Service charges: Why do commercial landlords need to be aware of the statutory restrictions on residential charges?

Citation

Dowden, M. (2012), "Service charges: Why do commercial landlords need to be aware of the statutory restrictions on residential charges?", Journal of Property Investment & Finance, Vol. 30 No. 4. https://doi.org/10.1108/jpif.2012.11230daa.004

Service charges: Why do commercial landlords need to be aware of the statutory restrictions on residential charges?

Article Type: Legal briefing From: Journal of Property Investment & Finance, Volume 30, Issue 4

Statute limits the amount that may be recovered from tenants of long leases of dwellings by way either of service or administration charges. In both cases the landlord may recover no more than is “reasonable”, notwithstanding any contrary provision in the lease. The landlord’s ability to forfeit the lease for non-payment is also subject to statutory control. In straitened economic circumstances there have been clear signs that tenants are willing to rely on those statutory controls to withhold or challenge service charge payments, and that unless the tenant is very clearly seeking after the event to rely on a merely technical argument, the court is highly likely to apply the law firmly in the tenant’s favour. Although directed to residential tenancies, the regime applies to mixed use properties, potentially limiting recovery from the residential elements. Further, it is possible that the tenants of commercial parts might challenge service charge demands as “interested parties” where the landlord’s failure to consult or make binding demands on residential tenants leaves the commercial elements facing a disproportionate charge.

Service charges

Under the statutory provisions (Landlord and Tenant Act 1985, ss 18-30) regulating service charges under residential long leases:

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  Service charge means “an amount payable by a tenant of a dwelling as part of or in addition to the rent which is payable, directly or indirectly, for services, repairs, maintenance, improvements, insurance or the landlord’s costs of management, the whole or part of which varies or may vary according to the relevant costs”.

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  Relevant costs are the ”costs or estimated costs incurred or to be incurred by or on behalf of the landlord, or a superior landlord, in connection with the matters for which the service charge is payable”.

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  Landlord means “any person who has the right to enforce payment of a service charge”, and so includes a tenants’ or other management company with whom a tenant has covenanted to pay service charges (see Cinnamon v. Morgan [2001] EWCA Civ 1616).

In Robinson v. Oram [2011] All ER (D) 83 (Nov), the Court of Appeal held that residential tenants’ liability to pay landlord’s repair costs came within the statutory definition of service charge. This meant that the conditions precedent to enforcement were:

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  determination of liability by the LVT; and

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  service of a s 146 notice.

Accordingly, the costs incurred before the LVT were recoverable under the clause in the lease requiring the tenants to pay the landlord’s costs in relation to proceedings under s 146.

The definition of “dwelling” in s 38 of the 1985 Act does not confine the use of the word to a principal home. In Phillips v. Francis (2010), the court confirmed that there is no reason why a person could not have two or more homes, including a holiday home. Unlike the Rent Acts, whose policy was to protect the tenant in his home, the emphasis of the service charge provisions in the 1985 Act was to provide a tenant with a means of challenging unreasonable charges sought by a landlord. The policy reasons for such restrictions on contractual freedom applied equally to leaseholders of holiday chalets. Such tenants were as deserving of protection from unscrupulous landlords as were tenants of accommodation that was their primary home.

Must be reasonable

A landlord cannot recover more by way of service charge than is reasonable. Relevant costs are to be taken into account in determining the amount of service charge payable only to the extent that:

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  they are reasonably incurred; and

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  where they are incurred on the provision of services or the carrying out of works, only if the services or works are of a reasonable standard.

There are two separate matters to consider in deciding whether a service charge has been reasonably incurred:

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  whether the action taken in incurring the costs was reasonable; and

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  whether the amount of the costs was reasonable.

In Garside v. RFYC [2011] UKUT 367 (LC), the Upper Tribunal (Lands Chamber) held that, giving the expression “reasonable” a broad, common sense meaning, the financial impact of major works on tenants through service charges, and whether as a consequence they should be phased, was capable of being a material consideration when considering whether the costs were reasonably incurred. However, the Tribunal made it clear that liability to pay service charges cannot be avoided simply on the grounds of hardship, even if extreme. If repair work is reasonably required, carried out at a reasonable cost and to a reasonable standard, the cost is recoverable. The tenant cannot escape liability by pleading poverty. The LVT cannot alter a tenant’s contractual liability to pay.

