Service charge accounts
An interview with Andrew Bond, partner at Smith & Williamson. Andrew's work covers a range of assurance related issues such...
What are service charges?
They are charges payable by the leaseholder to the landlord for the services the landlord is obliged to provide under the terms of the lease. They will be a variable amount from year to year depending on the costs the landlord incurs.
Examples of service charges
They can include maintenance and repair, and sometimes improvement of: – the exterior, structure, roofs, foundations, window frames, guttering, communal drains and pipes and common areas, also insurance of the building and the cost of management . This list is not exhaustive and leaseholders should check their lease for the full details of service charges payable.
When are they payable?
The lease will state when the service charge is due. It is often payable yearly or twice yearly either at the beginning of the calendar year or, the financial year (April –March), or sometimes on quarter days. Most modern leases allow for the service charge to be payable in advance of the landlord incurring the costs, based on an estimate of costs in the coming year. Some leases, usually older ones, allow recovery in arrears, that is the landlord has to incur the cost first.
Estimated costs and final accounts
As mentioned above, the lease may state that the landlord estimates what he is going to spend in the coming year and bases the service charge on that estimate. If this is the case, most leases require the landlord to produce an end of year statement of account of what he has actually spent and supply this to the leaseholder. Sometimes the lease requires that this account is audited or certified by an accountant or other professional.
If the end of year account shows that the landlord has spent more than he estimated the lease will normally allow him to recover the shortfall from the leaseholder via a” balancing charge”. If he has spent less than he estimated the lease may state that a credit for the overpayment should be carried forward as a credit to the leaseholder’s next yearly payment. Occasionally the lease may say it is returned to leaseholder or transferred to the “reserve fund”.
Also known as a “sinking fund”, some leases allow the landlord to demand a contribution towards this via the service charge. The purpose is to build up a fund to pay for future larger scale works, such as repainting/redecorating the whole building or replacing window frames. This means leaseholders will not face such a large one off bill when the work becomes necessary. Unless they agree to the contrary with their own buyer, the leaseholder will not receive any of this contribution back if they sell their premises.
Reasonableness and the Tribunal
The Landlord and Tenant Act 1985 (as amended) states that a service charge is only recoverable by a landlord so far as the costs have been reasonably incurred. Also, it states that it is only recoverable if works carried out for the charge are of a reasonable standard.
A leaseholder can challenge the reasonableness of a service charge if it does not comply with above, ultimately, by applying to the appropriate Tribunal. In England, this is the First-tier Tribunal (Property Chamber) and in Wales it is the Leasehold Valuation Tribunal. They have power to make a ruling whether, or how much of, a service charge is reasonable or payable.
Service charge demands
When a landlord demands a service charge it must contain the landlord`s name and address, an agents name and address is not sufficient. The demand must also include a “summary of leaseholders’ rights and obligations”. This includes details of such matters as a leaseholder’s right to apply to the Tribunal, as outlined above. The law states that if the demand does not comply with either of these requirements, the leaseholder has a legal right not to pay unless and until the service charge is demanded in the proper manner.
Service charge monies to be held “on trust” for leaseholders
The law states that any service charge contributions are held on trust by the landlord, for the leaseholders. This means, in practice, that the money can be held in one or more account such as a bank or building society to be used for the purposes set out in the lease. If the landlord becomes insolvent such money is protected for the benefit of the leaseholders from any other creditors seeking payment.
Limitation period on recovery of service charge costs
Section 20B of the Landlord and Tenant Act 1985 states that a landlord cannot recover service charge costs that were incurred more than 18 months before he formally demands them. The exception to this rule is if he writes to the leaseholder within 18 months of incurring the costs informing them that he has incurred costs, the amount of them, and that they will be demanded in due course. Case law has indicated that costs are “incurred “when the landlord pays them or becomes liable to pay them; for instance, through receiving an invoice from a contractor or supplier.
Major Works and consultation
If a landlord proposes to carry out works that will cost any one leaseholder more than £250, he is required to go through a consultation procedure under section 20 of the Landlord and Tenant Act 1985. This process involves providing leaseholders with notices allowing them to make observations on the proposals and sometimes to nominate a contractor from whom the landlord is to try to obtain an estimate. He also is required to notify leaseholders of the estimates. (Please see our advice guide for full details – Section 20 Consultation for Private Landlords, Resident Management Companies and their Agents)
The major works charge is still a service charge and, therefore, still has to comply with the requirement of reasonableness mentioned above.