Service Charges in Commercial Leases: Key Principles of Construction & Operation

Service Charges in Commercial Leases: Key Principles of Construction & Operation

Michelle Caney
St Ives Chambers
August 2017

Introduction

1. There is an inherent conflict between the interests of a landlord andthose of a tenant where service charges are concerned. Inevitably, a landlord will want to recover as much as he can from his tenant, whilst the tenant will want to pay as little as possible. The landlord and tenant may also have very differing views as to the appropriate standard or extent of repair, particularly when one takes into account the outstanding term.

2. This area of law has therefore created a vast amount of litigation. The aim of this article is to distill the key principles concerning the construction and operation of the service charge machinery, whilst also looking at some of the tripwires for landlords to avoid and providing some handy tips for tenants who wish to challenge service charge demands.

Construing the Lease

3. Frequently at the heart of a service charge dispute are questions of construction in relation to the service charge provisions which are being relied upon by the landlord. The starting point is that the particular service charge provision must be construed in the context of the lease in which it appears. As Bedlam LJ confirmed in Berrycroft Management Co Limited v Sinclair Gardens Investments (Kensington) Limited [1997] 1 EGLR 47:

“It is elementary that the specific covenants in each case have to be construed in the context of the lease in which they are contained. Construction of a clause in one lease in a particular way is no guide to the construction of a clause in another lease couched in different terms and set in a different context.”

4. There are, however, a number of general principles from which assistance can be derived when construing a particular provision. The reader will no doubt be familiar with the five principles set out by Lord Hoffman in Investors Compensation Scheme v West Bromwich

Building Society [1998] 1 WLR 896, namely:

(1) Interpretation is the ascertainment of the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract.

(2) The background was famously referred to by Lord Wilberforce as the ‘matrix of fact’, but this phrase is, if anything, an understated description of what the background may include. Subject to the requirement that it should have been reasonably available to the parties and to the exception to be mentioned next, it includes absolutely anything which would have affected the way in which the language of the document would have been understood by a reasonable man.

(3) The law excludes from the admissible background the previous negotiations of the parties and their declarations of subjective intent. They are admissible only in an action for rectification. The law makes this distinction for reasons of practical policy and, in this respect only, legal interpretation differs from the way we would interpret utterances in ordinary life. The boundaries of this exception are in some respects unclear. But this is not the occasion on which to explore them.

(4) The meaning which a document (or any other utterance) would convey to a reasonable man is not the same thing as the meaning of its words. The meaning of words is a matter of dictionaries and grammars; the meaning of the document is what the parties using those words against the relevant would reasonably have been understood to mean. The background may not merely enable the reasonable man to choose between the possible meanings of words which are ambiguous but even (as occasionally happens in ordinary life) to conclude that the parties must, for whatever reason, have used the wrong words or syntax (see Mannai Investment Co. Ltd. v Eagle Star Life Assurance Co Ltd [1997] AC 749).

(5) The ‘rule’ that words should be given their ‘natural and ordinary meaning’ reflects the commonsense proposition that we do not easily accept that people have made linguistic mistakes, particularly in formal documents. On the other hand, if one would nevertheless conclude from the background that something must have gone wrong with the language, the law does not require judges to attribute to the parties an intention which they plainly could not have had.

5. The law was developed further in Chartbrook Ltd v Persimmon Homes [2009] UKHL 38, where Lord Hoffmann said: “[T]here is not, so to speak, a limit to the amount of red ink or verbal rearrangement or correction which the court is allowed. All that is required is that it should be clear that something has gone wrong with the language and that it should be clear what a reasonable person would have understood the parties to have meant.”

6. Two years later, Rainy Sky SA v Kookmin Bank [2011] UKSC 50 was decided, in which the Supreme Court held that if there were two competing interpretations of a contract, thecourt was entitled to prefer the one which was more consistent with business, or commercial, common sense. The law was therefore very much developing in favour of a construction which made commercial sense, and courts would routinely interpret contacts in a way which made such sense even if it did not accord with the strict wording.

