England and Wales Court of Appeal (Civil Division) Decisions

IN THE COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT QUEENS BENCH DIVISION, TECHNOLOGY & CONSTRUCTION COURT
MR JUSTICE EDWARDS-STUART
HT11432

		Royal Courts of Justice Strand, London, WC2A 2LL
		17 December 2013

Lord Justice Lewison:

1. At common law the measure of damages recoverable by a landlord at the end of the lease for breaches by the tenant of his repairing obligations is the cost of the repairs that the tenant should have carried out, plus loss of rent during the period needed to carry out those works. However, the common law measure of damages is capped by section 18 of the Landlord and Tenant Act 1927 which limits damages to the diminution in value of the landlord's reversion caused by the breaches. The conventional way of calculating that diminution is by valuing the reversion in the state in which it actually was at the end of the lease and comparing that value with the value of the reversion in the state in which it should have been at the end of the lease. The difference between the two values is the diminution in value of the reversion.
2. In our case the tenant (Tiger) left the premises, which were offices in Soho Square, in very poor condition, despite having had a lease containing comprehensive repairing obligations. After the tenant had vacated the property in November 2008 the landlord (Sunlife) carried out extensive work in order to relet it; and then sued the tenant to recover the cost of those works.
3. Edwards-Stuart J, in a meticulous judgment, assessed the common law measure of damages at £1,353,254. There is no appeal against that finding, which therefore represents the starting point. He also found that the value of the reversion in its actual condition at the end of the lease was £4,462,000. There is no appeal against that either. The third component was the value of the reversion in the condition in which it ought to have been. The judge assessed that at £5,870,000. The outcome of these figures was that the diminution in value exceeded the cost of the necessary works, with the result that the statutory cap did not apply. Accordingly, the judge awarded the landlord the cost of the necessary works, plus various incidental items. It is the judge's assessment of the value of the reversion in the condition in which it ought to have been against which the tenant appeals. The judge's judgment is at [2103] EWHC 463 (TCC), [2013] 2 P & CR 55. Mr Mark Wonnacott QC presented the tenant's appeal, and Mr Martin Hutchings QC presented the landlord's response. For the reasons that follow I would dismiss the appeal.
4. The details of the landlord's claim and the tenant's responses to them were set out in a Scott Schedule. The judge described at [89] how the Scott Schedule was compiled. The important point to note at this stage is that it began by setting out the work that the landlord had actually carried out after the end of the lease, and which it alleged the tenant should have carried out in order to comply with its covenants. Some items were in dispute as to the extent of the work or the amount of the item. Some were in dispute as to liability.
5. The fact that there is no challenge to the judge's assessment of the measure of damages at common law is critical to an understanding of the issues. As Mr Wonnacott rightly said the common law measure of damages was established by the decision of this court in Joyner v Weeks [1891] 2 QB 31. Lord Esher MR formulated it thus:

"That rule is that, when there is a lease with a covenant to leave the premises in repair at the end of the term, and such covenant is broken, the lessee must pay what the lessor proves to be a reasonable and proper amount for putting the premises into the state of repair in which they ought to have been left."

6. Fry LJ agreed, approving the earlier judgment of Denman J in Morgan v Hardy (1886) 17 QBD 770, who in turn approved the statement in Mayne on Damages:

"Where the action is brought upon the covenant to repair at the end of the term, the damages are such a sum as will put the premises into the state of repair in which the tenant was bound to leave them."

7. Thus, in assessing the common law measure of damages the judge was required to find the sum that would have put the premises into the condition in which the tenant ought to have left them. The judge fully appreciated the nature of this task. At [38] he identified the three key issues, which were:

"First, what was the scope of Tiger's obligations under the covenants in the two leases? Second, what is the reasonable cost of putting the building back into the condition in which it should have been if there had been sufficient performance by Tiger of those obligations? Third, Tiger having failed to make sufficient performance of its obligations under the leases, what is the difference between the value of the building in its actual condition at the expiry of the leases and the condition that it should have been in if there had been sufficient performance by Tiger of its obligations? For the purpose of these last two questions, the tenant's obligation is to put and keep the premises in such repair as, having regard to the age, character, and locality of the building, would make it reasonably fit for the occupation of a tenant of the class who would be likely to take it: see Proudfoot v Hart (1890) 25 QBD 42. For shorthand, in the rest of this judgment I shall refer to this hypothetical tenant as the "appropriate type of tenant"."

