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Service charges

Whilst a tenant with a long residential lease of a flat will usually be liable to keep the internal parts of the flat in repair, generally, long residential leases contain an obligation for the landlord to maintain, repair and insure the building, to manage it and potentially also to build up a reserve fund for any major works. In return the landlord can expect to recover the costs incurred in this regard from the tenants through a service charge.

The precise details of what can be recovered through this service charge, how and when it should be demanded and paid, and the proportion to be paid by each tenant will be governed by the lease. Usually the landlord will not contribute financially to the services themselves, and such costs be borne by the tenants alone, although it is common for the landlord to have to pay for the services in the first instance and then recover the costs later.

The lease is a contract between the landlord and tenant and will dictate the particular service charge regime for the specific building/development. There is no obligation for a landlord to do anything or for a tenant to pay for anything other than what was provided for by the lease, and frequently this is a key area of dispute.

Whilst it is therefore vital to obtain and carefully review each particular lease, there is also a large body of legislation (and associated case law) around service charges and the recoverability of sums through service charges. Lease provisions must always therefore be reviewed in the context of this statutory "overlay".

Landlords should also always keep in mind the guidance provided by the RICS in the Service Charge Residential Management Code. It is not compulsory for landlords to comply with the Code, but it is considered desirable and non-compliance will no doubt require some justification in the event of a dispute.

The law in this article applies to Wales.

Definition

1. Some older leases provide for the payment of a fixed service charge. However, as costs of services or works can fluctuate over time, and landlords always want to ensure the full recovery of those costs each year, most leases provide for the payment of a variable service charge.

2. Section 18 of the Landlord and Tenant Act 1985 provides the following definition:

"(1) In the following provisions of this Act "service charge" means an amount payable by a tenant of a dwelling as part of or in addition to the rent - (a) which is payable, directly or indirectly, for services, repairs, maintenance, improvements or insurance or the landlord's costs of management, and (b) the whole or part of which varies or may vary according to the relevant costs.(2) The 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."

3. The words "in connection with the matters for which the service charge is payable" highlights that the service charge regime will vary from building to building.

4. If a service charge falls within this definition then it will be subject to the strict requirements of ss.18 to 30 of the Landlord and Tenant Act 1985.

Reasonableness

5. One of the fundamental principles in service charge law is that of reasonableness

6. Section 19 of the Landlord and Tenant Act 1985 states:

"(1) Relevant costs shall be taken into account in determining the amount of a service charge payable for a period -(a) only to the extent that they are reasonably incurred, and (b) 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;(2) Where a service charge is payable before the relevant costs are incurred, no greater amount than is reasonable is so payable, and after the relevant costs have been incurred any necessary adjustment shall be made by repayment, reduction or subsequent charges or otherwise."

7. Accordingly a landlord has to ensure that it acts reasonably in incurring costs, and that the services or works to which the costs relate are of a reasonable standard.

8. This is to ensure that no unnecessary costs are incurred and that the landlord ensures that he engages properly qualified and experienced contractors to provide services and works to a reasonable standard. If the tenant is able to demonstrate that the landlord has been unreasonable in either aspect, then the service charges will be limited accordingly, and the landlord may have to reimburse the tenant for any overpayment made.

9. What is reasonable will always tend to be a question of fact in each particular case, but disputes on the issue of whether or not costs have been reasonably incurred or whether or not services or works are of a reasonable standard will almost always require detailed expert evidence or strong evidence of comparable costs of services/works.

Money to be held on trust

10. Where tenants are required (under the terms of their leases) to contribute to the same costs as other tenants at the same building, or where a tenant is required to contribute to a cost separate to other tenants, and that contribution is made by way of a service charge payment, the landlord must hold their funds on trust for the benefit of those tenants in respect of future service charge costs, and in one or more accounts as the landlord sees fit.

Demands

11. The service charge must always be calculated and demanded in accordance with the terms of the lease. If the lease stipulates that the tenant is to pay 1/100th of the total costs incurred by the landlord, and that service charges are to be paid twice yearly, then the landlord cannot demand otherwise (save by agreement with the tenants). If the landlord does demand otherwise, then that demand will be invalid.

12. It is also relatively common to find provisions in a lease that demands will be issued throughout the service charge year based upon estimated expenditure, with a balancing payment required at the end of the financial year in accordance with the costs actually incurred. However, such provisions will usually involve the provision of audited accounts before the service of a demand for the balancing payments, and landlords must also be careful to ensure that they comply with any such requirements "to the letter".