7. This commonsense approach was curtailed somewhat in Arnold v Britton [2015] UKSC 36, which actually concerned the construction of service charge provisions. Britton and others were tenants of 25 chalets at Oxwich Leisure Park, occupying under various leases granted between 1974 and 1991, each for a period of 99 years. Each lease contained a service charge covenant relating to matters such as common grounds maintenance. Although the language differed slightly between the leases, a typical example was a covenant to pay: “without any deductions in addition to the said rent as a proportionate part of the expenses and outgoings incurred by the Lessor in the repair maintenance renewal and renewal of the facilities of the Estate and the provision of services hereinafter set out the yearly sum of Ninety Pounds and Value Added tax (if any) for the first Year of the term hereby granted increasing thereafter by Ten Pounds per hundred for every subsequent year or part thereof.”.

8. Arnold, the landlord, contended that this imposed an obligation on the tenants to pay an initial annual service charge of £90, increasing by 10% per annum thereafter. Britton and the other tenants argued that the covenant was only intended to cover each tenant’s proportionate contribution to the maintenance and related costs; and that the “£90 plus 10% per annum” calculation was only intended as a cap to the covenant. The distinction between these two interpretations was dramatic, as a consequence of the rapid growth potential of compound increases to the service charge. For a lease granted in 1980, the annual service charge would be £2,500 when the case was decided; and by 2072 it would reach £550,000. The tenants argued that this could not have been intended.

9. Lord Neuberger, giving the leading judgment, rejected the tenant’s argument and upheld the strict wording of the clause. He emphasised seven key factors at paragraph 17 – 23: (1) The reliance placed in some cases on commercial common sense and surrounding circumstances should not be invoked to undervalue the importance of the language of the provision which is to be construed. The exercise of interpreting a provision involves identifying what the parties meant through the eyes of a reasonable reader, and, save perhaps in a very unusual case, that meaning is most obviously to be gleaned from the language of the provision. Unlike commercial common sense and the surrounding circumstances, the parties have control over the language they use in a contract. And, again save perhaps in a very unusual case, the parties must have been specifically focusing on the issue covered by the provision when agreeing the wording of that provision.

(2) When it comes to considering the centrally relevant words to be interpreted, the less clear they are (or the more badly drafted) the more ready the court can properly be to depart from their natural meaning. That is simply the obverse of the sensible proposition that the clearer the natural meaning the more difficult it is to justify departing from it. However, that does not justify the court embarking on an exercise of searching for, let alone constructing, drafting infelicities in order to facilitate a departure from the natural meaning. If there is a specific error in the drafting, it may often have no relevance to the issue of interpretation which the court has to resolve.

(3) Commercial common sense is not to be invoked retrospectively. The mere fact that a contractual arrangement, if interpreted according to its natural language, has worked out badly, or even disastrously, for one of the parties is not a reason for departing from the natural language. Commercial common sense is only relevant to the extent of how matters would or could have been perceived by the parties, or by reasonable people in the position of the parties, as at the date that the contract was made.

(4) While commercial common sense is a very important factor to take into account when interpreting a contract, a court should be very slow to reject the natural meaning of a provision as correct simply because it appears to be a very imprudent term for one of the parties to have agreed, even ignoring the benefit of wisdom of hindsight. The purpose of interpretation is to identify what the parties have agreed, not what the court thinks that they should have agreed. Experience shows that it is by no means unknown for people to enter into arrangements which are ill-advised, even ignoring the benefit of wisdom of hindsight, and it is not the function of a court when interpreting an agreement to relieve a party from the consequences of his imprudence or poor advice. Accordingly, when interpreting a contract a judge should avoid re- writing it in an attempt to assist an unwise party or to penalise an astute party.