8. I did not understand Mr Wonnacott to challenge the accuracy of that self-direction. The judge repeated, in several places, the nature of the task that he had to perform in order to answer the second question. Thus at [41] he said that:

"…the court must consider what work would have been required at the expiry of the lease in order to put the premises (if properly maintained and put in good condition by the tenant) into a condition that would enable it to be let to the appropriate type of tenant at a fair market rent. This may have two consequences. First, the landlord cannot recover the cost of that additional work from the tenant. Second, the additional work may make worthless some of the work that would have been necessary to put the building into repair with the result that, if such work has not been done, the landlord has suffered no loss and accordingly cannot recover any damages in respect of that breach. This is known as "supersession"."

9. At [43] he said that:

"It follows, therefore, that if the cost actually incurred by the landlord in seeking to put the building back into the condition in which it should have been left by the tenant is greater than the cost of other work which would be sufficient to put the building into that condition, then the landlord is limited to recovering the costs of the latter."

10. At [45] he said:

"… the appropriate test is not whether the landlord has acted reasonably in carrying out remedial works, but rather whether what the landlord has done by way of repair goes no further than was necessary to make good the tenant's breaches of covenant."

11. In all these statements the judge was firmly focussing on what works were necessary to put the building into the condition in which the tenant ought to have left it.
12. The judge carried out the task identified by the second of the two issues with conspicuous care. A few examples will suffice. One of the items in dispute was a lead mansard roof which the landlord had replaced. The tenant's expert accepted that if the roof had crazed to the point of cracking, it would have had to be replaced. The judge found that it had "cracked in places to an extent that justifies total replacement": [100]. Thus replacement of the lead was something that the tenant was required to have done. Another disputed item was the cost of replacing boilers. The tenant's case was that they could have been repaired or reconditioned. The judge concluded at [139]:

"Taking the evidence as a whole I am satisfied that the boilers were not in the condition required by the leases when Tiger moved out. On balance, I conclude that given the uncertainty about the condition of the boilers the appropriate course was to replace them. I consider that Tiger's standards of maintenance were so poor that it could not be safely assumed in their favour that the boilers were in good working order."

13. On the other hand, when considering the basement toilets the judge concluded that the landlord had carried out works that went beyond that which the tenant could have been obliged to do. He therefore assessed the damages for that item at 50 per cent of what the landlord had actually spent: [121]. A further disputed item was the façade. The judge found that even if the tenant had left it in good repair, the landlord would have re-rendered the façade to make the building more attractive. He therefore disallowed the bulk of the landlord's claim for this item: [104].
14. He found that with some exceptions the work that the landlord had actually carried out was either work that the tenant ought to have carried out in order to comply with its covenants; or was cheaper work that the landlord had carried out by way of mitigation of its loss. There is no challenge to any of the judge's findings in that respect. The end result of the judge's careful examination of all the items in the Scott Schedule was that he came to the sum of £1,353,254. This represented what the judge considered was the cost of putting the building back into the condition in which it should have been left by the tenant, plus some additional incidental items. That, as he said, would be the measure of damages unless it exceeded the statutory cap.
15. One issue arose in the course of the appeal about the burden of proof in relation to the statutory cap. Mr Wonnacott submitted that in a case in which the landlord does work that differs from the work that the tenant could have been compelled to do in order to comply with its covenants, the burden of establishing that the statutory cap did not apply lay on the landlord. He relied in this connection on the decision of HH Judge Baker QC in Mather v Barclays Bank plc [1987] 2 EGLR 254. That was a case in which a banking hall had been substantially remodelled to suit the needs of an incoming tenant: the Halifax. The modifications included the relocation of lifts, the installation of part central heating and part air conditioning, the rearrangement and upgrading of toilets and so on. As Judge Baker put it "the whole place was stripped out"; and he found that there was no way of telling what would have happened if the tenant had left the premises in good repair. It was in that context that Judge Baker said:

"At this point, I should perhaps notice the submission of Mr Berry as to onus of proof. He said that once the landlords had established a diminution in value, the onus shifted to the tenant to show that the diminution was less than the cost of the repairs. He referred me to a number of cases on this, of which Jones v Herxheimer [1950] 2 KB 106 was the latest. This is a case where the landlord had to do some repairs to relet the premises. They were, I think, quite modest repairs. But, again, there was no question there of improvements to the premises. The Court of Appeal were concerned to dispose of a submission that in every case there had to be evidence of values of the reversion, such as I have got here. You cannot start off just by saying this is the cost of the repairs, ergo that is the cost of diminution of the reversion. That had been suggested in the earlier case that I mentioned, Landeau v Marchbank, by Lynskey J, but that idea was exploded in the Court of Appeal. They held that there are cases where the cost of repairs does afford prima facie evidence of the diminution in value, and those cases are where the premises are going to remain the same but where the landlord is going to do the repairs or have them done. In that case, he had in fact done them.

