UK property: service charge provisions put to the test

Landlord’s discretion

Following last year’s high-profile Supreme Court decision in Williams and others v Aviva Investors Ground Rent GP Ltd and another [2023] UKSC 6; [2023] EGLR 18, the Upper Tribunal (Lands Chamber) continued to grapple with the exercise of landlords’ discretion in calculating service charge in Fitzroy Place Residential Ltd and others v Lovitt and others [2024] UKUT 63 (LC); [2024] PLSCS 57.

Fitzroy Place is a large mixed-use development. The service charge provisions in the leases set out a “primary” method for calculating the proportion of service charge payable by each tenant by reference to the internal area, but allowed the landlord to vary the tenant’s proportion (on notice) if the block or estate was altered. The lease also gave the landlord the discretion, having regard to the “nature of any expenditure or item of expenditure incurred”, to use a different method of calculation which was “fair and reasonable” in the circumstances.

The landlord did not use the primary method for calculating service charge set out in the lease, as it considered the apportionment was unfair on the commercial tenants. Instead, it used a completely different method to calculate and apportion the service charge, arguing it had the discretion to do so. A residential tenant challenged the landlord’s decision.

The Upper Tribunal agreed that the landlord had exceeded the limits of its discretion, which could only be exercised on an ad hoc basis for particular items or types of expenditure, not for a “permanent and blanket change” to the method of apportionment. This interpretation also made commercial sense, as it gave the long residential leaseholders certainty, which would have been undermined by an open-ended landlord discretion.

Apportionment between commercial and residential tenants

The tension between commercial and residential tenants in mixed-used buildings was also in issue in Bradley and another v Abacus Land 4 Ltd [2024] UKUT 120 (LC); [2024] PLSCS 110.

The property had been converted from an office block to mixed use in 2006, and was made up of residential flats, four commercial units and a gym. The gym was originally exclusively for residents’ use but, from 2013, when the freeholder granted a lease of the gym, the residents shared the gym with paying customers, and, from 2020 onwards, residents could only use the gym at certain times.

The gym lease was described by the Upper Tribunal as a “remarkably good deal” for the gym tenant; the landlord was required to pay all utilities for the gym, and to provide, maintain and replace the gym equipment, yet the gym tenant was not required to pay service charge. The residential leases gave the landlord discretion to apportion the service charge by “such fair proportion as the landlord acting reasonably shall from time to time determine”.

The landlord initially agreed to use the rent it received from the gym tenant to maintain the gym, reducing the residential tenants’ contributions accordingly. However, after a dispute with the gym tenant, the landlord agreed to refurbish the gym (at a cost of over £200,000) and forgo rent from the gym tenant for three years, and sought to pass these costs onto the residential leaseholders.

The residential leaseholders argued that this was an improper exercise of the landlord’s discretion as it was not “fair and reasonable”.

The Upper Tribunal found that the landlord’s decision to charge the full amount to residential leaseholders from 2020 onwards – when they had restricted access to the gym – was neither reasonable nor fair, as required by the terms of the lease, and set it aside.

However, for the period between 2013 and 2020, the tenants could not challenge the service charge as they had paid it without complaint, and accepted the landlord’s use of the gym rent to reduce their service charge burden.

Speak now or forever hold your peace

The idea of acceptance of service charge precluding further challenge was also considered in Poplar Housing and Regeneration Community Association Ltd v Khan [LON/00BG/LSC/2023/0205] and G&A Gorrara Ltd v Kenilworth Court Block E RTM Co Ltd [2024] UKUT 81 (LC); [2024] PLSCS 73

In Poplar, the tenant was unable to challenge the reasonableness of costs incurred in carrying out major works to the property some 10 years earlier, because he had made multiple payments without any indication those payments were being made under protest. Those payments therefore amounted to an “implied admission”, so those costs were payable in full.

In Gorrara, five blocks of flats were managed by separate right-to-manage companies, but those companies – through a managing agent – ran the estate as a single unit. The tenants paid an estimated service charge each month, and, under the leases, the landlord should have carried out a balancing exercise at the end of each year based on actual expenditure. The leaseholders were provided with annual accounts at the end of each year showing what had been spent on the estate, but not on each block, and no reconciliation exercise was carried out. One of the tenants challenged the service charge payable for their block of flats.

The landlord argued – and the First-tier Tribunal agreed – that, because the tenant had paid multiple monthly service charges without protest, they could not later challenge them; first, because section 27A of the 1985 Act prevents applications in respect of “a matter which has been agreed or admitted by the Tenant”, and second, because, while under section 27A a tenant is “not to be taken to have agreed or admitted any matter by reason only of having made any payment”, the tenant had made multiple payments so that exception did not apply.

The Upper Tribunal rejected those arguments, and said the word “only” in section 27A did not mean anything more than a single payment was deemed admitted; rather it meant “absent any other circumstances”. A series of unqualified payments did not – by itself – indicate agreement to service charges and other factors, such as the tenant’s knowledge of the facts underlying the charges and any delay in challenging them, also needed to be present to constitute an admission.

Here, the tenants had accepted the interim charges, but not the final charges for each year, which they had insufficient information to challenge as it was not clear which costs were incurred for their block, and they had not yet been demanded.

Inherent defects

In Tower Hamlets London Borough Council v Lessees of Brewster House and Malting House [2024] UKUT 193 (LC); [2024] PLSCS 129, the Upper Tribunal considered tenants’ liability for structural works arising from inherent defects through their service charge.

The case involved two blocks of flats, which had been built in the 1960s using the “large panel system” (bolting together mass-produced concrete slabs to form the walls and floor).

In response to concerns about the safety of buildings constructed in this way, the landlord investigated and decided to carry out works to reinforce the structure costing around £8m, which they sought to recover from the tenants.

The tenants applied to the FTT for a determination of whether those costs were payable under the terms of the lease.

The landlord argued that the repairs amounted to “maintenance” of the property, aimed at preserving the building in a functional condition, and so fell within the service charge. The Upper Tribunal disagreed, and stated that “neither a covenant to repair nor a covenant to maintain is a covenant to remedy structural defects, nor to make safe a building that was not safe when it was built”.

Alternatively, the landlord argued that the works were caught within a “sweeper” clause, which allowed it to carry out works for the “safety” of the building.

While sympathising with landlords’ attempts to try to future-proof leases using wide sweeper clauses, the Upper Tribunal found that this clause did not require leaseholders to pay for expensive structural repairs, stating that “a tenant who signs up to pay for the landlord’s compliance with a covenant to ‘repair’ and to ‘maintain’ has to be taken to know that the courts have specifically held that neither of those terms includes an obligation to remedy a structural defect. Such a tenant would not intend that the obligation to do just that could be tucked in to the general words of a future-proofing clause…”.

Even more for 2024?

The wide-ranging issues considered so far this year show the complexity of this area, and the need for clarity in service charge provisions balanced against the flexibility required in long leases.

The tension between residential and commercial tenants seen in these cases is something we expect to see more of, given the rise of mixed-use properties in the market.

We will wait and see whether the final months of the year bring any more service charge surprises.

An earlier version of this article appeared in EG on 21 October 2024.

Authored by Lucy Redman and Ben Willis.