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Residential service charges: Be reasonable!

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28/07/2016

Service charges are a common source of friction between landlords and tenants. Residential service charge disputes in particular can be very contentious, especially when hefty charges are levied on unsuspecting tenants, and not least where tenants cannot easily see or understand where the sums charged are being spent, and whether they are reasonable.  A recent case involving ‘sinking’ or ‘reserve’ fund [1] service charges for future exterior maintenance and decoration works brings some clarity in this area, which should be welcomed by landlords and residential tenants alike.

A common scenario

The recent case of Syed Balkhi v Southern Land Securities Ltd [2] arose from the very common scenario where the freehold of a building was owned by a corporate investor (“the head landlord”); who let the interior of several floors of the property, comprising a number of residential units, to a landlord (“the intermediate landlord”); who then sublet one of the apartments to a residential tenant (“the tenant”).

The head landlord retained the exterior and structure of the building and the intermediate landlord was obliged, pursuant to its lease, to pay a service charge towards the head landlord’s costs of doing so. The intermediate landlord’s service charge obligation included a covenant to pay towards a reserve fund entitled the “Landlord’s Estate Charge”.  The tenant was also obliged to pay a service charge which, pursuant to its residential tenancy, was stated to be 20.04% of the intermediate landlord’s total expenditure incurred in carrying outs its obligations in respect of the property, which included making service charge payments to the head landlord.

Service charge dispute

From 2011 onwards the intermediate landlord paid significantly increased Landlord’s Estate Charge sums to the head landlord.  These sums were reserve fund contributions in respect of anticipated future works to the exterior of the building.  In accordance with the residential tenancy’s service charge provisions, the intermediate landlord sought to recover 20.04% of those sums from the tenant.

However, the tenant was shocked to suddenly receive service charge demands for much greater sums than in previous years and he refused to pay. The matter came before the Upper Tribunal (Lands Chamber) (“the UT”).

Decision

The UT noted that section 19 (2) of the Landlord and Tenant Act 1985 [3] provides that where a service charge is payable before the relevant costs are incurred, no greater amount than is reasonable shall be payable.  Any necessary refund or additional payment can then be made after the costs have been incurred.

The UT decided that it was not reasonable for any landlord to demand sums from a tenant simply because it had paid those sums over to its superior landlord. A landlord had to be able to justify, with evidence, that the sums claimed were reasonable.  To do that, an intermediate landlord may have to question its superior landlord.

Legal and practical advice

In the present case there was insufficient evidence to prove that the sums claimed by the intermediate landlord were reasonable. In fact, in reliance on evidence to the contrary provided by the tenant, the UT concluded that the sums claimed were unreasonable.  The UT decided that the sums to be paid by the tenant were significantly less than the intermediate landlord had demanded.

Whilst the intermediate landlord in Balkhi v Southern Land will not have been happy with the outcome, this case helpful for residential landlords and tenants alike in the clear guidance it provides with regard to justifying reasonableness when seeking to pass on sinking/reserve fund service charges.

In light of this case, the following steps should help minimise the potential for dispute:

  • Engaging in more frequent and effective communication with both superior landlords and residential tenants will help intermediate landlords to obtain, and to share, information about anticipated works and/or unexpected or additional service charges.
  • Focus on developing good overall relationships. Tenants who generally enjoy good relationships with their landlords are less likely to bring service charge challenges, than those for whom the landlord/tenant relationship is distant or, worse, hostile or antagonistic.
  • The earlier and better provision of information pertaining to the management and maintenance of a leasehold property helps both landlords and tenants to manage their affairs and accounts more effectively. Forewarned is forearmed when it comes to all property payments, and challenges are much less likely where service charge demands do not come as a surprise.
  • For their own sake and that of their tenants, intermediate landlords should ask superior landlords for explanations and breakdowns in respect of any service charges levied – they should not simply pay in the belief that all sums will be recoverable from under tenants.
  • Finally, before making any service charge demands or payments, landlords and tenants alike should carefully check the terms of the relevant lease, to determine whether recovery of the particular item is permitted.

As an aside…

On a separate but related issue, the UT has also very recently given guidance on the approach to be taken when considering the reasonableness, or otherwise, of a party’s behaviour in bringing, defending or conducting proceedings in a landlord and tenant or residential property dispute. The reasonableness of a party’s behaviour is, of course, relevant when it comes to the question of recovery of costs.

In Willow Court Management v Alexander [4] the UT held that unreasonable conduct included conduct that was vexatious and designed to harass the opponent rather than to advance resolution of the dispute.  It decided that in assessing conduct, a Tribunal should take into account all the circumstances of the case, including whether or not a party is represented and has legal knowledge; and the nature, seriousness and effect of the conduct which is the subject of the complaint. .  Whilst an unwillingness to mediate in a modest case may not necessarily equate to unreasonable conduct, it may well do, and conversely a genuine willingness to engage in ADR is an example of reasonable behaviour, for which credit should be given.

WM Comment

Overall, the message coming out of recent residential service charge case law is clear: be reasonable! It’s a win-win:  if you are reasonable in your approach to your landlord and tenant relationship generally, you are less likely to become embroiled in acrimonious and time-consuming disputes.

If you would like any advice or assistance in connection with any residential landlord and tenant matter, please do not hesitate to contact Karl Anders or any member of Walker Morris’ Housing Litigation and Management Team.

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[1] Strictly speaking a ‘sinking’ fund is monies set aside for the future replacement of wasting assets and a ‘reserve’ fund is monies set aside for future maintenance costs and the like, but in practice these terms are often used interchangeably.
[2] [2016] UKUT 0239 (LC)
[3] This section applies to certain residential tenancies – it does not apply to commercial leases.
[4] Willow Court Management Co v Alexander; Sinclair v 231 Sussex Gardens Right to Manage Ltd; Stone v 54 Hogarth Rd, London SW5 Management Ltd [2016] UKUT 290 (LC)

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