Therefore, one can quite see in that sort of situation that once the landlord has proved those facts, the burden should shift to the tenant then to show that the reversion has not been diminished at all by the repairs because he has done repairs that were totally unnecessary or something of that sort and they have not added to the value of the reversion at all. In that situation one would expect the tenant to have the burden of showing that that was so. But I cannot apply it to the situation here where the premises are inevitably going to be improved, and substantial works, costing well over twice what the repairs are going to cost, are going to be carried out by the Halifax. There is no onus in those circumstances on the tenant, once the landlord has shown that some allowance has been made to the tenant, even though it has been structured in a form attributing the rent allowance to the want of repairs. It has not been proved that any diminution in the value of the reversion is attributable to the allowance for the repairs."

16. The key to Judge Baker's reasoning is, in my judgment, his appreciation that he was dealing with a case in which "the premises are inevitably going to be improved." That is not our case because, on the judge's findings in our case, if the tenant had left the building in the state in which it ought to have been left, the landlord would not have carried out the works that it did; see [36] and [47]. In addition, as I have said, the judge's finding was that the work that the landlord in fact carried out was, with some exceptions, the work that the tenant ought to have carried out in order to put the building into the condition in which it ought to have been handed back. Thus, in my judgment, the judge was correct in concluding at [214]:

"… I consider that the amount of the diminution in value is to be inferred from the costs of the repairs reasonably necessary to make good the loss caused by Tiger's breaches of covenant, there being no satisfactory evidence that it is any lower amount."

17. That is sufficient to dispose of the appeal, but the main focus of the argument related to the valuation exercise. In deference to the careful arguments I must deal with that question.
18. Based on the Scott Schedule (and of course before the judge had made any factual findings) each side instructed a valuer: Mr Paul Krendel FRICS for the landlord and Mr Andrew Smith MRICS for the tenant. Each expert produced a report and a joint statement in which they attempted to distil the points on which they agreed and disagreed. That statement contained four valuations. The first two related to the actual condition of the building and need not concern us. Valuations (iii) and (iv) concerned the hypothetical state of the building; that is to say the value of the building in the state in which the tenant ought to have left it. The basis of valuation (iii) was that on 14 November 2008 (when the lease came to an end):

"… the works in the "REMEDIAL WORKS REQUIRED/UNDERTAKEN" column of the Scott Schedule had already been done."

19. On that basis Mr Krendel's valuation was £6,559,300; and Mr Smith's was £6,465,000. It is important to note that the basis of valuation was agreed between the valuers. It took as its starting point the assumption that the works that the landlord in fact carried out after the lease had ended had been carried out before it had ended. The underlying premise was that the work that the landlord had carried out was work that the tenant should have carried out in order to comply with its covenants. The valuers also agreed that on that hypothesis an incoming purchaser or tenant would not have carried out any further work of great significance. The underlying premise in fact tallied, for the most part, with the judge's findings.
20. In his first report Mr Krendel expanded on his reasoning. He said at paragraph 5.3.7:

"The Premises are to be valued in repair on the basis that what was originally demised was delivered up in the condition required under the Lease. Accordingly, I have valued the premises in repair with the benefit of an air conditioning system in accordance with what was originally installed, solid floors with perimeter power points, 2 automatic passenger lifts, double glazed aluminium framed windows, carpets, mineral tile suspended ceilings and recessed fluorescent lights. In certain cases, either due to replacement being required, or the disrepair allowing for replacement with credit to be given for betterment (such as the windows) the premises have been improved, but I do not consider that any of the works undertaken are improvements which have added to the letting or capital value of the Premises or caused any supersession in relation to the Defendant's repairing liabilities."

21. His conclusion was that:

"… the Premises, if left in a good state of repair would have been entirely appropriate for its location. It would be in terms of specification and rental levels what tenants in this area would have been looking for in the open market in late November 2008."

22. He amplified that conclusion in later parts of his report. In essence the judge accepted his evidence; and indeed it was ultimately common ground that if left in good repair, the property could have been relet without the need to carry out further works of any significance.
23. The basis of valuation (iv) was that on 14 November 2008:

"… only those works in the "APPROPRIATE REMEDY" column of the Scott Schedule had already been done."