13. Another key point is to ensure that service charge demands are served by or on behalf of the correct entity. If the landlord is an individual, then demands must be served in their name, and not, for example, the name of a connected company. Additionally, at larger estates, it is also common to have a Management Company. The lease may provide for the Management Company to raise service charge demands, and for service charges to be paid to the Management Company, rather than the landlord. Unfortunately this is a common area where mistakes can be made.

14. As well as ensuring full compliance with the terms of the lease (which will be strictly interpreted against a landlord), statute also imposes strict requirements.

15. Demands for the payment of ground rent and service charges must comply with s.47 of the Landlord and Tenant Act 1987, and set out the name and address of the landlord, and an address at which documents can be served on the landlord within England and Wales. For the purposes of the Landlord and Tenant Act 1987, the landlord is the person entitled to the reversionary interest of the property (i.e. a superior leaseholder or the freeholder). By virtue of s.48 of the Landlord and Tenant Act 1987, neither the ground rent nor the service charges demanded will be payable until the proper information required under s.47 has been provided.

16. Additionally, pursuant to s.21B of the Landlord and Tenant Act 1985, since 30 November 2007 in Wales (or 1 October 2007 in England), whenever a service charge demand is served, it must always be accompanied by a Summary of the rights and obligations of residential tenants in relation to service charges.

17. The prescribed form of the Summary is contained in the Service Charges (Summary of Rights and Obligations, and Transitional Provisions) (Wales) Regulations 2007/3160 (similar provisions exist in England).

18. Section 21B(3) of the Landlord and Tenant Act 1985 permits a tenant to withhold payment of service charges if the Summary of their rights and obligations is not provided. Many management agents print the Summary on the reverse of their service charge demands. It is important to ensure that landlords have updated their Summary following the replacement of the Leasehold Valuation Tribunal by the First-Tier Tribunal (Property Chamber) on 1 July 2013.

19. There are also time limits that can impact upon the ability to recover service charges. Pursuant to s.20B of the Landlord and Tenant Act 1985, tenants are not liable to pay service charges incurred more than 18 months before they are demanded, unless the tenant has been notified in writing that the sums have been incurred and that they will be required to contribute to those by way of a subsequent charge payment. Section 20B requires that notices served in writing by the landlord, which, for the purpose of the Landlord and Tenant Act 1985 (and different to the Landlord and Tenant Act 1987), is "any person who has a right to enforce payment of a service charge".

As set out above, the service charge may be payable to a Management Company, instead of the landlord. Where a service charge demand is rendered invalid by not complying with the terms of the lease or the relevant legislation, it is always important to ensure that the tenant has at least had written notice of the sums incurred pursuant to s.20B so that these can be claimed later, otherwise the right to recover these costs will be lost.

Right to a summary and further information

20. Section 21 of the Landlord and Tenant Act 1985 gives the tenant the statutory right (in addition to any contractual rights contained in the lease) to further information about the service charge account. Upon sending a written request direct to the landlord or their managing agent, the tenant is entitled to a summary of the relevant costs relating to the service charges payable in respect of the last accounting year or 12 months (where the accounts were not kept in accounting years). The landlord must provide the summary within 1 month of the request, or within 6 months of the end of the 12 month accounting period, whichever is the latest.

21. The summary should show:

  • How the costs relate to the service charge demand, or whether they will be included in a later demand;
  • Any items for which the landlord has not received a payment demand due in the accounting period;
  • Any items for which a payment demand was received but for which no payment was made during the accounting period;
  • Any items which a demand was received and for which payment was made during the accounting period; and
  • Whether any of the costs relate to works for which an improvement grant has been or is to be paid.

22. If the service charge is payable by the tenants of more than 4 residential dwellings, then the summary must also be certified as a fair summary by a qualified accountant and adequately supported by the accounts, receipts and other documents produced to that accountant. If the landlord is a public sector body, then a qualified accountant who is one of their officers can certify the summary, but otherwise the accountant and the landlord must be independent of each other.

23. Section 22 of the Landlord and Tenant Act 1985 also gives the tenant the right (following receipt of a s.21 summary) to inspect documents relating to the service charge. Within 6 months of receipt of the summary, the tenant can write to the landlord requiring access for inspection of the accounts, receipts and other documents relevant to the information provided in the summary, and can require that facilities be provided for photocopying those documents. Inspection facilities must be provided to the tenant within 1 month of the request, and remain available for a period of 2 months. If the facilities are just for inspecting documents then that facility must be provided free of charge, but if photocopying facilities are being made available then the landlord is entitled to make them available "on payment of such reasonable charge as he may determine". If the landlord does incur costs in providing inspection facilities, then those costs can be recovered as part of the landlord's management costs, where those are recoverable under the terms of the lease.

