Hot topic in negotiations - the 1927 Act compensation trap

A recurring issue in recent transactions and lease expiries has been the statutory compensation entitlement under section 1(2) of the Landlord and Tenant Act 1927, which provides that where a tenant has carried out authorised improvements, the landlord may be obliged to compensate the tenant for the value of those works at lease expiry.

Importantly, this statutory obligation cannot be contracted out — any clause purporting to exclude the obligation to pay this compensation is void.

In practice, the issue arises most acutely where:

A tenant (often an investor) has taken a bare or cleared site from the landlord under a long lease and constructed a logistics unit or warehouse at its own cost; and
The lease provides for reinstatement or 'shell and core' hand-back, but the improvements (i.e. the building itself) qualify as 'improvements' for the purpose of the 1927 Act.

This creates a tension between the contractual reinstatement obligation and the statutory compensation right. To avoid exposure, landlords should:

Carefully document that the works are to be treated as landlord’s works or otherwise outside the 1927 Act regime (for instance, by way of a development or agreement for lease structure, the long leasehold interest in land only being granted once the building has been built);
Require tenants to waive claims to compensation 'so far as the law permits', though this option is not devoid of risk; and
Ensure the lease and licence-for-works documentation properly categorise the improvements and record the parties’ intentions regarding ownership and reinstatement.

We have seen a number of situations where landlords inadvertently faced potential compensation claims worth millions at expiry, simply because the works had been authorised under a standard licence and no distinction was drawn between repair and improvement. This is rapidly becoming a negotiation hotspot in the logistics development market. Our litigation team have created bespoke provisions to be included in such circumstances to protect our landlord / investor clients.