(5) When interpreting a contractual provision, one can only take into account facts or circumstances which existed at the time that the contract was made, and which were known or reasonably available to both parties. Given that a contract is a bilateral arrangement involving both parties, it cannot be right, when interpreting a contractual provision, to take into account a fact or circumstance known only to one of the parties.

(6) In some cases, an event subsequently occurs which was plainly not intended or contemplated by the parties, judging from the language of their contract. In such a case, if it is clear what the parties would have intended, the court will give effect to that intention.

(7) On the specific question of construing service charge provisions, Lord Neuberger confirmed that there is no general principle that they should be construed “restrictively” or be made subject to any special rule of interpretation. Even if a landlord may have simpler remedies than a tenant to enforce service charge provisions, that is not relevant to the issue of how one interprets the contractual machinery for assessing the tenant’s contribution.

10. The headline point in Arnold v Britton is that the courts will focus more closely on the literal interpretation of a clause in seeking to construe it. It is only where the clause is ambiguous that the court may turn to consider what makes commercial common sense. The latter cannot be used to re-write a bad bargain.

Restrictive Approach

11. It is often said that courts will take a strict approach to the construction of service charge provisions. As Mummery LJ said in Gilje v Charlgrove Securities Limited [2002] 1 EGLR 41: “The landlord seeks to recover money from the tenant. On ordinary principles there must be clear terms in the contractual provisions said to entitle him to do so.”

12. More recently, in Wembley Stadium Limited v Wembley (London) Limited [2007] EWHC 756, Sir Andrew Morritt C went further and said that “No doubt, too, it is appropriate for the interpretation to be more restrictive in the case of residential tenancies as opposed to a commercial transaction between two substantial parties.“

13. However, as Lord Neuberger was at pains to make clear in Arnold v Britton [2015] UKSC 36, there is no general principle that service charge provisions should be construed “restrictively” or be made subject to any special rule of interpretation. Accordingly, if acting for a landlord it should be possible to persuade the court to take a more balanced approach to construction in the future.

Contra Proferentem

14. Following the decision in Gilje v Charlgrove Securities Limited [2002] 1 EGLR 41, the contra proferentum rule gained prominence in the context of service charge provisions. By way of reminder, the maxim was described as follows by Lord Mustill in Tam Wing Chuen v Bank of Credit and Commerce Hong Kong Limited [2002] 1 EGLR 41:

“…the basis of the contra proferentum principle is that a person who puts forward the wording of a proposed agreement may be assumed to have looked after his own interests, so that if the words leave room for doubt as to whether he is intended to have any particular benefit there is reason to suppose that he is not.”

15. Although the maxim has been deployed in service charge cases, its application has not been an easy one and it was generally considered to be a maxim of last resort. [C & J Clark International Limited v Regina Estates Limited [2003] EWHC 1622.] Following Arnold v Britton [2015] UKSC 36, it is likely to have been largely consigned to history, at least in the context of service charge provisions.

Background Factors

16. When construing service charge provisions, the type of background factors which might influence a court’s approach to the process of construction include the type of lease (i.e. commercial or residential) and the identity of the original landlord (i.e. a local authority or a commercial landlord). In an appropriate case, the court might also have regard to the fact that a landlord’s functions are exercised by a residents’ association.

18. The court is also likely to take into account the statutory background against which the clause was drafted; however, this is more likely to be relevant in a residential context. Conversely, the court is unlikely to construe a lease or imply a term into a lease taking into account legislation enacted after the lease was granted: Frobisher (Second Investments) Limited v Kiloran Trust Co Limited [1980] 1 WLR 425.Sweeping-Up Clauses/li>
19. It is extremely difficult for a draftsman of a lease to predict all potential future expenditure which may be incurred by a landlord, particularly when modern life is changing so rapidly. As such, it is common for draftsmen to include a ‘sweeping-up clause’ which is designed to cover unforeseen items of expenditure. Common sweeping up provisions include clauses allowing a landlord to recover:
    a. “Such costs or expenses as the landlord shall deem appropriate“;
    b. “Other costs and expenses reasonably incurred by the landlord“;
    c. “Expenses incurred for the benefit of the building“; or
    d. “Expenses incurred in the interests of good estate management“.

