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Service charges and insurance (general)

This page deals with the following points in relation to service charges and insurance
  • The ability to charge a management fee where there is no express clause providing for such payments.
  • Insurance rent - requirement to pay where no formal demand
  • The importance of the landlord accurately using the procedure in the lease.
  • The difference between reserve and sinking funds.
  • What happens to unused money at the end of the term?
For a more detailed looked at service charges in the context of residential leases go to "Long leases".


Management charges

St Modwen Developments (Edmonton) Ltd v Tesco Stores Ltd
[2006] EWHC 3177 (Ch)

Introduction

There were in fact three points in this case, which demonstrates the importance of paying careful attention to the drafting of service charge clauses; and on the need carefully to check those clauses on assignment of the lease, or as in this case, the reversion. There is a useful discussion of the position where there is no express clause permitting the landlord to recover a management charge.

Borough Treasurer's certificate

Tesco was the tenant of premises in Edmonton Green shopping centre under the terms of a 99 year lease dated 18 June 1974. The lease was originally granted to Enfield London Borough Council and it provides that the tenant shall pay service charge by way of further rent subject to:
    "The amount of the service charge [being] ascertained and certified annually by a certificate signed by the Council's Borough Treasurer"
The landlord's interest passed to the claimant in this case (St Modwen Developments). The lease contained an extended definition of "tenant" to include successors in title but there was no similar extended definition of landlord. It was common ground between the parties that references to "the Council" in the lease take effect as though they were references to St Modwen. However, the tenant argued that references to the "Council's Borough Treasurer" could not be construed as references to St Modwen's equivalent financial officer, namely the financial director. The court (Toulson J) placed great emphasis on the fact that the "Council's Borough Treasurer" was "somebody of known and well established status" (para 8) and held that the parties had not, when the lease was granted, anticipated that the person who might happen to have such a financial role in any future assignee organisation would have the power to create legal liability to pay. In the absence of the borough treasurer, the court found that the mechanism for determining the service charge amount provided for in the lease was of no effect. Accordingly, although the landlord retained the right to recover the service charges there was no mechanism to ascertain the amount and the landlord would have to establish its claim in court by full evidence (subject to the arbitration provisions in the lease). Accordingly, the service charge certificates issued by St Modwen were of no contractual force although they did in practical terms set out the sums claimed.

Removal of refuse

The court also looked at Tesco's refusal to pay that part of the service charge associated with removal of refuse from the common parts. Tesco argued that some of the refuse actually belonged to another tenant who had failed to prevent its refuse from spilling over into the common parts, and further that it removed its own refuse and that the landlord's covenant to keep the common parts clean did not extend to such costs. The court found that such costs did fall within the terms of the lease - whether within the landlord's covenants to keep the common parts clean, or as part of its overall management of the centre.

Management charge

Finally, the court looked at St Modwen's addition of a 10% management fee to the service charges. The court accepted that this was in line with modern practice, and that clearly management time had to be spent managing the centre. However, the lease did not allow for the recovery of such charges so that St Modwen were not entitled to such a figure in the absence of any investigation into the actual costs of providing the services in question. See in particular paragraph 34 of the judgment for some guidance in determining a fair percentage figure:
    "As a matter of principle, the parties are agreed that the right place to start is with the services that are themselves to be provided. The amount that St Mowden can charge for them is not necessarily confined to the lowest tier of employee or agent who provides the service. Some costs of middle and upper management may be recoverable if it can be demonstrated that their time has indeed been spent in ensuring that those services are provided. The further up the hierarchy one goes, the more difficult it may be to establish the amount of time that has been spent referable to the provision of the ultimate service. However, that is a matter of evidence, not a matter of principle. Ten per cent as a percentage has no magic value.."

Insurance rent

Request for payment

Patel v MRD Property Developments Ltd
[2012] EWCA Civ 727

Summary

Handing copies of written correspondence and copy renewal notices from the insurer constituted a valid demand for payment under the lease.

Facts

L had let commercial property to T for 15 years. The lease provided that:
  • The tenants pay "by way of further rent, the Insurance Rent payable within 14 days of written demand." (clause 4.2)
  • The tenants "pay the rents on the days and in the manner set out in clause 4";
  • "Insurance Rent" was defined in one place as as "the sums which the Landlord shall from time to time pay by way of a premium for insuring the Premises against [specified] risks set out [the Lease]" and in another place as "The gross sums that the Landlord from time to time pays … by way of premium for insuring the Premises …"
L sought to forfeit the lease. One of the key issues was whether the insurance rent was due. T argued that the arrears wrongly included sums in respect of insurance rent which had not been properly demanded and so were not due from them.

Although there were no formal demands for payment of the insurance rent, the landlord had provided copies of the insurance renewal demands from the insurance company to the tenants.

First instance

In the absence of any prescribed form of "written demand" the judge held that a reasonable person in the position of the tenants would have concluded that those demands were indeed "written demands" in accordance with the lease.

Decision on appeal

A written demand for insurance rent had been made in accordance with the lease.

