CHAPTER ONE – THE CONSTRUCTION OF THE SERVICE CHARGE CLAUSE
Introduction
The drafting of a service charge clause is paramount. Unlike residential service charges, commercial service charges are not subject to statutory controls and the service charge clause needs to be appropriately drafted. A Court will look at the wording of the lease as a starting point for dealing with most disputes. In addition, a badly drafted service charge clause can lead to numerous disputes regarding interpretation which could be avoided.
The main elements of a service charge clause
The main elements of a service charge clause should be as follows: –
- A definition of the services to be carried out.
- Details of the landlord’s obligation to provide the services.
- Details of the tenant’s obligation to contribute to the costs of providing those services.
- The mechanics of the service charge.
Defining the services
This is usually firstly a list of services which the landlord must provide for the communal areas of the property and secondly a list of services which the landlord can but is not obliged to provide.
The services specified will depend on what is applicable to the particular property, but it should be as detailed a list as possible and aim to cover all the services that could be provided.
The lease may also contain a sweeper clause. The purpose of a sweeper clause is to effectively cover any additional services the landlord may provide which are not specified in the list of services contained in the main service charge clause.
Practitioners should be wary of the inclusion and drafting of sweeper clauses and aim to restrict the clause to being tied to the categories of services that they have specified in the main clause. Sweeper clauses are construed quite restrictively, and there is no guarantee that the inclusion of a sweeper clause will allow the landlord to recover costs for any services that become necessary, or they decide to carry out that are outside of the those provided for.
Relevant Cases
Fluor Daniel Properties Limited v Shortlands Investments Limited [2001]
Provided that sweeper clauses shouldn’t be used to try and recover service charges for a service which the landlord has simply failed to provide for in the service charge clause in error.
Boldmark Limited v Cohan and another [1986]
It was held that the landlords attempt to claim interest that was incurred as a result of borrowing to finance the provision of services was not recoverable under a sweeper clause that provided for recovery of service charges for general administration and management of the property.
Excluded Services
Certain services are likely to be excluded from the calculation of a service charge.
- Original Setting-up costs for the development
If the landlord has incurred costs in setting up the development the tenants should not be liable to pay the costs of these set up costs. This has been held to include providing initial items such as cleaning equipment for use in common parts of the development.
- The costs of repairing latent and/or inherent defects
The tenant will not want to bear the cost of repairing any defects in the construction of the development. A tenant may agree to accept that these costs fall within the service s due if there is an obligation on the landlord to enforce its rights against the original party responsible for the defect i.e., the contractor or engineer. However, the question would then be whether the tenant is responsible for the costs of this enforcement action against the third party.
- The landlord’s costs in relation to breaches of covenants by tenants.
Tenants will wish to exclude any costs incurred by the landlord in pursuing a different tenant or tenants for failure to pay the service charge due or breaches of covenant. This would seem unjust if the tenant liable to pay the costs is up to date on their payments and has not breached the lease.
Relevant Cases
St Modwen Developments (Edmonton) Limited v Tesco Stores Limited (2006)
The costs in relation to the breaches of covenants by tenants will not be excluded automatically.
Plantation Wharf Management Company Limited v Jackson & Another (2011)
The Upper Tribunal had to decide whether a lease must contain an express reference to ‘legal costs’ for the landlord to recover its legal costs of taking action against defaulting tenants through service charges. It was held the legal costs could be recovered even though the service charge clause did not set out that legal costs were payable. Despite the failure of the lease to reference legal costs, it was decided that the legal costs could be recovered on a fair construction of the lease.
- Costs of rent collection
Tenants may want to try and exclude this expense from the service charge provisions. However, if the managing agents have the right to charge a single management fee under the lease that is inclusive of rent collection it is going to be more difficult for the tenant to argue it should be excluded.
- Costs relating to empty lettable units.
In developments there can sometimes be one of more units that are empty. Tenants need to ensure that the landlord is liable to contribute the part of the service charge that would have been payable by the tenant of the unlet unit. Whether this is possible is likely to depend on the method of apportioning the rent that has been adopted for the development. Apportionment of service charges is discussed later in this book.
Services that should be credited to the service charges paid.
- Any generated income
If there is anything in the development that is generating an income a tenant will want the income generated to be credited to the service charges due. An example of generated income would be a car park in a centre that charges money for the public to use. In these circumstances, the Code gives the option of the landlord including both the income and cost of upkeep of the car park in the service charge provisions or for the landlord to exclude both the costs and the income from the tenant’s service charge provisions.
Another example would be where there are utilities that belong to a third party which are shared between the centre or development and the adjoining property. If the third party which is using the utilities is under an obligation to the landlord to contribute to the cost of repairing those utilities, any sums paid by that third party should be credited to the service charges due from the tenants.