In Southall Court (Residents) v. Tiwari [2011] UKUT 218 (LC), the Upper Tribunal (Lands Chamber) confirmed that the test of reasonableness for recovery of interim charges is the same as for costs already incurred. The landlord had a wide discretion on the programme of works to be adopted. Whether works are reasonable, does not depend on whether they are the only option, but whether they fall within a range of reasonable decisions. The conclusion of the Leasehold Valuation Tribunal (“LVT”), that it was unreasonable for the landlord to recover the roof immediately, was reached in light of its view that the roof tiles had another 12-18 months of useful life. It was not, therefore, open to it to find that the landlord’s decision was unreasonable.

In the same case, the Tribunal confirmed that the existence of a sinking fund is relevant, as part of the factual matrix. However, the very small sinking fund could not have made the difference between the reasonableness of a decision to recover the roof now or in 12-18 months time, by when the LVT considered that the landlord may well have been entitled to carry out the works in any event.

The landlord is not obliged always to choose the cheapest service or service provider, but the amount charged must be in line with prevailing market prices. Because the definition of “relevant costs” includes “estimated costs”, the amount that a tenant can be required to pay in advance on account of anticipated service charge costs is also subject to the requirement of reasonableness.

However, a tenant should be careful as to the basis of his challenge. In Peverel, a claim that the cost of remedial roof works necessary due to defective work by a previous owner, was not reasonably incurred, failed on appeal to the Lands Tribunal. The tenant alleged that the building manager had a duty to recover the cost of the works from the previous owner. The Tribunal disagreed. The manager had no cause of action against the previous owner either in contract, in tort or under defective premises legislation. He had no contractual relationship with the previous owner, had no interest in the building beyond an obligation to manage and maintain it and had not suffered loss. Nor did he have a duty to enforce any defective premises claim that the tenant may have.

The Tribunal cannot make a finding on a reasonable apportionment of the costs. If they are reasonably incurred they must be apportioned in accordance with the terms of the lease (unless excluded by another statutory provision, e.g. failure to consult).

Any agreement by the tenant is void in so far as it purports to provide for the determination in a particular manner, or on particular evidence, of any question as to:

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  whether costs incurred for services, repairs; maintenance, insurance, or management were reasonably incurred;

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  whether services or works for which costs were incurred are of a reasonable standard; or

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  whether an amount payable before costs are incurred is reasonable.

This invalidates any provision in the lease that a certificate supplied by the landlord, or the landlord’s surveyor, or any other third party, is to be conclusive as to any of the above matters. S 19(3) of the Act exempts from this rule a relevant individual acting (expressly or impliedly) as an arbitrator.

The amount which may lawfully be recovered from a tenant by way of service charge must be determined in one of the following ways:

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  the landlord or the tenant (which can include a sub-tenant who wishes to challenge the amount of the service charge payable by the head tenant to the freeholder) may apply at any time (e.g. before or after the service charge has been paid) to a leasehold valuation tribunal for a determination as to the amount of service charge payable – however, no application can be made if any one of the methods in the next bullet point has been used to determine the amount due; or

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  the landlord and tenant can agree the amount that is due, or the tenant can admit the amount that is due (the mere fact that the tenant paid the amount demanded does not constitute an admission for this purpose), or the amount can be determined by the court or by an arbitral tribunal if the lease contains a “post-dispute arbitration agreement”.

Requirement to consult

In addition, the amount of service charge recoverable may be restricted unless the landlord has complied with the consultation requirements contained in the 1985 Act (Landlord and Tenant Act 1985, s 20). Subject to relatively modest financial thresholds, those consultation requirements apply where the landlord intends to:

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  enter into a qualifying long term agreement to which s 20 applies; or

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  carry out qualifying works to which that section applies.

Demands and accounting

Finally, a tenant may be entitled to withhold payment of service charge if any one of the following applies:

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  demand for payment was not made within 18 months of the relevant costs being incurred and the tenant had not been notified within that period that he would be liable to contribute to them;

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  the demand was not accompanied by a summary of the tenant’s rights and obligations in relation to service charge;

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  the landlord has failed to supply the tenant with a statement of account in writing for each service charge accounting period;

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  the landlord has failed to allow the tenant to inspect the underlying account records; and

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  the landlord has failed to hold the service charge funds in a designated trust account or has failed to provide the tenant with information about the account.

Timely demands

The “18-month rule” is designed to ensure that a tenant is not faced with a bill for expenditure of which he or she was not sufficiently warned to set aside provision.

In Jean-Paul v. London Borough of Southwark [2011] UKUT 178 (LC), the Upper Tribunal (Lands Chamber) took a dim view of a tenant’s attempt to rely on the 18 month rule to avoid paying service charges of which it had had sufficient warning. The tenant had been fully consulted in advance, given an estimated demand and had expressed total satisfaction with the works following their completion. The final amount demanded was less than the estimate and had been found, by the Leasehold Valuation Tribunal (LVT), to be reasonable. Chaser letters sent following the estimated demand were sufficient notification to prevent the operation of the 18-month rule. It did not matter that the amount was overstated.

