Service charges - two recent court decisions

Service charges
Sally Purtell examines the continuing saga!

As always service charges remain a controversial area. The courts continue to spend a considerable amount of time determining service charge disputes between landlords and retailers.

There have recently been two further court decisions which highlight the dangers of service charge certificates being issued which are incapable of challenge under the terms of the lease, and reserve funds.

Challenging certificates

In Universities Superannuation Scheme Limited -v- Marks & Spencer plc the High Court was concerned with the extent to which a landlord was able to reopen service charge invoices which had been rendered and paid, but which had been calculated incorrectly.

The facts were relatively straightforward. The lease contained the usual provisions for the landlord to supply the service charge certificate at the end of the relevant financial year setting out the amount of service charge for which the tenant was liable. The tenant was then to pay the amount due less any on account payments already paid.

The tenant was granted under the lease a limited right to challenge the amount of the service charge if the tenant objected within a period of 42 days from receipt of the certificate.

The service charge liability was to be calculated by reference to rateable value. The landlord made an error and used a rateable value of £346,800 for two service charge years instead of the correct value of £846,800. When the landlord discovered the error several years later, the landlord sought to recover a further £200,000 (being the shortfall) from the tenant for those earlier service charge years.

The court considered the wording of the particular lease and felt that (particularly bearing in mind the tenant's limited right to challenge the service charge certificate) the wording did not permit the landlord to actually re-open matters at a later date.

On the wording the court was not prepared to distinguish between a dispute as to the amount of expenditure incurred by the landlord and a dispute as to the calculation of the amount of service charge payable by the tenant - the landlord tried to argue that the certificate was only conclusive in respect of the amount of expenditure incurred not the landlord's calculation as to the proportion payable by the tenant.

Although the tenant may have been successful on this occasion, the danger of an inability to challenge a service charge certificate is obvious. If the landlord had used a rateable value of £946,800 in making the calculation and the tenant had not noticed this error, then the tenant would, presumably, not have been able to recover any surplus which was paid over in error.

As a matter of law, there is no reason why a service charge clause should not expressly state that although the method of calculation can be challenged, the retailer should have no ability to challenge the amount of expenditure incurred by the landlord and included within the service charge - but why should any retailer agree to this?

Even where there is no ability to challenge the service charge statement, it may be that it is not in fact the landlord that suffers a loss in the event of the landlord making an error. If one tenant is not paying enough service charge then the chances are the other tenants are paying too much and this would not be recoverable by them where there is no ability to challenge.

However, retailers should continue to argue that service charge certificates should be capable of challenge (even if only for a limited period) and during lease negotiations should remind landlords that it could be in the latter's interests as well!

Flexibility allows the service charge to be fairly apportioned between all tenants (and obviously it is important the landlord is unable to recover more than 100% of expenditure). There is however a disadvantage which is the lack of certainty for the retailers as to whether or not another bill may be issued for a prior service charge year!

Reserve funds

Lease negotiations frequently involve protracted discussions over service charge provisions. However, these tend to revolve mainly around the items of expenditure which will be included in the service charge and rarely focus in detail on sinking or reserved funds and what will happen to the monies at the expiry of the lease if these have not been expended.

A recently reported case (Secretary of State for the Environment -v- Possfund (Northwest) Limited and others) deals with the question of who owns such a fund at the end of a lease term. The Secretary of State was the tenant under a lease pursuant to which it contributed, over an 18 year period, to a sinking fund which, with interest, stood at the end of the lease at approximately £1,000,000. The tenant was seeking to recover these monies. The landlord under the lease covenanted "to maintain the main air conditioning plant ... so as to provide reasonably satisfactory air conditioning." The terms of the tenant's covenant was to pay a service charge to include "... the provision of future expenditure on fixtures and fittings by means of depreciation allowance".

The tenant argued that the landlord's obligations were to be performed only during the term of the lease and if the air conditioning was not replaced during that period the tenant's obligation to pay for it terminated and a right to repayment followed. The landlord however countered that it was irrelevant whether the money had actually been spent and that the payments, once made, belonged to the landlord.

The Judge agreed with the landlord and suggested examples of how the tenant's claim would lead to unintended results. For instance, it could not be the case that a tenant would be entitled to a refund if a lease was forfeited. Replacement of the plant a week before expiry of the term would, on the basis of the tenant's argument not result in a refund but replacement a week after would. The reference in the clause to "depreciation" included the cost of the wearing out of the plant but not necessarily the actual replacement. The payments were therefore not just on account of future expenditure but were "an indemnity against the costs actually and irreversibly incurred by the landlord during each year by virtue of the depreciation of the plant". The tenant was not entitled to repayment of the monies.

The lesson for tenants must therefore be, if you are expecting the reserve fund to be repaid at the end of the term, the lease must expressly state this.