In these straitened times and with the next quarter day’s payment of rent due shortly, service charges in commercial leases need to be looked at ever more closely. Disputes have led to complete a breakdown in relations between landlords and tenants in the past, and resulted in costly court cases. Two cases illustrate the need for landlords to act reasonably when enforcing service charge covenants in a lease.
In the case of Princes House Limited -v- Distinctive Clubs Limited, the High Court set out practical guidelines on service charge issues. The landlord had granted a tenant a lease of part of a building where the roof was in disrepair, and said that he would use all reasonable endeavours to complete repairs to the roof. The tenant agreed to pay service charges which were capped for the first five years of the lease.
However, the landlord failed to complete the works within five years, after which time the tenant’s service charge cap had expired. The court held that the landlord had breached its obligation to use all reasonable endeavours, and awarded damages to the tenant for his share of the repair costs incurred by the landlord.
Another case, Barrington v Sloane Properties, centred on the leases of a block which allowed the landlord to recover, through service charges, an annual amount equal to the cost of specified services. The landlord carried out building works to the block over three years, during which time the contractor asked for interim payments which the landlord paid.
Under the service charge accounts, however, the landlord asked tenants for estimated sums as to the amount of work undertaken in a particular year rather than the amount paid to the contractor.
One of the tenants objected to paying on that basis, and the Lands Tribunal agreed, saying that the accounts misstated the amounts chargeable to the tenants and so could not be properly certified.
The Code on Service Charges in Commercial Property was brought in to help cut conflicts, such as the two illustrated by making the management of charges transparent, and by promoting good communications between landlords and tenants.
The code’s key messages are:
Not for profit or loss. Service charges should not be a way of making more money for the landlord. The Code recommends that service charge costs should be restricted to costs properly incurred in the operational management of the building. There should no hidden mark-ups or charges on charges.
The Code suggests that any money that accumulates in a sinking fund, replacement fund or reserve fund is to be held in trust for the occupiers, separate from the owner’s own funds. This suggests that, at the end of the term, any money not used is to be repaid to whoever are then the tenants, or retained for the benefit of any new trust.
Management. All service charges should be managed professionally and openly so that tenants can see how their contributions are being used.
Transparency and communication. The Code says that producing accounts with explanatory notes, and notifying tenants promptly of any changes to plans, is essential to establishing transparency and promoting goodwill.
Relative certainty. Tenants should have a good idea of what their service charge bill will be each year. Landlords should produce budgets in advance and reconciliations in good time after the service charge year.
The right of reasonable challenge. Tenants should be given a timetable with an estimate of likely service charges delivered a month before the beginning of the service charge year. Tenants should then be allowed a reasonable period, four months from issue, in which to raise enquiries in respect of the certified accounts.
Service charge disputes are usually complicated and expensive proceedings. Landlords do well to consider the potential for possible disputes and put in place a plan to diffuse the possibility altogether.