19. As a general rule, courts are not favourably disposed towards sweeping-up clauses and will be reluctant to allow a landlord to use them to cure an otherwise defective service charge provision or to subvert an obvious omission from the lease. By way of example:

• Boldmark Limited v Cohen [1986] 1 EGLR 47:

o Sweeping up clause: “There shall be added to the costs and expenses and outgoings and matters referred to in the preceding paragraphs of this schedule such sums as the Lessors may from time to time expend in respect of the general administration and management of the Block.”

o Intended service charge recovery: Interest incurred as a result of borrowing to finance the provision of services.

o Decision: Not recoverable.

• Mullaney v Maybourne (Croydon) Management Co Limited [1986] 1 EGLR 70:

o Sweeping up clause: “Such further or additional costs which the Company shall properly incur in providing and maintaining additional services or amenities.”

o Intended service charge recovery: The cost of replacing wood-framed windows with double-glazed windows.

o Decision: Not recoverable.

• St Mary’s Mansions Limited v Limegate Investment Co [2002] EWCA Civ 1491:

o Sweeping up clause: “The cost of all other services which the lessor may at its absolute discretion provide or install in the said Building for the comfort and convenience of the lessees.”

o Intended service charge recovery: Legal costs.

o Decision: Not recoverable.

20. The message is therefore clear for landlords: fall back a sweeping up clause at your peril. It is always much better to provide for the expenses expressly in the lease. For tenants, this an area which is ripe for challenge on the scope and interpretation of such a clause. That said, sweeping-up clauses have been successfully relied upon by landlords in:

• Billson v Tristem [2000] L&TR 220:

o Sweeping up clause: The lease included a provision that the lessor may, “without prejudice to the foregoing do or cause to be done all such works installations acts matters and things as may in the absolute discretion of the lessors be necessary or advisable for the proper maintenance safety and administration of the Building.”

o Intended service charge recovery: The cost of works to all parts of the building, for which the otherwise poorly drafted lease would not have made provision.

o Decision: Recoverable.

Sun Alliance and London Assurance Co Limited v British Railways Board [1989] 2 EGLR 237:

o Sweeping up clause: “The costs of providing such other services as the lessor shall consider ought properly and reasonably to be provided for the benefit of the building, or for the proper maintenance and servicing of any part or part thereof.”

o Intended service charge recovery: The cost of window cleaning.

o Decision: Recoverable.

• Sutton (Hastoe) Housing Association v Williams [1988] 1 EGLR 56:

o Sweeping up clause: “Additional works considered necessary by the lessor in its absolute
discretion.”

o Intended service charge recovery: The cost of replacing wood-framed windows with double-glazed windows.

o Decision: Recoverable – in contrast to the decision in Mullaney v Maybourne
Croydon) Management Co Limited.

21. As will be seen below, the less (or none) restrictive approach which is to be adopted since Arnold v Brittan may see more sweeper clauses being upheld in the future.

No Presumption of Full Recovery

22. In Campbell v Deajan Properties Limited [2012] EWCA Civ 1503, Jackson LJ confirmed that: “It is not always the case that the landlord of a property with multiple tenants on historic leases recovers 100% of his expenditure through service charges. Obviously this is what the landlord desires, but there are many possible reasons why he may not achieve that. There is no presumption in construing a lease that the service charge provisions will enable the landlord to recover all of his expenditure.”

