Service charge recovery outside the term

Suzanne Hooks and Selina Badiani address what costs landlords can recover after a lease ends, and how tenants can resist claims. Many leases will expire or be terminated during a service charge accounting period, in which case a reconciliation exercise will be undertaken by the landlord to calculate how much service charge paid on account should properly be repayable to a former tenant, or indeed whether a balancing payment is payable by the former tenant. Tenants, quite rightly, will be reluctant to meet the costs of future repairs or works from which they will not derive a benefit, and so a detailed analysis of the service charge statement should be undertaken with reference to the lease terms to ascertain whether the former accurately reflects the latter. What the courts say Case law offers useful guidance on how to tackle this analysis. Costs incurred after termination of a lease cannot be recovered; for expenses during the said term to “be expended or incurred or become payable”, the work must have started by the expiry date (Capital and Counties Freehold Equity Trust v BL plc [1987] 2 EGLR 49). The landlord can only recover for works or services if this is expressly provided for under the lease terms. There is no presumption that a landlord should be able to recover 100% of its costs as the service charge function is for the landlord to recoup expenditure laid out in conformity with the provisions of the lease (Rapid Results College Ltd v Angell [1986] 1 EGLR 53). Where a lease allows a landlord to recover a “fair proportion” of costs “reasonably and properly expended or incurred” a court has found that, where a lease is for a term of only three years, a fair proportion should reflect the shortness of the term by reference to the expected life of (in this case) the new roof and the unexpired period of the term. The works would benefit a prospective new tenant, rather than being necessary for the incumbent one, especially given that sufficient temporary repair works had been carried out during the term and paid for by the tenant (cottish Mutual Assurance plc v Jardine Public Relations Ltd [1999] PLSCS 74). The approach of taking into account the proximity of the term expiry date in assessing what a tenant could fairly be expected to pay for was also a factor in ascertaining whether the landlord could properly recover for replacing air conditioning plant still in working order, but which had reached the end of its estimated lifespan. In this case, the judge commented that the landlord cannot overlook the limited interests of tenants who are having to pay for the carrying out of works which are calculated to serve an interest extending beyond the lives of the tenants. (Fluor Daniel Properties Ltd v Shortlands Investments Ltd [2001] 2 EGLR 103). In Southwark Roman Catholic Diocesan Corporation v Brown’s Operating System Services Ltd [2007] EWCA Civ 164; [2007] PLSCS 44, the lease allowed the landlord to include a provision for expected future expenditure in the service charge clause. However, this could only extend to expenditure likely to be incurred during the currency of the lease. The lease did not provide for the creation of a reserve fund, and therefore any unspent money held by the landlord at the date of termination of the lease should properly be returned to the tenant. Friends Life Management Services Ltd v A&A Express Building Ltd [2014] EWHC 1463 (Ch); [2014] 2 EGLR 53 followed Southwark; costs incurred after the term could not be charged, notwithstanding a provision allowing for “anticipated expenditure in any future financial years in respect of the services”. The service charge should be apportioned to reflect the termination date of the lease. Where a landlord has forgotten to claim for the cost of works it was entitled to under the lease, and the lease prescribes the contractual route down which the landlord must travel to be entitled to payment, then the landlord must follow that route in order to obtain payment. (Leonora Investment Co Ltd v Mott MacDonald Ltd [2008] EWCA Civ 857; [2008] PLSCS 217). The court will not imply a term providing for the tenant to obtain a refund of rent which it has paid quarterly in advance if it exercises a break right and the lease determines between rent payment days. However, the court commented that the service charge could be refunded in this instance as the lease provided a mechanism for the service charge to be apportioned. (Marks & Spencer plc v BNP Paribas Securities Services Trust Co (Jersey) Ltd [2015] UKSC 72; [2016] EGLR 8). Lessons to learn The theme running through these cases is that the courts will adhere to the drafting of the lease. It will not imply a liability for service charge costs where there isn’t one, but equally the tenant must meet costs which are expressly set out within in the lease, notwithstanding the fact it might be a bad bargain. The same goes for ensuring that the landlord has properly followed the procedure for invoicing, both in respect of the on account requests for payment and any balancing charge. The final negotiation of the drafting of the clause will come down to the relative bargaining positions of the parties. The landlord may also want to consider implementing a reserve or sinking fund. In Secretary of State for the Environment v Possfund (North West) Ltd [1997] 2 EGLR 56, the tenants paid into a depreciation fund for the eventual replacement of an air conditioning plant, but the plant was not replaced during the term. The court held that this was a cost incurred by the landlord each year for the cost of depreciation of the plant and that the tenants were not entitled to a refund. In Southwark, the case turned on the fact that there was no sinking fund and so the landlord was not entitled to charge for costs incurred after the expiry of the term. The RICS code of practice Service Charges in Commercial Property (3rd edition) is set to be superseded by a new professional statement on best practice in the management of service charge in commercial property. The statement sets out core principles, in accordance with which professionals involved in the management of service charge should act, but is not mandatory, and the drafting of the relevant sections of the lease will still be the determining factor as to what the landlord can recover. Suzanne Hooks is a senior associate and Selina Badiani is a trainee solicitor at Bristows LLP