Make sure you get good legal advice!
Commercial tenants will know that the rent they pay is only one part of the overall cost of occupying their premises. A service charge is another significant cost and, unlike rent, it can fluctuate from year to year depending on what the landlord intends to spend on maintenance and other services.
Commercial tenants keen to keep costs under control need to keep a close eye on service charge demands made by their landlords. A well-drafted lease should have a clear timetable for landlords to produce budgets and to reconcile them with actual spend each year, as well as limiting the things for which the landlord can charge. Prior to signing the lease it is important to find out how much the landlord has charged in previous years and their planned expenditure going forward.
We can raise enquiries with the landlord and explain your options. If you have already entered into your lease and you think you are being asked to pay too much then we can scrutinise the service charge provisions and advise whether the demands are fair or not. In this article we highlight why it is important for service charge provisions to be well drafted, and for tenants to get good legal advice on how to interpret them in practice.
What the service charge should cover
Service charges arise on properties where some parts are let to tenants and some parts, such as the structure of the building, private roads and common areas, are retained by the landlord. As a minimum, the landlord should be obliged to maintain those areas and to provide shared services to the common parts, such as heating, lighting, and water, as well as cleaning and refuse disposal. The landlord will want to recover these costs through the service charge, which is shared between the tenants. Depending on the nature of the property, the services may be quite limited or could be much more extensive. The key point for a tenant is that the landlord should only be charging for services that are allowed for in your lease.
What to look for in your lease
If you are negotiating a new lease, your solicitor will try to make sure the service charge provisions are fair. There is a statutory code which sets out requirements and recommendations for how a landlord’s surveyor should approach commercial service charges. Although the code is not binding on landlords, it is a useful benchmark of good and fair practice.
The lease should set out the services for which the landlord may charge and also the mechanism for the landlord to demand and recover the costs. The usual arrangement is for the landlord to produce a budget for the year, based on estimated expenditure. Then tenants will pay quarterly instalments on account, based on that estimate. At the end of the service charge accounting year, the landlord will reconcile actual expenditure against the estimate and produce a final budget. Tenants may have to make an additional balancing payment at that point or, if the actual expenditure is lower than the estimate, the overpayment will be credited against next year’s service charge.
Before entering into the lease your solicitor should request information about the amount of the service charge in previous years, how much the landlord is intending to charge going forward and whether there are any unusual or exceptional items likely to be charged for in the coming years. This will allow you to make an informed decision on whether to accept the lease or not. There are some key points your solicitor will be looking for:
- The basic services will be fixed, but the landlord will want some discretion to decide on what other expenditure is required. That should be limited to what is reasonable and can be justified as good estate management.
- The simplest approach to a fair apportionment between tenants is to allocate costs based on the relative floor area occupied by each tenant, but that might not be fair if tenants do not use all services equally. Whatever method is used, your solicitor will make sure that the landlord picks up the notional share for any vacant units, and if there has been any special deal with one tenant that will not result in the rest of the tenants paying more.
- There should be a list of excluded costs, which the landlord is never entitled to recover via the service charge. The list will vary depending on the nature of the property, but it will typically include things like capital expenditure, the costs the landlord incurs in letting units and enforcing other tenants’ obligations and often advertising and promotion. The trickiest area is setting out when a landlord is entitled to recover the cost of replacing an item instead of repairing it and whether that replacement may be something better than what was there before. Leases usually deal with this by allowing replacement where the original item is beyond economic repair, but reaching agreement about whether an improvement is legitimate and cost-effective can be very difficult.
- Minimum energy efficiency standards for commercial leases mean that landlords may need to make ‘green’ upgrades to improve energy performance and reduce the property’s carbon footprint. There is still no clear market position on whether the landlord can recover any of these costs through the service charge. It will depend on the nature of the property and the attitudes of landlord and tenant but it is definitely something your solicitor should cover in the lease.
- Whether the landlord would agree to cap the level of the service charge in any one year or limit your obligation to contribute toward exceptional items.
Dealing with disputes
Whatever the lease says, it is common for tenants to challenge their landlord’s service charge demands. If you think you are being charged too much, your solicitor will be able to advise you on how to raise a challenge. The lease should have a timetable for querying charges, inspecting invoices and other records, and it is important that you act within deadlines. You should check that everything demanded is in the list of agreed services and is reasonable.
Even if you are disputing an item of service charge, you may still have to pay it in the first instance. This will depend on what your lease says, but the Supreme Court recently decided that the fairest position for both landlord and tenant is that the tenant should ‘pay now and argue later’. You may ultimately recover some of your payments but the landlord will not be out of pocket in the meantime.
How we can help
Every service charge arrangement is different and we can give you the advice you need to make sure you are getting value for money. For further information, please contact David Marsh in the commercial property team on 01733 882800 or email [email protected].
David Marsh, Senior Associate
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