Implied Terms

25. The principles dealt with above emphasise the importance of construing the express terms in the lease correctly. But what if the lease does not contain an express term requiring a tenant to pay service charges? Will the court imply one?
26. In the residential context, the legislator has intervened considerably to govern and regulate the recoverability of service charges. In the commercial sphere, courts expect the parties to be more business savvy and ensure that the lease deals with all relevant points. We know from practice that this is not always possible.
27. As a general rule, no implied obligation to repair or provide services will be implied into a commercial lease. And where the lease provides a mechanism for the allocation of repair between the landlord and tenant, there will be minimal scope to imply further terms. As such, the more comprehensive a code in a lease, the less scope there is for the implication of a term: Hafton Properties Limited v Camp [1994] 1 EGLR 67 (at p.70).

26. Furthermore, it has not generally regarded as necessary to give business efficacy to a lease that the landlord should be obliged to keep the premises in repair or provide other services. As Dillon LJ said in Tennat Radiant Heat Limited v Warrington Development Corporation [1988] 1 EGLR 41 at 43:

“It may well be objectively sensible, or reasonable, that there should be such a landlord’s covenant, with a corresponding covenant by each lessee to contribute a proportionate part of the expense, but that is not enough to warrant implying such covenants.”

27. The law on implied terms in the context of service charge provisions must of course now be read in light of the Supreme Court decision in Marks and Spencer Plc (M&S) v BNP Paribas Securities Services Trust Company (Jersey) Limited (BNP) [2015] UKSC 72. In that case, the question was whether a tenant, in order to exercise a break option, had to pay a full quarter’s rent even though it would not have a full quarter’s possession up to the break date, or whether the tenant could reclaim that rent attributable to the period following the break under an implied term. The Supreme Court declined to imply a term; it was essential for implication of a term that it was necessary to give business efficacy to the contract, and if the contract lacked coherence without it. An agreement to pay a full quarter’s rent even though there would not be a full quarter’s enjoyment might be a bad bargain; but such an express term did not render the contract incoherent.

28. The BNP case therefore makes it even more unlikely that the courts will be willing to imply terms in relation to service charges in the future in the event that the lease does not include express provisions. The message coming from the Supreme Court, in both BNP and Arnold, is that the courts will not intervene to rewrite a bad bargain or mitigate the effects of an unforeseen development by implying a term into the lease or construing the express terms in such a way that make commercial sense. It is therefore even more important than ever for draftsman to ensure that the lease covers all eventualities.

Operating the Machinery

29. The preceding section demonstrates that the court’s focus will always be on the service charge provisions in any dispute. Insofar as recovery is concerned, the essential point to remember is that if a lease prescribes machinery that must be operated in order for service charges to be recovered, that machinery must be operated. That may seem obvious, but it is not overlooked. Managing agents frequently use accounting software that is not designed with the lease in mind, and many do not undertake a detailed construction of the lease to find out who is responsible for certain works before works are commissioned.

Recoverability

30. The landlord must therefore always first ensure that the head of cost which is being charged to his tenants falls within the ambit of the tenant’s service charge covenants. Typical heads of service charge include:

(i) Repairing/maintaining/renewing those parts of the building not demised;
(ii) Heating and lighting the building/common parts;
(iii) Cleaning and refuse collection;
(iv) Insurance;
(v) Compliance with legislation;
(vi) Employing managing agents;
(vii) Employing caretakers or other staff;
(viii) Legal costs;
(ix) Reserve / Sinking funds.

31. It is not uncommon for leases to give the landlord the power to add to or vary the services for which a service charge is payable. This is usually framed in such a way as to confer a discretion on the landlord. Such provisions often include a condition precedent to the exercise of such a discretion (e.g. giving notice to all tenants or consulting them). Where such condition precedents are included, they must be followed by the landlord strictly.

32. However, once those conditions precedent have been fulfilled, there is limited scope for a tenant to challenge the landlord’s exercise of discretion or decision making process. In Unique Pub Properties Limited v Broad Green Tavern Limited [2012] EWHC 2154, Warren J undertook a review of the relevant authorities and stated:

“What I conclude from those authorities is this principle, namely that a contractual discretion must be exercised honestly and in good faith and must not be exercised arbitrarily, capriciously or unreasonably, unreasonableness being assessed in the sense that no reasonable person would exercise the discretion in the manner proposed.”

