Service charge and outgoings

Both residential and commercial landlords aim for a 'clear lease' - where the costs of repair, maintenance and provision of services are met by the tenants rather than being deducted from the rent received.

Where a building is in multi-occupation it is sensible for repair, maintenance and services to be controlled by the landlord, with the costs being recovered from tenants through the service charge.

In commercial leases the tenant's obligation to pay service charge, and the landlord's ability to recover costs, are entirely contractual. In residential leases the tenant's obligation to pay depends on there being a contractual service charge clause, but the landlord's ability to appoint managing agents, carry out works and to recover costs is heavily regulated by statute.

What is recoverable?

Service charge clauses are narrowly construed against the landlord. If a cost is not clearly recoverable under the clause then the tenant will not have to pay.

'Sweeper' clauses, where the landlord seeks to recover costs not specifically referred to elsewhere in the clause - do not assist (Jacob Isbicki & Co v Goulding & Bird [1989] 1 EGLR 236). The clause must cover not only the direct costs of maintenance, repair and the provision of services, but also the costs of ancillary items such as employing and accommodating staff, and promotional activities in a shopping centre. Consequently, it is common to see two categories:

• essential services that the landlord must provide, and

• other services for which costs may be recovered if they are provided

Renewals and improvements

Service charges are not intended to fund improvements to the landlord's property. Consequently, disputes frequently turn on whether expensive works, such as the replacement of a roof, were genuinely required or whether a 'patch' repair would be enough. Even where expensive capital works are needed, the court will be reluctant to impose those costs on a tenant with only a short term interest in the property (Fluor Daniel Properties v Shortlands Investments [2001] 2 EGLR 103). The court is also likely to take a dim view where a landlord waits until a service charge 'cap' expires before carrying out, and charging for, expensive works (Princes House v Distinctive Clubs [2007] 2 EGLR 75).

On account payments and balancing

As the service charge figure for the current financial year will not be calculated nor due until the end of the year, it is sensible for the landlord to provide that the tenant makes interim payments 'on account' – probably quarterly with the rent instalment. At the end of the year, the on-account charge must be balanced against actual expenditure.

Leases generally provide for immediate payment of additional service charge, and arrangements for refund of the overpayment, although landlords may seek to retain overpayments against future service charge payments.

Statutory control

The Landlord and Tenant Act 1985 provides the ground rules for residential service charges, setting out requirements for reasonableness and for prior consultation of leaseholders. Any service charge demand and reminder letter after 1st October 2007 (30th November 2007 in Wales) must be accompanied by a formal summary of rights and obligations, the content and form of which is prescribed.

Where a landlord proposes to carry out works of repair, maintenance or improvement which would cost an individual service charge payer more than £250, he must first consult all those expected to contribute to the cost (Landlord and Tenant Act 1985, s 20). This has the dual effect of giving notice of his intentions to the leaseholders and seeking their view on the proposed works.

Where the landlord proposes to let a contract for the provision of services for a period of more than 12 months, and the apportioned cost to any individual leaseholder is more than £100 a year, he must also consult the service charge payers before proceeding.

Both landlords and leaseholders have a right to ask a Leasehold Valuation Tribunal ('LVT') whether a charge, or a proposed charge, is reasonable. An application may be made to the LVT whether or not the charge has already been paid. It can be in respect of costs already incurred for works, services or other charges, or in respect of an estimate or budget. However, if the charges have been agreed by the parties or finally determined by a court or tribunal, or by post-dispute arbitration, no application to an LVT can be made.

The LVT may also determine:

• whether the service charge is payable under the lease

• by whom and to whom it is payable

• the date on which it may be payable, and

• the manner of payment (eg if it may be paid by direct debit or standing order)

Payments due as member of a management company

The Court of Appeal has distinguished between payments demanded from a residential occupier in their capacity as tenant (which fall within the protection of Landlord and Tenant Act 1985, s 18) and payments demanded from occupiers in their capacity as members of the management company for the building. Where a payment is demanded in accordance with the company's articles of association, and pursuant to a special resolution of the company, it is not considered to be 'service charge' and so can be recovered without engaging Landlord and Tenant Act 1985 protections and consultation requirements (Morshead Mansions v Di Marco [2008] All ER (D) 113 (Dec)).

The Service charge code

Commercial service charges are not (yet at least) subject to statutory control. However, the Service Charge Code (the 'Code') was relaunched in 2007 as an RICS guidance note. Consequently, although the Code remains voluntary, surveyors would be vulnerable to claims of professional negligence if they fail to adopt its recommendations.

The Code aims to promote fair dealing, and requires landlords to deliver services in a way that represents 'value for money'. The underlying principle is that service charges should be run on a 'no profit no loss' basis

The principal recommendations of the Code are:

• management - the landlord has a duty of care to occupiers to manage the property in an efficient and cost effective manner

• communications - the landlord must regularly and clearly communicate with occupiers on matters relating to the service charge

• transparency - the landlord's service charge expenses must be clearly identified, preferably using the Industry Standard Cost headings set out in the Code

• service standards and provision - all services must be provided both commercially and professionally and in line with the 'best practice' procedures and recommendations set out in the Code

The Code states that service charge costs should be limited to charges and costs incurred by the landlord in the operational management of the property. They should not include costs incurred in relation to the initial design or construction of the property, or to the original installation of any plant or equipment.

The Code recommends that any income derived from an activity that is funded by the service charge should be treated as a service charge credit. Similarly, where the landlord keeps income generated from space in the common parts (eg where mall areas are used for kiosks or barrows) that space should be included in the service charge or the income treated as a service charge credit. This is an area in which landlords are least keen to adopt the Code. Landlords will generally not want to make a service charge contribution in respect of common areas that generate income, or to give up that income.

The RICS has launched the second edition of the Code which builds on the first edition and is effective from 1 October 2011. As with the first edition, the code has the status of a guidance note and is intended to embody ‘best practice’. There will be circumstances when it is not appropriate to follow the code, but there should be good reason. A practitioner is unlikely to be adjudged negligent if he or she adheres to the code.

The code is now set out more clearly, with core principles set out at the start followed by guidance and supporting information. Key elements include:

• consultation - managers to consult with occupiers (whilst the owner has the right to set the standard to which the building is managed), even where the lease is silent

• financial control and competencies - managers must demonstrate a high degree of financial competence and act in a non-partisan spirit; detail on how accounts and audits are to be carried out with suggested accounting policies (a criticism of the first edition was the lack of guidance on accounting policies); the advisory industry standard cost headings from the first edition are now a recommended ‘must’ in reporting budget and actual expenditure

• dispute resolution - all new leases to provide for alternative dispute resolution (‘ADR’) and parties to use it even where the lease does not require it; there is a clear explanation of four types of ADR (early neutral evaluation, mediation (facilitative or evaluative), independent expert determination and arbitration) and reasons why they are a sensible way to settle service charge disputes

• mixed use - reminder that with mixed use properties the residential service charge code may apply

• sustainability- section on sustainability promoting and supporting a ‘cooperative and collaborative approach in recognising and managing the environmental impact of the occupation and management of commercial premises’