Some statutory provisions are not as well understood as they should be. Property practitioners are likely to be familiar with section 19 of the Landlord and Tenant Act 1927 (LTA 1927), which implies into qualified covenants against the making of improvements to leasehold premises an obligation on the landlord not to withhold consent to such alterations unreasonably. This provision is not without authorities considering what amounts to unreasonably withholding consent, although admittedly fewer than the extensive canon of case law considering the related issue of consent to assigning or subletting under the Landlord and Tenant Act 1988. By contrast, there has been very little judicial consideration of the circumstances in which a tenant is entitled to compensation from its landlord for improvements carried out at the tenant’s expense.
A Trap for the Unwary
Why does this matter? The answer is because the LTA 1927 contains a mechanism which entitles a tenant to seek such compensation in certain circumstances, and that mechanism involves the service of notice and counter-notice; and that should always set alarm bells ringing. Anything involving the service of notices is a trap for the unwary.
So here, in a nutshell, is how it works: if a tenant proposes to carry out any works of improvement to business premises, it may serve on the landlord notice of such intention, together with a specification and plan of the proposed works, and the landlord has three months in which to object (section 3(1), LTA 1927). If no objection is received, the tenant is entitled to go ahead and carry out the works.
Even if the landlord does object, the tenant can apply to the First-tier Tribunal (Property Chamber) for permission to do the work, which the Tribunal will grant for any work which will add to the letting value of the holding, is “reasonable and suitable to the character thereof”, and which will not diminish the value of any other property of the landlord. This is notwithstanding any express prohibition in the lease against the carrying out of such work, although the landlord can avoid the tenant acquiring the right to carry out the works by agreeing to carry them out itself, in return for a suitable increase in the rent, which sounds like cold comfort.
And of course, to add insult to injury, section 1 of the LTA 1927 obliges the landlord, at the end of the term, to compensate the tenant for the cost of carrying out work which it may well not have wanted done in the first place.
This entitlement to compensation is subject to a number of important exceptions, (which probably explains why it is not as well-known as it should be) but it remains a potentially powerful tool for a tenant.
Firstly, it only applies where the tenant of an applicable holding – which is to say one which is used for carrying on a trade or business – has served notice under section 3 and either received no counter-notice from the landlord, or obtained permission from the Tribunal, notwithstanding the landlord’s objection. It then must have carried out the works of improvement in accordance with the plans submitted and obtained a certificate to that effect from the landlord, which will either have been given voluntarily or, again, at the compulsion of the Tribunal (section 3(5), LTA 1927).
Secondly, no compensation is payable for tenant’s fixtures or, importantly, for any works of improvement which the tenant was contractually obliged to carry out. So building leases are excluded, although the term ‘building lease’ is not defined by the LTA 1927.
The real issue arises in the case of a lease or agreement for lease which provides permission for the tenant to carry out certain works to the demised premises (for example where such permission is conditional upon a successful planning application), but not an obligation to do so.
In that case, the landlord would be in difficulty objecting to a notice served by the tenant under section 3 because the existing licence to carry out the work, subject to planning, would tend to suggest that the works added to the letting value of the premises and were both reasonable and “suitable to [its] character”. Landlords in such a situation are often perfectly content for their tenants to carry out works to business premises – at their own option and expense – to make them more commercially attractive, but would baulk at the suggestion that they should foot the bill for those works at the end of the term. The problem does not arise where leases contain a covenant on the part of the tenant to restore the premises to their original condition prior to the end of the term (because in that case there are no longer any improvements giving rise to the right to compensation), but not all leases contain such a provision, and in agreements for lease which provide for the tenant to carry out extensive work of construction, they are rare.
Such agreements are akin to building leases but are not excluded from the compensation scheme under the LTA 1927 because the provision for carrying out work is permissive rather than mandatory.
In such cases, practitioners acting for prospective landlords should be alive to the risk that the tenant could serve notice under section 3 prior to carrying out the permitted work, which would present the landlord with a stark choice: either take on the work itself or face a bill for improvements at the end of the term. Conversely, practitioners acting for prospective tenants need to remember to serve notice under section 3 before any works of improvement are carried out, otherwise a potentially valuable right to compensation could be lost forever.
This article was first published in Thomson Reuters Practical Law Property Litigation Column.