financial decisions. This offers extra peace of mind because, if the deductible is exceeded, the insurer meets the additional costs, including professional fees, up to the limit of indemnity.

The policy is designed to allow the tenant to walk away from the premises without further unspecified financial commitment, leaving the insurer as a backstop. By remedying these liabilities, the company renders its balance sheet more attractive to potential investors or buyers, while insurance is also likely to increase the confidence of tenants in taking on their landlords as well as making them more receptive to their surveyor’s advice.

Top tips for tenants

  1. Take advice from surveyors at the beginning of a lease and again at least 2 years before expiry.
  2. Understand the legal basis of your liability under the lease.
  3. Consider insurance to cap your future liability.
  4. If no agreement is reached with the landlord, suggest early mediation.

Nick Mace is Commercial Risks Director at chartered broker Clear Insurance. Simon Hartley is a partner at RadcliffesLeBrasseur

Further information

Download a complete “Dilapidations insurance: reducing uncertainty about costs” PDF