In OM Property Management v. Burr [2012] UKUT 2 (LC), the Upper Tribunal (Lands Chamber) confirmed that the 18 months runs from when the cost, not the liability (here the use of gas), is incurred. There was no authority to suggest that a cost is incurred when the liability is incurred. A cost and a liability are separate things and Parliament chose to use the word “cost”. Liability to pay may have been incurred when the gas was used, but the costs had not been. Costs are incurred on the presentation of an invoice or on payment.

The 18 month-rule does not apply if within the 18 month period the tenant was notified in writing that the costs had been incurred and he or she would subsequently be required to pay them as service charge under the lease. In Brent London Borough Council v. Shulem B Association [2011] All ER (D) 238 (Jun), the High Court held that the notification must refer to actual, not estimated, costs. Parliament plainly recognised that there would be cases, especially with modern form service charge cycles, where 18 months was too short a period. That was the reason for s 20B(2). If a landlord is not able to specify the actual costs accurately at the time of the written notification, it can still comply with the sub-section by specifying a figure which it thinks will cover the claim it will later wish to make.

Advance payments/balancing charges

In, Holding & Management (Solitaire) v. Sherwin [2010] UKUT 412 (LC), following Gilje v. Charlgrove Securities [2004] 1 All ER 91, the Upper Tribunal (Lands Chamber) held that s 20B does not apply to limit the tenant’s liability in respect of advance payments. These are prospective costs and so clearly have not been incurred more than 18 months before the demand for the advance payment.

Balancing charges differ as they relate to costs that have been incurred. They reflect the costs incurred after the advance payments have been used up. A tenant is not liable to pay a balancing charge in respect of any costs incurred more than 18 months before the demand for the balancing payment. Any amount payable and paid as an advance payment is unaffected.

In Brennan v. St Paul’s Court [2010] UKUT 403 (LC), the Upper Tribunal (Lands Chamber) held that, as s 20B does not apply to advance payments, it did not apply where the balancing charge was taken from a reserve fund. The Tribunal had some sympathy with Mr Brennan. The result of the wording of s 20B was that a tenant was protected against “old” costs where the landlord has not got enough on account to pay them, but not where they have been paid for out of the tenant’s interim payments and the credit standing to his account. Nonetheless it had to interpret s 20B according to its wording. If Parliament had intended the 18-month limitation to apply to a request for payment on account of future expenses, as opposed to a demand for payment in respect of costs already incurred, it would have said so.

Summary of tenant’s rights and obligations

In Tingdene Holiday Parks v. Cox [2011] UKUT 310 (LC) (involving tenants of holiday chalets), the Upper Tribunal (Lands Chamber) held that:

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  a summary sent 11 days after the demand to which it was intended to relate manifestly had not accompanied the demand; and

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  the sending of a copy of the statutory instrument setting out the prescribed form of summary did not constitute compliance with the statutory requirements. The summary had to be in the prescribed form.

Excessive service charges

Landlord and Tenant Act 1987, s 35(2)(f) prevents a landlord from recovering more than 100 per cent of its recoverable service charge expenditure. It authorises the LVT to vary a lease where the aggregate amount of all the service charge proportions is either greater or less than the whole of the expenditure. It is not uncommon for the aggregate of all service charge proportions to exceed 100 per cent.

A variation is not justified if the lease does not provide for a service charge to be a proportion of expenditure. This was the case in Cleary v. Lakeside Developments [2011] UKUT 264 (LC), where a landlord was seeking a variation to four leases to include an obligation to pay a management fee. None of the leases provided for a proportion of the management fees to be payable as a service charge.

Nor can s 35 be invoked to challenge the allocation of service charge proportions between individual tenants and/or any other person who is liable to contribute. Therefore, where a challenge was initially brought under s 35(2)(f) by six of eight residential tenants in a block of flats on the ground that the total of the service charge contributions from all eight flats amounted to 116 per cent of the service charge expenditure, and the landlord corrected that discrepancy by reducing the proportion for which the other two flats (one of which it occupied) were liable, so that the aggregate total was reduced to 100 per cent, the court had no jurisdiction under s 35 to vary that allocation, even though the service charge payable for some of the flats was 16 times greater than that payable for the largest flat (which was occupied by the landlord) (see Morgan v. Fletcher [2009] UKUT 186 (LC)).

