Plan vanilla diminution
Diminution: a plain vanilla case explained by Peter Beckett and Terry Davis
How a diminution valuation works in an imaginary claim with only one effective difference between the parties
Check the attachments (the two-digit number in the footer is a version number. When we get the inevitable corrections, we’ll add a 1 and produce a new series)
|2||Contractual Claim and shortcut valuation||1|
|In a real-world case, of course, there would also be:|
|6||The Scott Schedule||n|
but, to simplify, not here. You’ll have to trust us when we say that Exhibit 2 faithfully summarises all you need to know about the detailed claim.
In order to make this “plain vanilla” exposition as simple as possible, a lot of the complicating detail of real-world cases has been removed:
- The claim relates to a small office building in a viable office location. The lease came to an end on 25 March 2013.
- The claim is in relation to covenants for repair only, and is therefore capped by “limb 1” of s18(1) of the Landlord and Tenant Act 1927. (What we mean by the expression “The Contractual Claim” below (and on the attachments) is the claim the Landlord would have under the terms of the Lease were there no s18(1)).
- The tenant had a standard full repairing and insuring (“FRI”) lease of the whole.
- The landlord now has the freehold in possession.
- Peter (Beckett) acts for the Landlord; Terry (Davis) acts for the Tenant.
- The parties have agreed everything except two things – an unheard of situation in the real world, but that’s what we assume. The differences relate to: the new ceiling that was going to be put in once the lease expired; and time losses (in the Contractual Claim only).
You can follow how the differences feed through into the valuation by following the yellow highlighting on:
|2||Contractual Claim and shortcut valuation|
|4||Landlord’s valuation||2 and 3*|
|5||Tenant’s valuation||2 and 3*|
* There are other differences on Page 3, but these are all merely mathematical consequences of the two highlighted differences. Also, ignore the pink highlighting for now.
Notice that the difference on time losses in the Contractual Claim disappears on assessment of the diminution in value, so the only effective difference between the parties is the ceiling.
Easiest to start at the top level and drill down:
Exhibit 1: Final positions
At the simplest possible level, Exhibit 1 tells us that the two valuers disagree and that diminution in value, in classic valuers’ fashion, is:
Essentially suspended ceiling
There’s your answer: if you’re bored, or you don’t want to know how we got there, that’s it! It’ll be for the Court to say who’s right.
If you’re slightly less bored, you can see from the full table on this Exhibit that, although the Contractual Claim is £510,000-ish or £300,000-ish, depending on who you believe, the loss to the landlord is some £235,000 or £180,000, again depending whose side you prefer. A few other interesting points, even without drilling down into the detail:
- The “Shortcut valuation” gives a fair approximation of the full diminution.
- There’s “Essentially” no difference between the parties at either valuation level, except in relation to the ceiling.
- The difference between the parties shrinks when valuation comes in (although it may not always do), even using the “Shortcut” method.
- The difference between the parties shrinks further when the full diminution valuation is calculated (although it may not always do).
- The claim is the lowest of the three measures: Contractual Claim, shortcut valuation and full diminution valuation.
Now, for those who are not yet bored – indeed are eager to understand how we got there:
Exhibit 2: Summary of Scott Schedule and shortcut valuation
This one-page exhibit tells you what is and isn’t agreed.
What is agreed at the Contractual Claim level
Everything is agreed at the Contractual Claim level, except the Landlord thinks he is entitled to claim time losses at this level, notably loss of rent. So the breaches, their remedy, and the costing of that remedy, are all agreed. (Ever heard of that happening?)
What is agreed at the valuation level (supersession)
Everything is agreed at the valuation level too, except in relation to the ceiling.
The valuers have agreed that the contractual obligation to repair the WCs and the reception area is superseded. The landlord and any likely buyer of the freehold would have wanted to upgrade those parts of the building even if they had been in fully covenanted order. Note in passing that covenanted order is the right perspective on supersession: if the tenant had done what he covenanted to do, would it have made any difference? If the answer is “no”, the item is fully superseded.
The resulting supersession is most easily seen by looking at the “Contractor’s costs” line, Landlord’s “Dilution/supersession” column. Both sides accept that £30,000 (£36,000, once we add contractor’s preliminaries, overheads and profit) of the Contractual Claim is superseded, and the Landlord can’t claim it.
What isn’t agreed at the Contractual Claim level
There’s only one thing: time losses. These disappear when valuation comes in anyway but, for the record:
- The Landlord says it would take time, once the lease ended, to prepare for and execute the agreed works, and he should be compensated for the resulting loss of time.
- The Tenant says the Landlord didn’t have a new prospective tenant standing by, so he can’t claim this.
What isn’t agreed at the valuation level (supersession)
This is the shortcut approach to the Landlord’s loss. The only effective disagreement between the parties relates to the new suspended ceiling the Landlord has put in since the lease ended:
- The Landlord says the old ceiling was in such disrepair that he was forced to repair it. The only practical and/or economic way of doing that was to replace it.
