House of coins

Recently there has been much written in the press about how consumers are blindly paying insurance policy renewal premiums by direct debit and how this is allegedly allowing insurance companies to increase premiums without any competitive justification.  So could service charge payments be the same for tenants? Are they a hidden expense? Wasted money? 

Unlike rent and rates, which tend to be fairly constant and predictable, service charges can be a fluctuating and unexpectedly expensive item for a business tenant.  To ensure that tenants are not wasting money or paying unnecessary hidden expenses they should be checking that they are actually liable for the charges being demanded.

The tenant’s lease is the first port of call for any tenant wanting to check the validity of a service charge demand.  The lease should set out the services that are to be provided by the landlord and the costs and expenses that can be recovered.

To make sense of the lease terms, tenants will probably need to see a breakdown of how their service charge has been calculated and the allocation of the costs of providing the services.  A tenant should be entitled to request this information under the terms of the lease but, again, this should be checked.

A lease that has been well negotiated for a tenant will provide a detailed list of what services and costs are to be included in the service charge and those that are to be excluded.  So the initial question should be: Are the items that are included in the service charge demand actually allowed to be included?

Many leases will exclude items of improvement and also repairs unless they are beyond economic repair.  If a landlord is trying to pass on costs which are actually improvements, and therefore capital expenditure which is in reality for the landlord’s long term benefit, then it may be that the lease terms will allow the tenant to challenge these costs.

Even if a lease does allow for items of improvement to be included the courts have taken the view that in some circumstances the extent of the tenant’s interest in the premises, or the lack of it, still needs to be considered. This means that it may not be reasonable for a landlord to seek to recover large capital costs (such as the replacement of a roof or resurfacing of a car park) from a tenant who only has a short period left to run on its tenancy.  The tenant will probably not get sufficient benefit from the new roof or resurfaced car park to justify the cost being passed on to the tenant.

Having established that the items of costs that have been included in a demand are valid, then the second question a tenant needs to consider is whether the lease requires the landlord to charge only a reasonable cost. This may be expressly stated, and commonly is in modern leases, or implied in older leases. This is a more complex area to dispute and a tenant should not assume that reasonable cost equals the cheapest. The industry guidance would suggest that the principle is for the cost to be an appropriate value in order to provide the service effectively.

Unless the lease terms actually require a landlord to have regard to the code a tenant cannot insist upon the landlord following it but, there is a voluntary industry guide to service charges produced by the RICS. The RICS Code of Practice for Service Charges in Commercial Property.  Some landlords are now voluntarily adopting the code.

The overriding ethos of the code is that a service charge is not meant to be there to make a profit for a landlord. The code stresses that a service charge arrangement should be transparent and value for money.

Landlords will need to change their historical attitude to leases if they are to adopt the code.  For landlords the traditional starting position has always been that they should be able to recover 100% of the costs of providing services.  This allows landlords to receive a ‘clear income stream’, in other words, the ability to receive the rent without any deductions.  In new leases landlords are now becoming more willing to be flexible in their approach by adopting aspects of the code. Also, given current market conditions, many tenants are even able to negotiate service charge caps.  Such caps give the tenant some comfort as to its total maximum liability in any one year.

If landlords are managing their properties in accordance with the code then they should not be worried about having to demonstrate to their tenants that the service charge is value for money.

At the end of the service charge year, tenants should not be afraid to ask for the statement of accounts and evidence of reconciliation of those accounts that they are entitled to under their leases.  The landlord should ideally be providing the tenant with both the budget and the actual finalised account.  The tenant can check the accounts against the terms of its lease considering whether the costs recovered are allowed and are not of a capital nature; that any apportionment is correct; and raise any queries.

As already mentioned, some landlords are voluntarily agreeing to adopt the code in respect of old leases and agreeing to adhere to it as a term of new leases.  This is part of a wider industry change where some landlords are now seeing the landlord and tenant relationship as more akin to a supplier and customer relationship rather than purely as an investment one.

Tenants should be taking the time to look at their service charge demands and landlords should be considering whether they want to attract new tenants, and indeed keep existing tenants, by showing innovation and adhering to the guidance on service charges.

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This blog is intended only as a synopsis of certain recent developments. If any matter referred to in this blog is sought to be relied upon, further advice should be obtained.