This article was produced by Olswang LLP, which joined with CMS on 1 May 2017.
Pay close attention to lease requirements when calculating service charge and crediting provisional sums.
Friends Life Management Services Limited v A&A Express Building Limited [9 May 2014] provides a useful illustration of the treatment of service charge payments made in advance by the tenant and whether they can relate to a period after the tenant has ended its lease by a break right.
Friends Life had a lease of most of a commercial building and its landlord was A&A. The term ended in 2013, but the tenant could end the lease early on 24 March 2010. The lease required the tenant to pay service charge. A provisional sum was payable quarterly in advance based on landlord's estimates of what the annual expenditure was likely to be. After 31 December in each year, the landlord would prepare an account showing the expenses actually incurred during the previous financial year and also showing sums by way of provision for anticipated expenditure in any future financial years.
If the service charge exceeded the provisional sum for the relevant financial year, the tenant had to pay the excess and if there was an overpayment the landlord had to credit the tenant. The total provisional sums amounted to £875,000 of which the tenant paid £795,000.
The tenant successfully exercised its break to end the lease on 24 March 2010. After that date, the landlord carried out major works, some before 31 December 2010, but most were completed in 2011. The landlord's claim related to the last accounting period under the lease.
The High Court was asked to determine issues in relation to the service charge calculation for the last accounting period. Even though the lease terminated on 24 March 2010, the Court decided that, on the lease wording, the period ended on 31 December 2010. This was important as, potentially, it enabled the landlord to recover service charge for major works provided up to that date. The parties had agreed that the tenant would only pay for the period up to the end of the lease.
The Court analysed the process of crediting provisional sums against expenditure actually incurred. Such sums should be credited against the matching expenditure and, if the provision exceeded the expenditure for which it was originally charged, the balance should be credited against other sums actually incurred.
The lease provided that it was not possible to include a provision for expenditure, which would not be incurred during the term or the last accounting period. The landlord argued that it could charge for provisional expenditure expected to be incurred in 2011 (including major works), since 2011 would have been within the contractual term if the tenant had not terminated the lease earlier. However, the Court rejected this distinction between expiry of the fixed term and termination by tenant's break. The landlord would not be able to charge provisional expenditure for 2011 in the account for the year ending 31 December 2010, when it was certain that the lease would end prior to 2011.
The account to 31 December 2010 should include the credit for the £875,000 provision with a daily apportionment to determine the service charge to be allocated to the relevant part of the year.
The Court having provided its guidance, it is now for the parties to agree the computations.