How Must A Service Charge Be Calculated & Can A Sinking Fund Be Maintained?

The above questions are one which have been asked by tenants for many years, but are now being asked by home-owners on estates where there are shared private facilities such as open spaces, playgrounds and drainage lakes and who have to pay service charges to management companies to maintain them.

The recent landlord and tenant case of Criterion Buildings Ltd v McKinsey & Company Inc (UK) & Anor [2021] EWHC 216 (Ch) has shed new light on the subject.

Criterion Buildings Ltd v McKinsey & Company Inc (UK) & Anor

The office Tenant was disputing liability for over £2.2 million of service charge arrears. It alleged that the Landlord’s method of apportioning service charge between its Tenants was nor fair and that contributions to a sinking fund were unlawful.

The lease obliged the Tenant to pay a ‘due proportion’ i.e. ‘a fair proportion to be determined from time to time by the Landlord or the Landlord’s Surveyors taking into account the use made of and the benefit received from the services and expenses and each of them’.

The Tenant argued that the proportion allocated to them was not fair because the manner in which the Landlord apportioned costs favoured another Tenant in the building (the Criterion Theatre). The treatment of the floor area in the theatre had provided the theatre with an element of discount at the Tenant’s expense.

The Court said that in deciding what was fair, the Landlord did not need to adhere to any objective standard of fairness. The Judge held that, where it made no financial difference to the Landlord how costs were divided between Tenants, it was not sensible to see this as an objective process:

The Court also decided that the lease entitled the Landlord to include in the service charge “an amount which the Landlord reasonably determines is appropriate to build up and maintain a sinking fund and a reserve fund.” The service charge contributions to the Service Charge Sinking Fund were lawful.

The case highlights the importance of what the service charge provisions say.

There is, however, some protection from unfair treatment. The Courts will however imply a term that the discretion may only be exercised honestly and in good faith and not in an arbitrary, capricious or irrational way (Braganza v BP Shipping Ltd [2015] 1 WLR 1661).

But in order to dispute their due proportion of a service charge, the burden is on the tenant to establish a prima facie case (Yorkbrook Investments Ltd v Batten [1985] 2 EGLR 100). The tenant should demonstrate that the landlord’s decision is irrational and/or that the landlord has breached an implied term pursuant to Braganza v BP Shipping Ltd.

Conclusion

Therefore, when entering into a lease where the service charge is apportioned between various tenants, tenants should carefully review and consider the apportionment of the service charge clause in the lease. The tenant might want to make enquiries to further understand the landlord’s methodology behind the apportionments before entering the lease and before payment. It is also important that a tenant takes swift action to challenge anything which they consider may not be payable under the terms of their lease.

Favourably to landlords, the Judge observed that where there are several tenants among whom the service charge is divide, it was not sensible to see the question of apportionment as an objective standard where a tenant could simply reject a decision as unfair. The Judge describes that it makes no difference to landlords how the service charges are apportioned so the landlord can be “trusted” as it has “no axe to grind”. Nonetheless, in readiness for any challenges or disputes, when calculating apportionments of service charges, it is advisable for a landlord to gather and retain evidence to demonstrate the basis upon which they have done their calculation.