Compensation for tenants’ improvements

Compensation for tenants’ improvements

Most commercial leases restrict a tenant’s ability to alter or improve the premises. In most cases, this takes the form of a lease covenant prohibiting alterations to the premises’ exterior and structure. Conversely, internal, non-structural alterations are often permitted with the landlord’s express consent. However, leases also typically include an obligation on the tenant to reinstate the premises at the end of the term. In most cases, this is a pre-condition of the landlord granting permission for the alterations. Sometimes, tenants’ alterations enhance premises’ value and/or letting potential. In such cases, the law might allow compensation for tenants’ improvements.

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Landlord and Tenant Act 1927

Sections 1, 2 and 3 of the Landlord and Tenant Act 1927 (“the Act”) give a tenant who has improved the premises during their tenancy a right to compensation when the tenancy ends. Interestingly, this can even occur if the landlord did not consent to the improvements.

Whilst many pre-conditions must be satisfied before a tenant is entitled to compensation, the parties cannot contract out of this statutory right. However, certain improvements do not give rise to a claim for compensation, specifically:

• Tenant’s and trade fixtures in the premises, which the tenant is legally entitled to remove.
• Any improvements made under an obligation for which the tenant received valuable consideration.

Notice requirements

To claim compensation under the Act, before commencing the improvement work, a tenant must have served the landlord with:

• notice of their intention to carry out improvements, and
• a specification and plan showing the proposed improvements.

In addition, the notice must:

• refer to the tenant’s rights under the Act, and
• be sufficiently detailed to allow the landlord to assess the proposal and decide whether to carry them out themselves.

If the landlord does not respond to the notice within three months, the tenant can proceed with the improvements described.

Where the landlord objects to the proposed works, the court can either allow or prohibit the improvements on application.

If the court allows the improvements or the landlord does not reply within three months, the tenant has the same right to compensation as if the landlord had consented.

Where the landlord consents, the tenant can subsequently require the landlord to provide written confirmation that the work has been properly carried out in accordance with the Act.

What constitutes improvements?

Any alterations making the occupation of the premises more beneficial to the tenant constitute improvements under the Act.

If the tenant can demonstrate that:

• the works will add to the letting value of the property at the end of the tenancy, and
• are reasonable and suitable to the character of the property, and
• do not diminish the value of any other property belonging to the landlord (or a superior landlord),

then the landlord cannot apply contractual restrictions in the lease to prevent the tenant from carrying out the works. That applies even if, in the absence of the Act, the landlord refusing consent would not be unreasonable.

Time limits for a compensation claim

There are time limits within which a tenant must bring their claim for compensation:

Where the tenancy ends by notice to quit by either party, the claim must be made within three months of the notice date.

Where the tenancy period expires, the claim must be made not earlier than six nor later than three months before the tenancy ends.

It’s a matter of some debate whether the right to compensation carries over to the new tenancy following the lease renewal.

Compensation for tenants’ improvements: how much?

The maximum amount of compensation payable to the tenant is the lesser of:

• the net addition to the value of the holding (as a whole) directly resulting from the improvements; and
• the reasonable cost of carrying out the improvement works at the tenancy’s termination.

The landlord’s intentions after the tenancy’s termination are relevant in relation to the first of these. If they intend to demolish the property, change its use, or make structural alterations, this is taken into account when deciding what additional value is attributable to the improvement. Of course, there may be none.

Compensation for tenants’ improvements: comment

In practice, it’s rare for tenants to take the steps required by the Act when carrying out improvements. Nevertheless, landlords acquiring leasehold property should identify any works potentially qualifying for compensation and check for service of the relevant notice. Without notice, the tenant cannot bring a compensation claim.