Statutory rules for service charges

Legislation controls the level of service charges. Different Acts have been passed since 1985 to apply to different types of service charges. Disputes about service charges can continue for many years and it is important to apply the law as it stood at the relevant time.

Statutory controls on service charges have applied since the Landlord and Tenant Act 1985 or have been introduced subsequently.

The statutory controls apply to 'variable' amounts of service charges as defined by section 18 of the Landlord and Tenant Act 1985 only; not to fixed amounts, which are not strictly defined as service charges.

Any references to a 'tenant' include references to a long leaseholder.

A tenant is not liable to pay a service charge in respect of costs incurred more than 18 months before the landlord makes a contractually valid demand for payment, unless they have been notified in writing within the 18-month period that:[1]

• the costs had been incurred

• a demand for a contribution through a service charge will be made later

The notification must include a statement that the tenant is required under the terms of their lease to contribute to those costs. It does not need to detail exactly what proportion of the costs the tenant will be liable for.[2]

Application of the rule by the courts

The costs are incurred by the landlord when the underlying liability 'crystalises' - this will be at the point where the landlord is presented with the invoice for the works, or (possibly) when the landlord pays the invoice.[3] The latter point is arguable because it could lead to a situation where a landlord's delay in paying an invoice brings works within the 18-month limitation period.

The time runs from when the present landlord incurs the liability, not from when invoices for works were originally sent to a previous landlord by mistake[4].

Where there is a 'chain' of landlords, for example, a superior landlord and an intermediate landlord, separate 18 month periods arise at the point each landlord along the chain incurs a cost.[5]

This means that a leaseholder may be liable for charges that relate to work carried out more than 18 months before their immediate landlord incurred the cost

A service charge demand is only contractually valid when it is made in accordance with the lease.

In one case, where the lease required that a demand must be accompanied by an estimate of costs and a statement showing the tenant's liability, the Court of Appeal held that demands served by the landlord were only validated from the date the estimates and accompanying statement were served. Service of the estimates retrospectively did not validate the original demand. The service charge was only payable in respect of costs incurred within 18 months of the estimates being provided where this was later than the date the demand was made.[6]

A landlord who has served a contractually invalid demand within the first 18 months cannot rely on that once they are outside the time limit. The rule is similar to a limitation period, which can sometimes result in harsh outcomes for a claimant.[7]

On-account payments

The 18-month rule applies equally to a service charge demand in respect of costs that the landlord will incur in the future, as for costs that the landlord has already incurred. However, the rule only comes into play where the payment made on-account does not cover the actual costs incurred by the landlord and the landlord has to issue a demand for a 'balancing' payment. The 18-month rule will apply to that demand.[8]

Service charges (including payments on account) must be reasonably incurred, and incurred on services or works of a reasonable standard.[9]

If these requirements are not satisfied, the service charges will not be recoverable to the extent that they are unreasonable or (if paid in advance) must be refunded to the extent that they are unreasonable.

Reasonableness is a question of fact

In each case it is a question of fact, depending upon all the circumstances, as to what is reasonable.

There is not necessarily only one reasonable way that a service charge can be incurred. In some situations a landlord may have a choice of reasonable options when carrying out works required under the lease. As long as each option is reasonable, the landlord may decide which to pursue.

In one case, where both repairing or replacing windows were reasonable options, the landlord's choice to repair them gave rise to a reasonably incurred service charge even though the First-tier Tribunal had agreed with the leaseholders that replacement was 'more reasonable'.[10]

The onus is on the landlord to show that its demands for payments on account of costs to be incurred are reasonable. It may (or may not) be reasonable for the estimated amount to turn out to be approximately twice the expenditure in any given year. However, where a landlord had failed to justify why the amounts demanded on account were twice as much as the actual expenditure incurred over a number of years, the Upper Tribunal reduced them by 50 per cent.[11]

Tenants and leaseholders can apply to the First-tier Tribunal for a determination on the reasonableness of service charges.

Where there is an intermediate landlord

In a situation where there is a superior landlord, an intermediate landlord and individual leaseholders, the intermediate landlord will usually seek to recover from the individual leaseholders sums they have paid to the superior landlord in service charges.