33. For the purpose of this article, I will consider two specific common areas of dispute in relation to service charges: (i) repairs and maintenance; and (ii) legal costs.

(i) Repairs and Maintenance

34. Service charges governing the repair and maintenance of a building often prove to be one of the most contentious areas of dispute. Often this is because they involve large sums of money. In addition, landlords and tenants frequently disagree on the scope and extent of any necessary works, and who should bear the costs of the same. This is likely to be influenced by the length of the term length. If, for example, a tenant only has one year left to run on a 25 year lease, they will not be keen to contribute towards the cost of replacing the roof of a building which they will not be in occupation of for much longer.

35. In broad terms two key questions usually arise in a commercial context:(1) Is the tenant obliged to contribute towards the cost of remedying a particular problem? This will depend on the construction of the service charge provisions.

(2) If the tenant is liable to contribute towards the cost of remedying the problem, is the
landlord entitled to charge for the work which he has chosen to carry out? Where a dispute
arises on this issue, this may require expert evidence to be obtained in relation to the
different ways of addressing the issue i.e. patch repairs / complete replacement.

37. As with any service charge dispute, the starting point will be to check that the proposed work and the part of the building to which is relates is covered by the lease. It will also be necessary to consider whether the proposed work amounts, for example, to a repair. As a general rule, where the service charge is payable in relation to ‘repairs’, there can be no recovery if the subject matter of the obligation has not deteriorated from its earlier condition i.e. it is not in disrepair: Quick v Taff Ely Borough Council [1986] QB 809.
38. Where there are a number of different ways of remedying a defect, the usual rule is that the covenanting party must adopt such method as the reasonable surveyor would advise as being appropriate: Gibson Investments Limited v Chesterton PLC [2002] EWHC 19.

38. Service charges are often drafted in such a way so as to produce bilateral rights and obligations. The landlord will often covenant to keep parts of the building in repair, whilst the tenants covenant to reimburse the landlord’s costs. This can produce a clear tension in that it is not the covenanting party who will ultimately be paying for the work.

39. This particular issue arose in Plough Investments Limited v Manchester City Council [1989] 1 EGLR 244. In that case, the landlord of an office building brought a claim for declaratory relief in relation to their proposal to remedy defects to the steel frame of the building. On the question of whether the landlord could choose the more expensive form of repair and then recover the cost from the tenants, Scott J observed that:

“The landlord’s fifth schedule repairing obligation is, although nominally an obligation, in a sense also a right. If it were simply an obligation, then, presumably, the three tenants of the building could choose to release the landlord, in whole or in part, from that obligation. But the provision is not, in my view, simply, or even mainly, for the benefit of the tenants. It is also a provision for the benefit of the landlord. It enables the landlord to keep its building in repair at the tenant’s expense. If the repairing obligation had been imposed on the tenant, the tenant would have been entitled to decide on the manner in which it would be discharged. Provided remedial works were sufficient to discharge the obligation, the landlord could not require a different type of repair to be effected. Under these leases, however, the relevant decisions regarding repairs to the exterior are to be taken by the landlord. If reasonable remedial works are proposed by the landlord in order to remedy a state of disrepair for the purposes of its fifth schedule obligation, the tenants are not, in my judgment, entitled to insist that cheaper remedial works be undertaken.”