In Mehra v. Citywest Homes [2011] UKUT 311 (LC), the Upper Tribunal (Lands Chamber) found that the LVT had not had jurisdiction under s 27A to hold that the landlord’s method of service charge apportionment (as opposed to the amount of service charge or the costs for which it was payable) was fair and reasonable. However, the finding undoubtedly underlay its decision to vary leases under s 35, so its reasoning on the “purported” s 27A application was material to its decision. The Tribunal held that confirmation in a licence for alterations, that the tenant’s covenants applied to a flat in its unaltered state, meant that the service charge had to be computed by reference to the configuration of the flat prior to the works being carried out.

The LVT does not have exclusive jurisdiction. Had Parliament intended to provide for exclusive jurisdiction in service charge disputes, it would have used much clearer language than that adopted in s 27A of the 1985 Act. The use of the word “may” indicated that where the LVT had jurisdiction, that jurisdiction was concurrent with that of the ordinary courts. Although it would be more convenient in the majority of cases for such disputes to be canvassed before a tribunal that was expert in trying those issues, there was no reason why, in an appropriate case that was otherwise before one of the ordinary courts of law, the provisions relating to service charges contained in ss 18 to 30 should not be resolved by such a court (Phillips v. Francis (2010)).

Costs of legal proceedings

As a matter of law, the costs of legal proceedings are only recoverable via the service charge if the wording of the lease allows it. In Greening v. Castelnau Mansions [2011] UKUT 326 (LC), the Upper Tribunal (Lands Chamber) held (following Sella House (where the clause had the same wording) that on the wording of the lease, a clause allowing recovery, as service charge, of the fees of professionals in the administration of the building, did not extend to legal fees for the collection of unpaid service charges. A clause allowing for recovery of such fees should be clear and unambiguous.

In Twenty Two Clifton Gardens v. Thayer Investments [2012] UKUT 71 (LC), the Upper Tribunal (Lands Chamber) held that the landlord’s legal fees and the fees of its expert surveyor, in respect of legal proceedings before the leasehold valuation tribunal, were not recoverable as service charge under the terms of the lease. Service charge recoverable for services necessary for the “better use and enjoyment” of a property did not include the landlord’s costs of proceedings. The provision referred to physical enjoyment.

By contrast, in Iperion v. Broadwalk House [1995] 2 EGLR 47, the Court of Appeal held that a service charge provision encompassing “all costs” incurred by the landlord in carrying out its covenants and in the “proper and reasonable management” of the building did allow recovery of legal costs. In Plantation Wharf Management Company v. Jackson & Irving [2011] UKUT 488 (LC), the Upper Tribunal (Lands Chamber) held that the recovery of legal costs was included in the “fees charges and expenses of professional advisors” in the enforcement of covenants.

The LVT or Upper Tribunal have discretion to direct, on application by the tenant, that any costs incurred by the landlord in proceedings (not just in relation to service charge) cannot be recovered as service charge in the future. In Iperion, the court confirmed that leaseholders who have been successful in litigation should not face meeting the landlord’s costs as part of the service charge.

Administration charges

For amounts due after 30 September 2003, “administration charge” means any amount payable by a tenant of a dwelling as part of or in addition to rent, which is payable directly or indirectly for:

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  the grant of approvals under the lease or applications for such approvals;

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  in connection with the provision of information or documents by or on behalf of the landlord or a person party to the lease other than the landlord or tenant;

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  costs arising from non-payment of a sum due to the landlord; and

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  costs arising in connection with a breach (or alleged breach) of the lease.

A “fixed administration charge” is one whose amount is either fixed by the lease or is capable of being calculated by reference to a fixed formula contained in the lease. A “variable administration charge” is any administration charge that is not a fixed administration charge.

In either case, the requirement of reasonableness applies in relation to the amount which may be recovered:

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  In the case of a fixed administration charge the tenant can apply to a LVT for variation of the lease on the grounds that the amount fixed in the lease, or the formula contained in the lease, is unreasonable.

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  A variable administration charge is payable only to the extent that it is reasonable, which imports the same considerations as apply in relation to the reasonableness of service charge; so either party may apply to a LVT for a determination as to whether a variable administration charge is payable and, if so, how much it should be, and when, how and by and to whom it is to be paid, provided that the tenant may not apply if he has already admitted or agreed the amount of the charge or it has been determined by a court or by arbitration.

The tenant may refuse to pay an administration charge if:

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  the landlord has failed to give the tenant notice of an address for service; or

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  the demand for payment is not accompanied by a summary of the tenant’s rights and obligations in relation to administration charges.

Malcolm Dowden