The court considered the comments of Lord Steyn on the construction of commercial contracts in Mannai Investment Co. Ltd v Eagle Star Assurance Co. Ltd [1997] AC 749 that:
    "words are... interpreted in the way in which a reasonable commercial person would construe them. And the standard of the reasonable commercial person is hostile to technical interpretations and undue emphasis on niceties of language." (para 771B).
Clause 4.2 (see above) required a written demand, so the crucial question was what was meant by that? As Ward J said,
    “What would the reasonable man have understood to be the purpose of being handed Aviva's renewal notice? He would know his obligation to pay the additional Insurance Rent as prescribed by clause 4.2.”
A reasonable person would have known that the landlord was requesting payment on provision of the renewal notice, and therefore the landlord had validly demanded insurance rent.

Comment

The court made it clear that had the lease required a “written demand made by the Landlord of the Tenant” the mere provision of the insurer’s renewal notices would not have satisfied this requirement.


Procedure in the lease

Need to get it right

Leonora Investment Company Ltd v Mott Macdonald Ltd
[2008] EWCA Civ 857

Summary

This case demonstrates the importance of following the service charge procedure in a lease. The landlord failed to include the cost of works to the common parts in a service charge statement required by the lease. As a result the tenant was not obliged to pay a service charge invoice (for £263,117) arising out of works to the common parts. The obligation to pay the service charges had not therefore arisen.

Facts

The case concerned four floors of a multi-storey office block let by L to T under four separate leases. The leases were on identical terms. Each one provided that T would pay a fair proportion of the service charge costs for each service charge year. The proportion was to be assessed by L or its surveyor, according to a reasonable and proper basis of apportionment from time to time. The service charge was defined as follows:
    “The Service Charge to be paid by the Tenant shall be such fair proportion (which may if appropriate be the whole amount) of the actual or anticipated Service Costs for each Service Charge Year which shall be assessed by the Landlord or its Surveyor according to a reasonable and proper basis for apportionment applicable from time to time to the Premises."
The lease further provided that, at the end of the service charge year, L would prepare a statement of the actual service charge costs. If this resulted in an overpayment having been made by T, this would be credited to the tenant. If the end of year statement resulted in a deficit, this would be demanded from the tenant:
    “3. The Landlord will (unless prevented by causes beyond its control) prepare and send to the Tenant a statement of the actual Service Costs and Service Charge for each Service Charge Year as soon as practicable after the end of such year and in the event of the Service Charge for the Premises exceeding the aggregate amount paid by the Tenant for such year the Tenant will pay the balance due to the Landlord within fourteen days of demand and in the event of the aggregate amount being greater the excess will be credited by the Landlord by way of set-off against the next instalment of Service Charge due from the Tenant but so that any credit held for the Tenant shall be refunded to the Tenant on the expiry of the Term.”
L prepared such a statement for the year ending 24 December 2002 but later discovered an item of expenditure had been omitted by mistake and wrote to T seeking payment. T refused to pay arguing that L had only one opportunity of raising a balancing statement.

First instance

At first instance, the court found that, on the terms of the lease, there was no such restriction although it went on to hold that the demand for the extra payment was not made in accordance with the lease. The further demand should have included a revised statement of total service charge costs for the service charge year in question and should have set out the proportion payable by T under each of its leases; and on that basis alone the court held T had no liability to pay the extra sum as demanded.

Appeal

The Court of Appeal, in a short judgment given by Tuckey LJ, dismissed L’s appeal saying:
    “20. ... When paragraph 3 talks of the balance due it must be intending to refer to any amount due from the tenant whether or not he has made advance payments. The statement he is entitled to receive will show him what that amount is and how it has been calculated.
    22 …..I do not see this as a case in which the leases contain a condition precedent to the landlord's right to recover. Rather they prescribe the contractual route down which the landlord must travel to be entitled to payment. ……. The statement will be of considerable importance to the tenant. It gives him information about the actual service costs for the past year, which only the landlord will know, and how they have been apportioned to him so that he can make an informed decision as to whether to pay or not in the knowledge that the landlord may acquire a right to forfeit if he does not.”
    23…. the judge was right to decide that the landlord was not entitled to payment of the invoice because it had not followed the paragraph 3 procedure and its requirement for provision of the statement of service charge which triggered the obligation to pay …"
Conclusion

The court left open the possibility that the lease could be interpreted to say that the landlord had only one opportunity of getting the procedural requirements right, although it thought it unlikely in a commercial context:
    "24. The conclusion I have reached may seem harsh or over technical, but if so it results from what I consider to be the proper construction of the leases. No one has challenged the judge's conclusion that it was open to the landlord to issue a revised statement. Nor would I. Provisions of this kind should not be seen as procedural obstacle courses. Businessmen dealing with one another often make mistakes and there is no scope for saying that the provisions in this clause only gave the landlord one opportunity to get it right. I say nothing about the landlord's prospects of being able to get it right even now, because we have not heard argument about this. But for the reasons I have given I would dismiss this appeal."