41. A contrary approach was adopted in Scottish Mutual Assurance PLC v Jardine Public Relations Limited [1999] EG 43 where the lease was only three years long. In that case, it was held that the lease did not entitle the landlord to charge the tenant the cost of carrying out works suitable for the performance of his obligations over a period of twenty or more years when such works are not necessary for the fulfillment of those obligations over the period to which they relate.
42. When faced with the same issue in Fluor Daniel Properties Limited v Shortlands Investments Limited [2001] 2 EGLR 103, Blackburne J said this:

“In short, the works – i.e. the standard to be adopted – must be such as the tenants, given the length of their leases, could fairly be expected to pay for. The landlord cannot, because he has an interest in the matter overlook the limited interest of the tenants who are having to pay by carrying out works that are calculated to serve an interest extending beyond that of the tenants. If the landlord wished to carry out repairs that go beyond those for which the tenants, given their more limited interest, can be fairly expected to pay, then, subject always to the terms of the lease or leases, the landlord must bear the additional cost himself.”

42. As such, a landlord does not have an unfettered discretion to choose between different schemes of work. The landlord must in particular have regard to the more limited interest of the tenant and the duration of his lease.

(ii) Legal Costs

43. Another item on the service charge agenda which frequently causes a bone of contention between landlords and tenants is the former’s ability to recover legal costs.

44. The conventional approach which dictated that service charges should be construed restrictively meant that in order for a landlord to recover its legal costs of suing a tenant as a service charge, there needed to be a clause which permitted recovery in “clear and unambiguous terms“: Sella House v Mears [1989] 1 E.G.L.R. 65.

45. Fast forward 25 years to Assethold v Watts [2014] UKUT 0537 in which the Upper Tribunal had to decide whether legal costs incurred by a landlord in obtaining an injunction against an adjoining owner prohibiting works on a party wall structure were recoverable as a service charge. The clause permitted recovery of costs of: “…all matters as in the reasonable discretion of the landlord might be considered necessary or desirable for the proper maintenance, safety, amenity and administration of the property”. The Deputy President, Martin Rodger QC, held that the landlord’s costs of such legal proceedings were recoverable as a service charge under this clause, stating at [58]:

“It seems to me to be wrong in principle to start from the proposition that, with certain types of expenditure, including the cost of legal services, unless specific words are employed, no amount of general language will be sufficient to demonstrate an intention to include that expenditure within the scope of a service charge. Language may be clear, even though it is not specific.”

46. The ‘sweeping up’ clause in Assethold was therefore found to be sufficiently clear to enable recovery of such legal costs, despite the express reference to the landlord’s legal costs in other parts of the lease.

47. In Geyfords Ltd v O’Sullivan [2015] UKUT 683, the opposite conclusion was reached. In that case, the landlord sought recovery of legal costs incurred by the landlord in County Court proceedings against lessees and of resisting Tribunal proceedings brought by lessees. The landlord relied on part of a schedule of service charge items which listed expenses to be incurred in maintaining and repairing the various parts of the building, cleaning and lighting the common parts, decorating and repairing the exterior of the development, discharging rates taxes and outgoings, and obtaining insurance against third party and public liability risks. The lease also contained a sweeping-up clause enabling the charging of: “All other expenses (if any) incurred by the Lessors or their managing agents in and about the maintenance and proper and convenient management and running of the Development”.

48. In construing the lease, the Upper Tribunal held that “management” may sometimes include obtaining professional advice, including legal advice, and might involve litigation but rejected the argument that the parties contemplated that the “sweeping-up” clause embraced the landlord’s costs of County Court and Tribunal litigation between the landlord and the lessees concerning enforcement and quantification of the lessees’ service charge liability. The Deputy President concluded that “clear and unambiguous terms” are required to impose what Taylor LJ in Sella House regarded as an onerous and unusual payment obligation.

49. So far as the statutory background to the lease was concerned, it was apparent that, in the late 1970’s, it was standard practice for payment of service charges to be enforced by proceedings seeking forfeiture of the lease in the County Court. Forfeiture would be avoided by the lessee (or the mortgagee) paying what was owed and the landlord’s legal costs on an indemnity basis. It would not have been expected that the landlord would incur costs in establishing the quantum of the service charge before a Tribunal operating in a no costs jurisdiction. The “sweeper” clause was interpreted on the basis that the landlord would have no need to recoup its legal costs through the service charge.

