Property Focus November

Service charges in commercial property - how to reduce the arguments

To say that service charges are a fertile ground for disputes is an understatement; Jonathan Gaunt QC summed up the situation perfectly when he stated that “a more potent recipe for expensive and unproductive litigation it would be difficult to devise”.  His comment, which was made in the 2006 case of Princes House Ltd and another v Distinctive Clubs Ltd, highlights the opposing views of landlords and tenants in relation to service charges, but is it possible to lessen the risk of dispute?

Careful drafting is key and in this alert we will look at what landlords should consider in service charge provisions and what view the courts are likely to take.

Impact of the RICS Professional statement, Service charges in commercial property (Statement)

Unlike residential leases, there are no statutory controls for commercial service charges and so the parties are free to negotiate terms.  The main guidance is contained in the Statement which sets out best practice for the management and administration of service charges.  The Statement imposes mandatory obligations on RICS members, although it is not binding on the parties or their lawyers, and recognises that it cannot override the terms of a lease.  However, if the provisions of the Statement are incorporated in the lease then they will be binding on the landlord and increasingly, the courts will look at RICS guidance particularly in relation to whether service charge provisions are reasonable.

What can the landlord charge for?

The landlord cannot charge for items which are not specified in the lease and so a comprehensive list of services should be included.  In addition, a tenant will not generally be expected to pay to upgrade or improve the landlord’s property as opposed to repairing it. 

Anticipating future expenditure can be particularly tricky, for example in relation to energy saving where improvements often need to made, and so the landlord may want to include a “sweeper” clause to catch any items of expenditure which have not been included in the original list.  However, this type of clause is likely to be narrowly construed against the landlord as case law has shown – it cannot be used to “sweep up” items which the landlord has left out of the lease by mistake, or wish it had included with the benefit of hindsight.

Do charges have to be reasonable?

It would seem that unless there is an express term which states that charges are to be fair and reasonable, such a term will not be implied.  This does not mean that the landlord has the ability to charge whatever it wants as was illustrated in the case of Finchbourne v Rodrigues [1976].  The court held that a term should be implied that the costs were to be “fair and reasonable” on the basis that it was never intended that the landlord should have an “unfettered discretion to adopt the highest conceivable standard and to charge the tenant with it”.

Even where the landlord has included an express provision which provides that the service charge must be “reasonably and properly” incurred, the landlord may not be able to recover the full cost even if the works are within the scope envisaged by the lease.  The court in Scottish Mutual Insurance v Jardine Public Relations [1999] held that a tenant under a three year lease was not liable to contribute towards non-urgent roof repairs which were felt to be more appropriate for a longer term letting, even though the service charge provisions in the lease were widely drawn.

Is the landlord’s certificate conclusive?

The lease will usually provide for the landlord’s accountant or some other party to certify the sum payable by the tenant.  Landlords can take comfort from the recent case of Sara & Hossein Asset Holdings Ltd v Blacks Outdoor Retail Ltd [2020] which confirmed that where the lease provides for the certificate to be conclusive, except in the case of fraud, the tenant will be unable to challenge the sum.  The Court of Appeal held that this applied to both the itemised works and total amount as the clause was clear and unambiguous and could not be contested.

There was a similar ruling in Criterion Buildings v McKinsey & Co [2021] where the landlord successfully claimed service charge arrears of over £2 million.  The lease stated that the tenant would pay a “due proportion” of the service charge as determined by the landlord.  The court decided that as long as the lease covered the works done the landlord’s determination would be conclusive save in exceptional circumstances.

Summary

The landlord’s primary intention is to ensure that rents obtainable from a multi-occupied development are not reduced by the landlord having to pay for various services provided to the individual units or common areas of the building or estate.  As case laws show, this is often in direct conflict with the tenant’s aim which is to carve out items from the service charge that it thinks the landlord is liable to pay for.

Ultimately, the content of a service charge clause depends on the relative bargaining strength of the parties, but it should include as a minimum:

• A definition of the services which can be charged for;
• a clearly defined obligation on the tenant to pay towards services which shows how the tenant’s proportion of the overall cost will be calculated;
• which services the landlord is obliged to provide including essential services and other services which may be provided; and
• the mechanics of the service charge which typically will include: dates for payment, how the service charge accounts are prepared and a mechanism for resolving disputes.

Although it is impossible to guarantee that a dispute will not arise at some stage, the risk can be reduced where the lease terms are clear and the parties know precisely where they stand in relation to the provision of services and who is liable to pay for them.

If you would like to discuss this topic in more detail, please speak to James Atkins or Rob Harrison.