- The Tenant agrees it was in substantial disrepair, but it was an old-fashioned fibreboard ceiling in a crude, exposed 1,200 x 600 grid unsuited to the modern LG7 standard of lighting. The Landlord has replaced it with a metal tiled ceiling in a modern, hidden 600 x 600 grid, well suited to LG7, and he would have done this even if the Tenant had returned the old ceiling to him in covenanted order. The contractual obligation to repair that ceiling is therefore superseded.
The disputed supersession is most easily seen by looking at the “Contractor’s costs line, Tenant’s “Dilution/supersession” column. Both sides accept that the value of this point is the cost of repairing or replacing the ceiling: £45,000 before we add contractor’s preliminaries, overheads and profit. The differences between the parties from that point onward are consequential – the absolute numbers depend on the difference over the ceiling, but the percentages to be applied to any given level of cost are agreed.
Everything you see on this one-page exhibit (down to the “TOTAL Scott Schedule” line) will feed into the formal, fully-worked diminution valuations.
Exhibit 3: Valuation summary
So it’s a comfort to see that the valuers have agreed almost everything:
What is agreed
Pass over the “Other works” and “resultant supersession” columns. Almost unheard of this – but the valuers have agreed floor area! They have also agreed: ERV (estimated rental value) of the finished product; and yield (the return an investor would want to buy in that ERV). They agree all the “Constant factors in the valuations” and even, apart from the disputed ceilings, the scope of “Other works” – the works the wise Landlord will want to do, but which the Tenant (equally wise, no doubt) did not covenant to do.
Staggeringly, they sort of agree the value the building would have had had it been returned to the Landlord in covenanted order (Valuation A). They don’t actually agree the number, because of the difference over the ceiling as explained above. If the ceiling is the Landlord’s responsibility, not the Tenant’s (as the Tenant claims), then obviously the value of the building with those works not yet done will be a bit lower than if (as the Landlord claims), the tenant would have done them in compliance. However, the valuers for the two parties are professionals – not in the sense of saying “I’m a professional” on their CVs and at cocktail parties, but in the sense of helping each other, their clients and the courts, by agreeing what the position will be if they are wrong: in other words “if you’re right about the ceiling, even though I don’t think you are, then the figure is correct”.
What is not agreed
As already seen when looking at the shortcut method, just the new suspended ceiling and whether it did, or did not, supersede the Tenant’s obligations in relation to the ceiling.
Now, for those of you who are not even capable of boredom – yes, for you unfortunate souls:
Exhibits 4 and 5: the formal, fully-worked diminution valuations
These valuations consist of five pages:
|1||Diminution: Valuation A minus Valuation B|
|2||Valuation A: covenanted condition|
|3||Valuation B: actual condition|
Even those who have come this far have a boredom threshold somewhere, so you hardly need to look at pages 4 and 5. Page 4 is just to convince pedants like the two valuers in this case that the valuation is internally consistent. Page 5 (timings) is fully agreed.
If you look at the first line on page 1 of each of these exhibits, you’ll note first that the two Valuations A – valuations in compliance (or covenanted order) are pretty well agreed, and if you look at them in the “professional” sense suggested above, fully agreed – to the pound! You can see the full workings on page 2 of each valuation. Anyone who has ever done a development appraisal will recognise these workings: they are residual valuations. Instead of starting with a known price to be paid and trying to work out whether a profit can be made (development appraisal), these take a level of profit as given and try to work out the value of the “site” (residual valuation).
Now for the fiddly stuff; it all occurs on page 3 – Valuation B, the value of the building in its actual state, not fully in compliance with covenants:
|Pink||Agreed differences between both Valuations A and both Valuations B|
|Yellow||Differences between Landlord and Tenant|
Compare the two Valuations B. You can see that, with one exception, the valuers have even agreed the appropriate differences between Valuations A and B. The only difference between them is the £45,000 difference in their view of the ceiling (£54,000 when preliminaries, overheads and profit are included).
Note that, in relation to both kinds of difference, there are several other figures that are different, but all of them can be traced back to originating differences between valuations or between the parties.
One warning – against premature approximation. All the numbers are spuriously precise. They’re correct, though. Approximate too early in the valuations, and you run the risk of burying the very thing you’re looking for. Approximate to a sensible market-like figure right at the end – right back to the results figures shown on Exhibit 1, figures it will now be apparent are drawn from the calculations we’ve just been going through.
Conclusion: why can’t life be like this?
Many complications: leasehold; less than FRI; continuing subtenants; refurbishment; huge disagreements at the Contractual Claim level; other dilution; deeper analysis; multiple futures. None of these affect the basic, simple logic much.
It’s the detail that buries the logic; try to keep a clear head, and apply the principles.
 Damages for breach of a covenant …… to keep or put premises in repair during the currency of a lease, or to leave or put premises in repair at the termination of a lease …… shall in no case exceed the amount (if any) by which the value of the reversion (whether immediate or not) in the premises is diminished owing to the breach of such covenant …