24. On that basis Mr Krendel's valuation was £4,885,000 and Mr Smith's was £4,659,000. In this case, however, the basis of valuation was not agreed. It is, however, important to understand what the disagreement was. The tenant's primary case at trial was that performance of the relevant covenants would have left the building in a state in which it was unlettable, with the consequence that any incoming purchaser would have ripped out much of the repair work that the tenant ought to have carried out. Mr Smith's valuation (iv) therefore proceeded by taking the capital value of the building following refurbishment, deferring that value for the period needed to carry out the refurbishment and then deducting the cost of works that the incoming purchaser would need to carry out plus a developer's profit on those costs. The deferment factor reduced the capital value of the completed building by just over 12 per cent, and the developer's profit on the cost of the works was 20 per cent. He explained his methodology in section 15 of his expert report. Mr Smith's valuation was, therefore, what is referred to as a residual valuation. This kind of valuation takes the finished product as its starting point and then deducts the time cost and money cost of getting there. It assumes that what a purchaser will pay is the surplus after he has met out of the proceeds of sale of the finished building his costs of construction, his costs of purchase, the time and money cost of finance, and an allowance for profit. What is left is the residual value. The essential point about a residual valuation is that the less the purchaser has to spend in achieving the end product, the greater will be the surplus and hence the greater will be the residual value. Thus the more the tenant ought to have done, the less is left for the incoming purchaser to do. Since the residual value is heavily dependent on the accuracy of the estimated deductions, a change in those deductions will change the residual value. That is one reason why residual valuations are not favoured where more reliable valuation methods exist. The tenant's case encapsulated in valuation (iv) was that the incoming purchaser would have had to spend £2 million or thereabouts because the building would have been unlettable if left in a state that complied with the tenant's covenants. But the tenant's case in that respect was abandoned by the end of the trial.
25. There was some debate about the way in which Mr Krendel produced his equivalent valuation (iv). It is fair to say that his workings were not entirely clear. This may have resulted from a misunderstanding on his part of what assumptions Mr Smith's valuation (iv) entailed. Mr Krendel said in his third report that his valuation (iv) was based on the building being "still in its 1973/4 state", which is what he understood to have been the basis of Mr Smith's valuation (iv). He understood that he was required to proceed on the assumption that a purchaser of the building would have had to spend a large sum of money (which he took as £1.3 million) in order to make the building lettable. But he protested that he did not agree with that assumption.
26. In the event, Mr Smith was not called to give evidence. Mr Krendel was, and he was cross-examined. Mr Wonnacott relied strongly on two passages in that cross-examination. The first was this:

"Q. … What you are saying is that if we did all the works that we say ought to have been done, you could have let it for £511,500 per annum?

A. That's my estimate.

Q. Yes, I understand. And that is lower than your estimate of what it could have been let for if the £1.7 million of works were to be done?

A. Yes."

27. The second was this:

"Q. … Just to be clear, you are saying I think that if we had done all of our works before the lease end then the property in that condition would have fetched £4.85 million pounds?

A. £4.88."

28. Based on those passages Mr Wonnacott argued that Mr Krendel had accepted that the building, in the state in which the tenant should have left it, would have commanded a price of £4.88 million. It therefore followed that the diminution in value of the reversion was the difference between that sum and the value of the property in its actual condition. That difference would have been of the order of £420,000 instead of the £1.35 million that the judge awarded. However, that argument, in my judgment mis-states the assumptions that Mr Krendel made in coming to his valuation figure. The underlying assumption was that the valuation had to take into account the further assumption that a considerable quantity of further works needed to be carried out in order to make the building lettable. It was that assumption that Mr Krendel challenged. That he had in fact made that assumption for the purposes of valuation (iv) is clear from other parts of his cross-examination. Thus he said that the assumption that he made was in an e-mail to the landlord's solicitors. It is that e-mail which explains that he had assumed that a further £1.3 million of works would be necessary. But he was cut off in his explanation by the terse comment from Mr Wonnacott that assumptions were a matter for the judge. Later on Mr Krendel explained that his figure was a "comparative valuation" because he had been asked to put his figures on Mr Smith's valuation (iv). Mr Smith's valuation (iv) assumed that some £2 million of work would be needed to make the building lettable, so Mr Krendel worked on a similar basis. As he explained:

"I've applied a cost of works of just over £1.3 million as compared to his £2.02 million…. So the whole stance of this valuation is that you go further, not because you have to, but because you need to to be able to achieve a letting of the building."