50. Whilst both of the above cases concerned residential leases, lessons can also be learned in the commercial context. Whilst it may be possible to persuade a court to allow a landlord to recover their legal costs under a sweeping up clause, as in Assethold, tenants can take comfort in decisions like Geyfords and will undoubtedly still have ammunition in the event that legal costs are not provided for in “clear and unambiguous terms”.

Operating the Contractual Scheme

51. Where the lease prescribes a contractual mechanism to recover service charges, that mechanism must be adopted. It has been repeatedly stated that the parties to a lease will be held to the procedure which they have agreed.

52. By of example, in Leonora Investment v Mott McDonald [2008] EWCA Civ 857, the landlord was entitled to recover for specified service charge items, by providing an estimate of cost in advance of the service charge year, with an on-account payment due quarterly. At the end of the year, a balancing payment was then due. The landlord forgot, however, to claim for particular works items. Rather than re-serve any estimate and demand, or seek recovery under the year-end balancing payment, an entirely separate invoice was given, which the landlord said was outside the lease, but which the landlord claimed it was entitled to do as the lease was to be treated as non-exhaustive.

53. The Court of Appeal upheld the decision of the first instance judge that, on the correct interpretation of four commercial leases, the landlord could only claim service charge in respect of works carried out if it had served on the tenant an end of year statement which included reference to those works. There was no provision which allowed the landlord to claim the sums by means of an invoice outside the service charge machinery which was “the contractual route down which the landlord must travel to be entitled to payment.“

54. However, this rule is sometimes tempered by the fact that, unless the lease or statute provides to the contrary, more than one attempt may be made to satisfy the contractual requirements. In general, time for taking those steps will not be of the essence unless the lease provides that it is. As such, if the tenant takes issue with a particular step in the process it may be better for a landlord to repeat the step (without prejudice to the landlord’s contention that the previous step was valid) rather than plough on as in the case in Leonora Investment v Mott McDonald and find that they were not entitled to recover. As Tuckey LJ said in that case:

“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.”

Conditions Precedent

55. In addition to including contractual machinery in a lease, it is not uncommon for leases to include some form of condition precedent to the landlord’s recovery. In some cases, it is obvious and inherent in the nature of the obligation imposed that an event must occur before liability arises. For example, where service charges are payable in arrear, the landlord must be able to point to some actual expenditure which he is seeking to recoup: Quirkco Investments Limited v Aspray Transport Limited [2011] EWHC 3060.

56. On whether a provision operates as a condition or not, the following was said to be a proper statement of the law in Yorkbrook Investments Ltd v Batten [1985] 2 EGLR 100:

“The question whether liability in respect of one covenant in a lease is contingent or not upon the performance of another is to be decided, not upon technical words, nor upon the relative position of the covenants in the case, but upon the intentions of the parties to be gathered from the whole instrument.”

57. A common requirement of a lease is to require certification of accounts (or other matters) before a service charge is recoverable. That requirement is generally considered to be a true precondition to liability but, as with most things in a landlord and tenant context, not always. A detailed exploration of when they are not is outside the scope of this article.

Disputing Service Charge Demands

58. In a commercial context, the scope for challenging demands for service charges is much more limited than in a residential context which is strictly regulated by statute. However, it is clear from the preceding sections that tenants have much ammunition to use to challenge a landlord who is trying to recover service charges on an improper basis.

59. The starting point is always to carefully analyse the terms of the lease to assess whether the item which the landlord is seeking to charge for is covered by the lease. If it is, consider whether the landlord is entitled to claim for the work or incur the expense. Consider also whether there is a condition precedent to recovery, and whether this has been fulfilled. And always carefully check whether the landlord has correctly operated any contractual machinery to enable them to recover the charges under the lease.