Service charges – who decides what is fair?

Service charge clauses in leases are commonly drafted so that the tenant will pay a “fair proportion” of the cost of services provided to a multi-occupied building, shopping centre or estate.  The lease will usually stipulate that the landlord will decide on the proportion payable after taking into account the use of services by the various occupiers.  But when the tenant disagrees about the share of service charge being demanded, who has the last word on whether the landlord’s assessment is fair?

This situation was considered in the recent High Court case of Criterion Buildings Ltd v McKinsey and Company Inc United Kingdom and another [2021] EWHC 216 (Ch).

Facts

McKinsey was the tenant of offices in part of the Criterion Building in Piccadilly Circus which included three properties: the Criterion Theatre, the Criterion Restaurant and Lillywhites the sportswear retailer.  Under the service charge provisions in the lease McKinsey had covenanted to pay a “due proportion” of the total cost of the services and expenses specified.  This proportion was defined as “a fair proportion to be determined from time to time by the landlord taking into account the benefit that was derived”.

Disputes arose between McKinsey and its landlord Criterion over the proportion of the service charge allocated to them.  By 2019, the arrears of service charge had reached £2.2M plus interest and Criterion sued for the amount due.

McKinsey objected to the claim by raising two main issues:

1. Whether Criterion had apportioned the service charges due between the various tenants of the building in accordance with the provisions in the lease. McKinsey’s case was that the “due proportion” of costs charged did not comply with the lease because it was not “fair” when assessed on an objective standard.  McKinsey argued that the way in which the service charges had been apportioned favoured another tenant (the Criterion Theatre and Criterion Restaurant) resulting in them paying too high a percentage.
2. Whether Criterion had properly operated the sinking/reserve fund provisions in the lease. McKinsey argued that some payments charged by the landlord as contributions to a sinking fund were not contractually due as they were being used to fund routine service charge costs.

Decision

On the facts, the High Court found in favour of Criterion and held that McKinsey’s objections failed on the points it had raised:

1. Apportionment. The court held that when apportioning service charge between tenants, the decision as to what constitutes a “fair proportion” is one for the landlord to make rather than the court.  It is for the tenant to establish (and not the landlord) that it has been charged more than a “due proportion” of the service costs.  It was also acceptable for the landlord to make a subjective decision in relation to apportioning the charges subject to that decision being rational.
2. Sinking/reserve fund. The lease specified that Criterion was permitted to demand an amount “it reasonably determines is appropriate to build up and maintain” the relevant fund.  McKinsey had not shown that Criterion had made unreasonable decisions as the service charge contributions to sinking funds were to be spent during the following years.  It was not possible for any unspent advance payments to be returned, as the sinking fund was subject to a trust to be spent on certain types of expenditure.

Practical points

This is a helpful decision for landlords as it confirms that provided a landlord acts with rationality, it has the ability to determine apportionments and it is for the tenant to prove otherwise.

An interesting point made by the judge was in relation to the claim by the tenant that the decision should be an objective one.  He commented that the proportion of the service charge payable by each tenant made no financial difference to the landlord (the landlord has “no axe to grind”) so on that basis, the landlord is able to make a subjective decision about the percentage.

However, it is advisable for landlords to keep evidence of how they calculate the apportionments of service charge in case they are challenged at a later date.

For tenants, it is a reminder that they should check the service charge clauses carefully so they are aware of how the charge is apportioned and also understand the landlord’s methodology for calculating this.  Unless the tenant can prove its landlord’s decision is irrational then they will be bound by it and the courts will not interfere.

If you would like to discuss this topic in further detail, please contact David Hobbs, Partner.