Navigating Latent/Inherent Defects: Key Considerations for Landlords Granting Leases in New Build Commercial Properties

As demand for commercial office space evolves, landlords must navigate carefully when granting leases for newly constructed properties. In this article we outline the key considerations for landlords focusing on defects, an issue that can significantly impact both the landlord’s and tenant’s interest in the premises, the value and its use.

A latent defect, also known as inherent defect is a hidden flaw in design, materials or workmanship of construction of a building which existed but was not apparent on completion of the building works nor visible during inspection but may emerge later.

Landlords to conduct thorough inspections: Prior to granting the lease of a premises, a landlord should ensure comprehensive inspections are carried out by all members of the professional team involved in the development including building surveyors, structural engineers, mechanical, electrical and plumbing engineers or building inspectors. These experts can identify defects and prepare reports for landlords highlighting issues to remedy prior to the grant of lease or by way of disclosure to a potential tenant. Most of these items may have been revealed in snagging when the building was completed, but more issues may evolve when the building is brought into use.

Disclosure: Landlords should be aware of their legal obligations to disclose known defects to a prospective tenant during lease negotiations and when preparing replies to enquiries. Failure to disclose known defects could lead to legal action initiated by tenants who experience issues during the term of their tenancy. Providing tenants with a complete history of the building, defects and remedial actions will promote transparency and trust between landlords and tenants.

Collateral warranties: During construction of the building, a landlord should ensure that building contracts and professional appointments (e.g. contractors or consultants) clearly set out the actual works performed and services provided. This will enable the landlord to offer collateral warranties or third-party rights to a tenant on grant of a new lease. The collateral warranty or third-party rights will be between the contractor or consultant and the incoming tenant who will acquire a new interest in the building. For example, when drafted correctly, a collateral warranty will enable a tenant to make a claim against an architect if the architect’s design was defective.

Leases: As a landlord usually prepares the first draft of a new lease, the starting point tends to be, if a defect causes damage to a tenant’s premises and the tenant has a full repairing covenant, remedying the defect will fall under the tenant’s repairing obligation. If the defect causes damage to a part of the building under the landlord’s demise, the landlord will carry out the works and recoup the expenses under the service charge.

Generally, leases will include a clause stating that “As soon as the Tenant becomes aware of any defect in the Property, the Tenant must give the Landlord notice of it.” However, if a tenant fails to notify the landlord of a defect, any damages that the tenant might be able to claim from the landlord may be reduced. Similarly, if the defect is due to the tenant’s default, the landlord will not be liable to the tenant but will be liable to others.

Alternatives to consider: During lease negotiations and depending on the bargaining strength between the parties, a landlord may consider offering the tenant the following alternative options to secure the lease:

1. Credit the tenant’s service charge account with monies recovered from third parties responsible for defective works; or
2. A service charge cap so that the tenant will not be liable for repair works over a certain amount; or
3. A side letter excluding the cost of remedying any inherent defects from the service charge account.

Tenant Fit-Out: A landlord’s design and construction team should review the tenant’s fit-out works and consider how the tenant’s modifications may affect the building ensuring that all fit-out works are performed in compliance with all regulations to fully comply with the building as built.

Insurance: Insurance products for inherent defects are available to both landlords and tenants.

For landlords, the product needs to be considered before the development works are commenced, so that the insurer can be involved in the supervision of the works whilst they are being carried out and so the policy can be available at the end of the development. These policies are expensive policies and therefore not yet the norm, but an increasing number of landlords are looking at these policies to give their buildings the edge.

If the landlord and tenant agree the standard provision whereby inherent defects are not excluded from the tenant’s repairing obligations, tenants can take out inherent defect insurance to cover the cost of carrying out repairs required due to financial losses associated with repairs or disputes arising from inherent defects. Insurance policies for inherent defects usually last for 10 years from practical completion of the building works.

To make a claim under an Inherent Defects Insurance the insured only needs to show evidence of damage. This is a simpler process than a claim under a collateral warranty where evidence of negligence or liability on the part of the professional team is needed.

Most Inherent Defects Insurance policies can be assigned to any purchaser or new tenant during the policy term.

Communication: To foster positive landlord-tenant relations, landlords should establish a clear maintenance plan outlining regular inspections and encourage open lines of communication and forums with tenants to promptly address any concerns regarding defects.

Wrapping it up: Granting leases for new build commercial units involves careful consideration of potential defects. By conducting thorough inspections, ensuring proper disclosures and drafting robust leases, landlords can protect themselves while providing a safe and satisfactory environment for tenants. In a competitive market, a proactive approach to these issues not only enhances landlord-tenant relations but also preserves the landlord’s long-term investment.

At Newmanor Law we have an experienced team of solicitors who can guide and advise you in all stages of your construction of a new building and subsequent grant of leases to tenants with experts in construction, finance and environmental law. Please do get in touch if you have any questions.

Special thanks to Robert Kelly of Stewart Title Limited for his valuable comments on Insurance.