29. Now, whether Mr Krendel was right or wrong in his understanding (and although the judge's next intervention on the transcript suggested that he thought that Mr Krendel might have been wrong in his understanding, personally I think that he was right) it was unquestionably what Mr Krendel thought valuation (iv) was meant to do.
30. In his judgment the judge said at [206]:

"In fact, valuation (iv) does not simply represent the value of the premises in repair to 1973/74 standards: it has built in to it the assumption that this state of repair can be or could have been achieved by the expenditure identified by Tiger. This is not the case."

31. This was a finding of fact that the work identified by the tenant which formed the basis for valuation (iv) would not have amounted to compliance with the covenants.
32. The judge continued at [207]:

"A difficulty with any consideration of Mr Krendel's valuation (iv) is that no breakdown of the calculation has been provided to the court, and neither side is willing to ask for one. However, there are three things that can be said about Mr Krendel's valuation (iv). First, Mr Krendel did not agree with (and, so far as one can tell, probably did not adopt) Tiger's approach to supersession as set out in Mr Smith's valuation (iv). Second, Mr Krendel took Tiger's figures as set out in the Scott Schedule (as the basis of the valuation required him to do). Third, Mr Krendel did not agree with the approach involved in valuation (iv) for the reason recorded in the experts' joint statement…"

33. The point about supersession is that Mr Krendel did not agree that a further £2 million (or, for that matter, £1.3 million) worth of works would have needed to have been carried out if the building had been left in a condition that complied with the lease. The judge also said, correctly, that Mr Krendel's valuation (iv) took the tenant's figures set out in the Scott Schedule, because the valuation required him to. Having considered the difficulties the judge said at [210]:

"In the absence of the calculations supporting Mr Krendel's valuation (iv), the court is not in a position to adjust it in order to reflect the court's assessment of the cost of the work that was necessary to remedy Tiger's breaches of covenant."

34. The judge described what he did at [212]:

"Although Mr Smith's valuation (iv) has not been proved in evidence, it has been referred to extensively and, as a calculation, it is before the court. It is reasonably clear and the working is self-evident and, so far as the methodology is concerned, much of it is uncontroversial. Mr Smith's figure for valuation (iv) of £4.659 million was slightly lower than Mr Krendel's figure for valuation (iv) of £4.885 million. It seems fair to assume, therefore, that if I adopt Mr Smith's methodology but substitute the figures that I have found to be the cost of the work that represents Sunlife's loss as a result of Tiger's failure to comply with its covenants, I will arrive at an "in repair" valuation that is a fair reflection of the material before the court and my findings."

35. Mr Wonnacott QC, on behalf of the tenant, made two broad criticisms of the judge's approach. First, he said that since Mr Smith was not called to give evidence the judge should not have used his valuation as the template for his calculation. Second, he said that the tenant accepted Mr Krendel's valuation (iv) and, having done so, the judge should simply have adopted it without more.
36. The tenant's decision not to call Mr Smith to give evidence did not make his report (or his valuations) disappear into thin air. On the contrary, CPR Part 35.11 says:

"Where a party has disclosed an expert's report, any party may use that expert's report as evidence at the trial."

37. If a party can use the report as evidence, I can see no objection to the judge doing so. I think that Mr Wonnacott in fact accepted that in so far as the judge was using Mr Smith's valuation as a template (having described its methodology as uncontroversial) he was entitled to do so.
38. Mr Wonnacott's second objection was that the judge ought to have stopped at paragraph [210]. If he could not make adjustments to Mr Krendel's valuation he should simply have accepted Mr Krendel's headline figure. I reject that submission. Mr Krendel had valued on a basis that required him to make an assumption that he thought was wrong. The judge agreed with him that the assumption was wrong. In those circumstances it would have been quite inappropriate to have simply taken a headline valuation figure made on an erroneous assumption.
39. I have explained that valuation (iv) was a residual valuation. The eventual output is thus heavily dependent on the inputs. Although both Mr Krendel and Mr Smith were valuation experts, they were not experts in building costs or repairing liabilities, which were dealt with by other experts and the judge respectively. Each of them acknowledged this in the preparation of their reports. Accordingly, having made his findings the judge was fully entitled to adjust Mr Krendel's valuation (iv) or Mr Smith's valuation (iv) in order to insert the correct inputs for the cost of works. That is what he did, and in my judgment, he cannot be faulted for having done so.
40. I would dismiss the appeal.

Lord Justice Floyd:

41. I agree.

Lord Justice Longmore:

42. I also agree.