Reserve and sinking funds

Terminology

The terms “sinking fund” and “reserve fund” are not usually seen as synonymous. The purpose of a sinking fund is generally regarded as being to provide for expenditure which may be incurred no more than once or twice during the lifetime of a lengthy lease on specific items such as lifts, central heating boilers, air conditioning plant and roofs. In that sense it is essentially a replacement fund. A reserve fund, on the other hand, tends to be established to meet recurring expenditure, such as external decoration costs, in such a way that fluctuations in the annual amounts of service charge are avoided. It is essentially an equalisation fund.

Advantages and disadvantages

Sinking funds or replacement funds in particular offer some very obvious advantages. The landlord will have money available before incurring major expenditure, and the tenant will not be faced with a disproportionately high service charge bill in any one year. Against that, of course, there are some equally obvious disadvantages. The tax treatment may be adverse, and management and administration can be complex. (It may be preferable from the landlord’s point of view if the lease gives him the option of establishing a sinking fund rather than obliging him to do so.). Unless the fund is held on trust, the tenant may become an unsecured creditor of an insolvent landlord.

Furthermore, in the case of both sinking and reserve funds, the tenant may be required to contribute to future expenditure from which it will derive no benefit if the lease expires before the work is carried out. The following cases illustrate this particular problem for tenants.


Unused money at the end of the lease?

What happens to it?

In Secretary of State for the Environment v Possfund (North West) Limited [1997] 2 EGLR 179 the tenant, as part of the service charge, had made quarterly payments to the landlord that were set aside in a separate fund earmarked for the air-conditioning plant serving the premises. On the expiry of the lease almost twenty years later, the money had not been spent. (At the date of the hearing the fund was worth £1 million.) The tenant claimed that it was entitled to recover the money.

Rimer J held that once the payments were made they became the absolute property of the landlord. They had not been made on account of future expenditure. Their purpose was to indemnify the landlord against the cost incurred by virtue of depreciation each year of the plant. In that sense they were a depreciation allowance. (One factor against the tenant’s contention was an absence in the lease of any machinery for repayment.)

However, this decision was distinguished in Brown's Operating System Services Limited v Southwark Roman Catholic Diocesan Corporation [2007] EWCA Civ 164

The facts

This case concerned a service charge provision in a 15 year lease with a tenant's break clause.

The tenant was obliged under the terms of his lease to pay service charges as additional rent being the tenant's contribution towards the costs of the services the landlord was obliged to provide. Those services included the usual repairs, building maintenance, heating, insurance, cleaning, maintenance of car park and gardens etc. Also included in those services was the ability of the landlord to make "reasonable provision for expenditure likely to be incurred in the future". There was no provision within the lease for the setting up of a reserve or a sinking fund, nor did the landlord set one up.

The landlord had been in the habit of demanding on account service charge payments from the tenant that were higher than the anticipated and actual cost of the services provided, and then carrying forward the balance each year "on account of future expenditure" (but in fact never using this surplus). By the time the balance of the "on account of future expenditure" held by the landlord reached £17,000, the tenant demanded a service charge holiday. The landlord refused and the tenant then exercised his break clause under the lease, refusing to pay the last two quarters service charge of almost £10,000. The landlord sued for that sum (with interest) and the tenant counterclaimed for the balance of the monies held "on account of future expenditure" as being rightfully his.

At first instance, the court held that the "on account" amount was the landlord's money, that it had been built up for the benefit of the building and that the landlord was entitled to retain it at the end of the lease.

Decision

The Court of Appeal overturned that decision, and found in favour of the tenant. Lady Justice Smith:
    "the lease permitted the landlord to include in the total service cost a reasonable sum for future repairs and renewals. However, the lease did not provide for the creation of a reserve fund. Nowhere in the lease does the expression 'reserve fund' appear." (para 29)
She did however accept that the lease provided that monies could be held by the landlord either in reserve or retained as excess, but emphasised that this was not a reserve fund. She then went on to look at the provisions of the lease in order to decide what should happen to any money held by the landlord when the lease came to an end, in the absence of any provision on that point in the lease. The only provision was that such money was to be applied (paragraph 2(d) of the 3rd Schedule of the lease) to meet authorised expenditure in each succeeding year. From that paragraph, Lady Justice Smith inferred that such money belonged to the tenant and should therefore be returned to the tenant at the end of the lease regardless of whether the lease expired by effluxion of time, or (as in this case) was ended by the operation of a break clause.

Comment

This was not a reserve or sinking fund case. Under its lease, the tenant had no liability to contribute through the service charge to repairs that took place after the end of the lease, so sums not spent by then had to be returned to the tenant. The decision was based on the lease wording, which failed to provide for how excess service charge monies would be managed.

The case highlights the importance of considering at the outset who is to be entitled to excess service charge monies when the lease is terminated, and then drafting the lease clearly to reflect the parties' intentions.

Where a fund is set up a tenant will also wish to know that:
  • It is held in a separate designated account.
  • The purposes for which it can be used are clearly stated.
  • Contributions have been calculated against reliable estimates.
  • It will be properly invested and income will accrue to it.
  • It cannot be used in respect of expenditure incurred after lease expiry.
  • It is held on trust for the tenants for the time.


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