DILAPIDATIONS The tale of the Pearl City: Section 18(1), phased works and expert evidence

Henry Mahalski

Henry is a principal associate within the property disputes team at Mills & Reeve. He works with both private and public sector clients, dealing with landlord and tenant disputes and other property related issues.

Henry presented at ACES North West Branch’s CPD Day and kindly agreed to give a detailed explanation of disrepair and dilapidation claims at lease end, by way of this article, using the High Court’s decision for one recent case, explained below. 

The High Court’s decision in Peachside Ltd v Lee and Keung is a significant modern authority on dilapidations, offering a detailed application of section 18(1) of the Landlord and Tenant Act 1927. While it does not establish new law, it is particularly valuable for its practical treatment of (i) the statutory cap under section 18(1), (ii) the landlord’s phased works strategy in “escaping” the tenant’s s18 defence, and (iii) the decisive role of expert evidence in determining quantum.

Background

The claim arose out of a commercial lease of restaurant premises in Manchester’ Chinatown, known as the Pearl City. At lease expiry in March 2021, the landlord alleged (and the tenant did not dispute) that the tenant had left the property in a severe state of disrepair, having effectively only removed their chattels and carried out no repairs as required by the lease. The judge memorably described the property as a “warzone with grease.” This firm wanted to M&R fact check the judge’s findings here and a deep dive online revealed a 2017 Google Review commending five stars and enthusing that there was “nowhere batter in the Chinese Quarter after midnight”…

The landlord sought substantial damages, asserting that extensive works were required to remedy breaches of the repairing covenant. The tenants resisted the claim on familiar grounds:

• That the claim exceeded the section 18(1) diminution cap (“first limb”); and

• That the landlord intended redevelopment such that repairs would be rendered valueless (supersession) (“second limb”).

Understanding and utilising both limbs of s18 is essential in identifying a landlord’s true claim for damages, and avoiding an overly slavish kowtowing to the schedule of dilapidations or Scott Schedule negotiated by the landlord and tenant’s respective surveyors following lease termination. Section 18(1) imposes a dual restriction, often described as the first limb and second limb of s18, on a landlord’s claim for damages for breach of repairing covenants. What made the case notable was that both limbs of section 18(1) were fully engaged and considered by the court and secondly how the landlord escaped the tenant’s s18 defence via a two phased works programme.

The first limb of s18 – diminution in value

Under the first limb, damages are capped at the reduction in value of the landlord’s reversion caused by the disrepair. This is assessed objectively by comparing:

• The value of the property in its actual condition; and

• Its hypothetical value if it had been in repair at lease expiry.

This first limb is an important statutory defence for tenants seeking to reduce a potential dilapidations claim and serves as a key caveat to the landlord’s schedule of dilapidations, which simply identifies the landlord’s asserted costs for carrying out the works required to comply with the tenant’s yield up obligations. The courts have identified that the costs of the works are evidence of loss, but not the correct measure of loss, an important distinction. Effectively, if it would not be reasonable for a landlord to carry out the works identified in the Scott Schedule, given the limited financial improvement to the landlord’s reversionary interest by carrying out those works, then those works should be discounted.

The second limb of s18 – supersession

Damages are irrecoverable where the landlord intends to carry out works (such as demolition, structural alterations or improvements) that would make the repairs valueless. Importantly for the second limb to be engaged, the landlord must intend to carry out the works, irrespective of the state of repair of the premises as left by the tenant. For older units or units which require modernisation, to comply with Minimum Energy Efficiency Standards regulations, this second limb can be an important defence where it can be shown that the landlord would carry out the relevant works, irrespective of the state of the premises as left by the tenant on lease expiry.

In Peachside, the court had to grapple with both limbs simultaneously. The first limb required a valuation exercise grounded in expert evidence, and the second limb required investigation of the landlord’s actual intentions regarding redevelopment, and was heavily influenced by evidence of fact provided by the landlord.

The two phases of the landlord’s works

A central factual and legal issue was the landlord’s decision to carry out works in two distinct phases. A key issue of contention between the parties was whether the landlord always intended to carry out the works in both phases, or only intended to carry out the second phase if the landlord did not obtain a letting after carrying out the first phase of works. This is important, as the second limb is only engaged where the relevant works of “supersession” are to be completed on lease expiry or shortly after lease expiry.

Phase 1: Repair and reinstatement 

The first phase involved stripping out the premises to a shell and carrying out repairs to remedy the disrepair required under the terms of the lease and returning the property to a basic shell in a lettable condition. This phase aligned closely with the landlord’s dilapidations claim, as set out in the Scott Schedule, as it corresponded to the works required to remedy breaches of covenant.

Phase 2: Redevelopment and conversion

The second phase was more ambitious and included:

• Conversion of the property for office use in a manner whereby it would be effectively ready to let to a prospective tenant; and

• Installation of structural changes including a new passenger lift serving the premises using additional premises on the ground floor which were also owned by the landlord, but were let at the time of the Phase 1 works. When the Phase 2 works would be conducted, it was anticipated that these additional premises would be available to the landlord to install the ground floor lift.

The landlord and tenant’s arguments 

The tenants characterised the two-phase approach as an “elaborate charade”, arguing that the landlord always intended to carry out both phases of the works and had merely split the works to avoid the second limb of s18. If the landlord always intended to carry out Phase 2 of the works and convert the restaurant into lettable office space with improved access via the lift, then the repair works required by phase 1 would be superseded under the second limb of s18, and the landlord’s claim severely compromised. The tenant argued that the only reason the landlord was delaying the works was to allow time for the ground floor unit to become available, to allow them to install the new lift to the premises and improve the ground floor access.

The landlord however effectively pleaded poverty. They argued they wanted to spend the minimum required to achieve a letting and if the smaller Phase 1 works had been successful in achieving a letting, they would not have carried out the Phase 2 works.

The court’s approach

The judge carefully analysed whether the phases were:

• Sequential and conditional, or

• A disguised single redevelopment scheme.

Ultimately, the court accepted that Phase 1 works had a genuine standalone purpose (to enable reletting) and that the Phase 2 works were contingent and not inevitable at the term date. This finding was crucial. If redevelopment had been inevitable, the claim could have been defeated under the supersession principle. Instead, the landlord succeeded in recovering substantial damages.

The Importance of expert evidence

Perhaps the most instructive aspect of Peachside is the central role played by expert evidence. There was at the time of trial a significant conflict between the parties’ experts, especially on:

• The diminution in value of the property under the first limb of s18 (having found that the second limb did not apply); and 

• The impact of the Phase 1 and Phase 2 works on rental value and marketability.

The court ultimately preferred the landlord’s valuer, finding that the property, if repaired under the Phase 1 works, could achieve a reasonable office rental value and the landlord’s conditional two stage works were commercially rational, given the financial position of the landlord. 

The tenant’s expert faced criticism for straying outside his area of expertise (e.g. into building surveying issues); and appearing overly aligned and advocating their client’s case. As a result, the court preferred the expert evidence of the landlord.

This highlights a recurring judicial theme - expert independence and discipline are critical. An expert who becomes an advocate on behalf of his client risks losing credibility. The role of the expert is to present their expert opinion to the court and not argue legal or factual points before the court; that is the role of parties’ respective barristers.

Conclusion

Peachside v Lee and Keung is a valuable modern illustration of how courts approach section 18(1) in practice. Its detailed treatment of phased works and expert evidence underscores that dilapidations claims are rarely straightforward.

Above all, the case demonstrates that success depends not just on legal principle, but on credible evidence and persuasive expert analysis.