Where a leaseholder questions the reasonableness of the service charge claimed from them, it is for the intermediate landlord to justify the reasonableness of the sum claimed – they may need to seek assistance from the superior landlord to do this.[12]

Impact of the charges on leaseholder

It is proper for the landlord to take into account the financial impact of the charges for major works on the leaseholders, although this does not require detailed inquiries into the means of individual leaseholders. They should also consider whether costs (and any works) could be spread over a longer period.[13] A decision not to defer roofing work was held not to be unreasonable, in the absence of any expert evidence to the contrary.[14]

Enhanced duty where works are improvements

Where the works are improvements rather than repairs, the landlord has a heightened duty to consider the financial impact on the individual leaseholder and to give full consideration to alternative, cheaper options.[15]

Terms of the lease cannot supplant the authority of the court or Tribunal to determine reasonableness

Any clause in a lease stating a particular method for resolving the question of reasonableness (for example, a determination by the landlord or its surveyor) is ineffective as these are questions for the court or First-tier Tribunal (Property Chamber).[16] This includes where the lease provides a method of apportionment of a 'fair proportion' of the costs.[17]

However, a fixed apportionment of service charges in the lease, for example by reference to a fixed percentage of the costs or floor area or rateable value, cannot be challenged as being unreasonable.[18]

Payment of charges does not have to constitute agreement

The leaseholder may agree specific items, or they may be determined by arbitration, but the leaseholder's agreement is not to be implied simply because they pay the sum claimed by the landlord.[19]

Impact of failure to follow the statutory consultation process

The failure of a landlord to follow the statutory consultation process before entering into a qualifying long-term agreement or carrying out qualifying works may be a factor taken into account by a Tribunal in deciding the reasonableness of a service charge demand for monies on account (ie where the work or service has not yet been carried out or provided).[20]

Reasonableness requirement does not apply to fixed charges

When a County Court had determined that the amount of service charges demanded by a landlord was fixed, rather than variable, and had entered a money judgement for the full amount, the First-tier Tribunal had no jurisdiction to determine the reasonableness of the charge.[21] The reasonableness requirement only applies to service charges as defined in Landlord and Tenant Act 1985, where they are defined as charges that vary according to the relevant cost.

Where the lease provides for a fixed apportionment of service charges, for example as a percentage of the total cost, the landlord can change the apportionment without varying the leases with the tenants’ agreement. The reapportionment must be allowed in the lease, and it must be reasonable.[22][23] UKSC 6. ]

Reasonableness of the amount in all the circumstances

The burden of proving that a charge was either reasonable or not falls on the person appealing against a first-instance decision.

There are two questions relating to whether a charge is reasonable:

• was the decision to incur the cost a reasonable one?

• did the landlord take appropriate steps to test the market?[24]

The requirement to test the market does not mean that the landlord must obtain the lowest possible price for works or services. However, in a case where a landlord charged for insurance premiums through a service charge, the fact that the premiums he had obtained were around four times higher than premiums identified by leaseholders that would achieve like for like cover was evidence that the charges were not reasonably incurred. There were no significant advantages in the policies obtained by the landlord, and he was unable to explain the reason for the discrepancy.[25]

Service charges payable in advance

Where the contractual terms are such that a service charge is payable before the costs are incurred, once the actual cost is known, adjustments should be made by repayment, reduction or altering the amount of future service charges.[26]

In one case, the Upper Tribunal held that where the lease provided for a service charge to be paid in advance on the basis of budgeted figures subject to adjustments on the basis of spending in the previous year, the landlord did not have, and was in fact unable to, provide proof that the expenses itemised in the statement were incurred before the charge became payable.[27]

A service charge provision in a lease should be interpreted so as to prevent ‘double recovery’. As such, the landlord was required to give credit for third-party funding, whatever its source (for example, it could be from a third party’s insurers or public sector funding), received in respect of the works done and reduce accordingly the service charge to be paid by the leaseholder.[28]

Where certain types of pubic funding have been received by way of a grant towards the cost of works, the service charge must be reduced accordingly.[29]

Even where the public funding is not in the list specified by statute, a service charge should be reduced to exclude the possibility of double recovery – from the funder and again from the leaseholder – by the landlord. [30]

With effect from 12 August 2014, social landlords (local authorities and private registered providers of social housing) cannot recover from their tenants service charges for repairs, maintenance and improvements work in excess of £10,000 (or £15,000 in London) in any five-year period when all of the following conditions apply:[31]

the works are funded, wholly or in part, through Decent Homes Backlog funding, or other Government or Homes and Communities Agency funding for the repair, maintenance or improvement of social housing

• the tenant occupies the property as their only or principal home

• the tenant was the leaseholder at the time the works commenced

Right to buy or right to acquire

During the first five years following the sale of the property under the right to buy (or right to acquire) scheme, the landlord cannot recover more than the service charges for repairs and improvements estimated in the section 125 notice served to the tenant.[32]

This figure can only be exceeded by an allowance for inflation, as calculated by reference to the formula set out in the regulations.[33]