24. If the landlord fails to comply with the request for a s.21 summary or for a s.22 inspection of documents, without a reasonable excuse, they commit a summary offence on conviction and can be liable for a fine of currently up to £2,500. Local authority landlords are exempt from prosecution.

Consultation

25. Where a landlord intends to carry out works over a certain value or enter into a long term agreement for services to be provided then they must consult the tenants first. Section 20 of the Landlord and Tenant 1985 sets out stringent requirements in terms of the consultation required and the procedure to be followed.

26. There are two circumstances when a landlord may have to consult:

Qualifying Works

27. Where a landlord proposes to undertake works of repair, maintenance or improvement which would cost an individual service charge payer more than £250. Previously this £250 limit was considered (following Martin v Maryland Estates Ltd (Service Charges) (2000) 32 H.L.R. 116) to be £250 per set of works .

28. This has been an area of much controversy recently. In the case of Phillips v Francis [2012] EWHC 3650 (Ch); [2013] 1 W.L.R. 2343, the outgoing Chancellor of the High Court (Sir Andrew Morritt) interpreted this to be £250 for all major works in any one service charge period instead. For example, if a landlord proposed works which would cost an individual service charge payer £200, and then a second, separate, set of works which would cost an individual service payer £60, the second set of works would have to be consulted upon as they would take the service charge contribution for major works cumulatively over £250 in that service charge year. This therefore left landlords and their advisors in a situation where they would have to undergo the lengthy consultation process for even minor works, incurring delays and increased costs for tenants.

29. The High Court decision has, to the relief of landlords and managing agents across the country, recently been overturned by the Court of Appeal (Phillips v Francis [2014] EWCA Civ 1395; [2015] 1 W.L.R. 741). The Court of Appeal commented that Sir Morritt's interpretation could not have been as Parliament initially intended, and held instead that landlords have to identify individual sets of works (as previously). Only if any one set of works exceeds the £250 limit does the statutory consultation now need to be undertaken. The Master of the Rolls provided some helpful guidance as to how to determine what constitutes a set of works - he encouraged a common sense approach and consideration of factors such as (but not limited to) where works are carried out and their physical proximity to one another, whether the works are covered by the same contract, whether the works are undertaken at the same or different times, and whether the works are similar in nature or not.

Qualifying Long Term Agreements

30. Where a landlord proposes to enter into a contract for the provision of services for a term of more than 12 months, and the apportioned cost to any individual service charge payer is more than £100 a year, then tenants must be consulted. There are certain, limited, types of contract which are exempt from the consultation requirement (reg.3 of the Service Charges (Consultation Requirements) (Wales) Regulations 2004/684).

31. The statutory consultation process is relatively long, and comprises several distinct stages. The procedure for consultation on either Qualifying Works or Qualifying Long Term Agreements is contained in the Service Charges (Consultation Requirements) (England) Regulations 2003/1987 (similar provisions exist for Wales).

32. Consultation must be completed before Qualifying Works are undertaken or a Qualifying Long Term Agreement is entered into. However, the penalties for non-compliance with the consultation requirements can be severe. If consultation should have been carried out and was not, or if any of the stages of the consultation process are not fully undertaken, then, in relation to a Qualifying Long Term Agreement, the landlord is only entitled to recover £100 per tenant, and in relation to Qualifying Works, the landlord is only entitled to recover £250 per tenant. This clearly could leave a landlord with a significant financial burden.

33. Dispensation from the consultation requirements can be obtained, and can be sought in advance (i.e. for emergency work) or after the event (i.e. where an error in the consultation process is identified) from the First-Tier Tribunal (Property Chamber). However, obtaining dispensation can be difficult. The Supreme Court recently provided guidance on the factors to be taken into account on an application for dispensation in Daejan Investments Ltd v Benson [2013] UKSC 14; [2013] 1 W.L.R. 854 (an application for retrospective dispensation arising from failings in the consultation process relating to major works). The Supreme Court ruled that the focus should be whether tenants have suffered any actual prejudice as a result of the failure to consult, and the burden is on the tenants to demonstrate such prejudice. If prejudice can be established, then the service charge contributions can be reduced so as to compensate the tenants appropriately or limited strictly to £250 per tenant.

Disputes

34. As stated above, service charges are a frequent area of disputes between landlords and tenants. Disputes can centre around incorrect or invalid demand documentation, non-compliance with statute or the terms of the lease, questions of reasonableness, and failing to consult in respect of Qualifying Works or Qualifying Long Term Agreements. Disputes can be brought before the Court or the First-Tier Tribunal (Property Chamber) (previously known as the Leasehold Valuation Tribunal).