- Insurance money
There is some overlap between service charges and insurance money. When insurance money is received in respect of items that the tenants are responsible for under the service charge provisions, the insurance money should be credited to the service charge account.
One of the common issues is that when there has been damage by an uninsured risk, the landlord will usually have to continue with their obligation under the lease such as providing the services and carrying out repairs. Similarly, the tenant will still be liable to pay for those services carried out. This can cause issues when the property has been substantially damaged and, in some circumstances, no longer useable. The service charge provisions therefore need to be carefully drafted to cover such scenarios.
Landlord’s obligation to provide the services
It is crucial that a service charge clause sets out that the landlord is obliged to carry out the services detailed. If not, a tenant is potentially left living in a property where the common areas may fall into disrepair.
There is sometimes an obligation on a landlord to carry out some services and then a clause that sets out the services the landlord can provide if they choose. In respect of the latter the tenant will be under an obligation to pay for those services if carried out, but the landlord does not have to carry out those services.
The clause can set out that the landlord’s obligation to carry out the works are conditional on the tenant paying the service charge due. However, practitioners should be aware that this may not be enforceable if other tenant have paid their service charge contributions. In addition, a Court is likely to be reluctant to allow a landlord to withhold services which are considered essential.
Relevant Case Law
Yorkbrook Investments Limited -v- Batten [1986]
The landlord’s covenant to provide services began: “Subject to the Lessee paying the Maintenance Contributions pursuant to the obligations under Clause 4 hereof”. The tenant withheld their payment of the service charges in respect of the maintenance contributions as they believed the landlord was in breach of its obligations under the lease. It was held that despite the tenant’s non-payment the landlord was still under an obligation to provide the services and that the wording of the clause did not amount to a condition precedent when the lease was read as a whole.
Tenant’s obligation to contribute to the service charge
The service charge provisions should state that the tenant is obliged to pay for the services specified and also deal with the below.
The apportionment of the service charge
The apportionment of service charges between the tenant is usually one of the following:
- By way of fixed proportions. This method provides certainty. However, it is quite inflexible and can be unfair if the building is later developed/extended. If the fixed proportion is a percentage, tenants should also be wary as if any of the flats in the property are not let, they are likely to have to pay a higher sum towards the service charges unless provision has been specifically made for this occurrence.
- The tenant is asked to pay a fair proportion. This method of apportionment is likely to lead to disputes because what is ‘fair’ is open for interpretation. What a landlord and tenant consider to be a fair proportion is likely to differ.
- By reference to floor areas. Although to a degree this method seems fairer it can sometimes be difficult to calculate.
- By reference to rateable value. Again, this seems one of the fairer methods but can cause problems if the property is a new build and no rateable values have been set or in cases where there have been any improvements to the property.
As can be seen from the above, specifying how service charges are to be apportioned is a difficult task. Disputes can arise no matter which method is used, and all practitioners can do is try and choose the method which appears to be the most fair and reasonable for the particular property.
Relevant case
Aviva Investors Ground Rent GP Ltd and another v Williams and others [2021]
A tenant’s lease required them to pay service charges that was stated to be a fixed percentage of a proportion to be reasonably determined by the landlord. The Court of Appeal held that section 27A (6) of the Act rendered the landlord’s discretion void. The discretion was transferred to the First Tier Tribunal to determine the proportion of the service charge.
How tenants are to pay the service charges
The service charge clause needs to set out how the tenant is to pay the service charges. The usual way is for the tenant to make quarterly payments on account during each service charge year.
The clause should also provide for any additional sums that may become due at the year-end due to a shortfall once the service charge accounts have been finalised or any surplus of funds at the year end.
The Mechanics of the Service Charge
For any workable service charge clause there needs to be provision for the following: –
- The Service charge year – the tenant needs to know the period for the service charge accounts are to be prepared.
- Provision for the statement of account to be prepared. This needs to set out who is to prepare the statement and who is to certify the statement. It is important that the landlord then follows this requirement to avoid the statement of account being invalid and providing a defence to the payment of the service charges that have arisen.
- A timetable for preparing the service charge accounts. This can just be a requirement for the landlord to provide the accounts as soon as reasonably possible if the landlord is concerned about being tied down to a strict period. The important thing for landlords to note is that there shouldn’t be excessive delay and a period of approx. 4 months after the end of the service charge year is usually deemed reasonable.
- How any disputes regarding the service charges are to be dealt with. This will normally set out if there is to be a referral to a third party.
Summary
Practitioners need to take great care when drafting the service charges provisions in a lease. They should take into account the 4 areas set out above and also ensure that they include as many services as possible as well as account for all possible scenarios. It is a difficult task but the more detail that is provided and the clearer the provisions are at the outset will lead to less disputes over interpretation.