35. Disputes are more usually brought in the Tribunal, and a new set of rules governing the procedure in the Tribunal - The Tribunal Procedure (First-tier Tribunal) (Property Chamber) Rules 2013/1169 came into effect on 1 July 2013.

36. A common issue for landlords is the non-payment of service charges. These can be recovered as a normal contractual debt. However, where service charges are reserved as rent in a lease, it is common to find that the lease will provide for forfeiture upon non-payment of rent, or breach of any other covenant contained in the lease. Frequently there is also an associated clause in the lease allowing a landlord to recover their costs of forfeiture proceedings, and therefore this has become a preferred method of recovery of service charge arrears for landlords.

37. It is important to remember however that, if a landlord is entitled to forfeit the lease for non-payment of service charges then, prior to forfeiture, a Notice under s.146 of the Law of Property Act 1925 must be served upon the tenant.

38. That Notice cannot be served unless the arrears have been outstanding for more than 3 years, or amount to more than £350. Additionally, s.168 of the Commonhold and Leasehold Reform Act 2002 requires that the landlord must first obtain an admission from the tenant that the sums are outstanding, or alternatively a declaration or determination by a relevant Court or Tribunal. The limitation period for the recovery of service charges is 6 or 12 years, depending upon the terms and form of the lease.

Costs of disputes

39. In any dispute between landlords and tenants, both parties will of course incur costs - Court or Tribunal fees, legal fees, expert's fees and so forth. Depending upon the terms of the specific lease, a landlord may be entitled to recover its costs incurred in dealing with any dispute from the tenant or may be entitled to recover those costs through the service charge. It is therefore open to a tenant in any Court or Tribunal proceedings to make an application under s.20C of the Landlord and Tenant Act 1985 for an Order that all or any of the costs incurred, or to be incurred, by the landlord in connection with those proceedings are not to be regarded as relevant costs to be taken into account in determining the amount of any service charge payable by that tenant or any other person or persons specified in the application.

40. The guidelines on whether or not the Court or Tribunal should make a Section 20C Order are limited, and s.20C(3) simply states that "the Court or Tribunal to which the application is made may make such an order on the application as it considers just and equitable in the circumstances".

41. It is suggested by the author that this will generally turn to a very large degree upon whom it can be properly said has "won".

Insurance

42. It is common to find that a lease will provide for the landlord to arrange the insurance of the building (leaving the tenant to insure their own home contents), and for the landlord to then recover the cost of that insurance policy through the service charge. Where the service charge provides for the insurance premium to be recoverable, a tenant can ask the landlord for a written summary of the policy, or to inspect and take copies of the policy. Such a request must be made in writing, and the landlord must comply within 21 days of receipt.

43. If the tenant simply requires a written summary, then the landlord must confirm the sum for which the property is insured, the name of the insurer, and the risks covered in the policy. A landlord is only required to provide a written summary once in each insurance period. If the tenant requires sight of the policy, then the landlord must provide facilities for the inspection of the policy and any other relevant documents (including receipts) and facilities for photocopying them. Alternatively, the tenant can simply request that the landlord provides a copy of the policy and specified documents. The provision of inspection and/or copying facilities can be treated as a management cost and therefore it may be possible for the landlord to recover this through the service charge mechanism.

Administration charges

44. Separately to service charges, Sch.11 of the Commonhold and Leasehold Reform Act 2002 introduced rights in respect of administration charges.

45. Administration charges are defined in para.1 as:

"an amount payable by a tenant of a dwelling as part of or in addition to rent which is payable, directly or indirectly for - (a) for or in connection with the grant of approvals under his lease, or applications for such approvals; (b) for or in connection with the provision of information or documents by or on behalf of the landlord or a person who is party to his lease otherwise than as landlord or tenant; (c) in respect of a failure by the tenant to make a payment by the due date to the landlord or a person who is party to his lease otherwise than as landlord or tenant; or ; (d) in connection with a breach (or alleged breach) of a covenant or condition in his lease."

46. Any such administration charge demanded by the landlord must be reasonable before it is recoverable, and must be accompanied by a summary of the tenants' rights and obligations in respect of administration charges. The charge is not payable until the summary is provided. If the administration charge is variable, then a tenant can challenge the reasonableness of the administration charge (as with service charges) by way of an application to the Tribunal. If the administration charge is fixed by the lease or by a formula contained within the lease, then the tenant can apply to the Tribunal to vary those provisions on the ground that the amount specified in the lease or the formula provided in the lease is unreasonable. 

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