All animals are created equal: service charge or fixed charge?

Service charge or fixed charge? What is a service charge and what is simply a fixed charge incurred under a lease?

The Gateway (Leeds) Management Ltd v Naghash and Shamsizedah [2015] UKUT 0333 (LC)

All animals are equal, but some animals are more equal than others. So wrote George Orwell in his brilliant satire, Animal Farm, published in 1945. In a different context, one might say, all cases are instructive, but some cases are more instructive than others.

One such being in The Gateway (Leeds) Management Ltd v Naghash and Shamsizedah (citation above), a decision of Martin Rodger QC, Deputy President in the Upper Tribunal (Lands Chamber), in which I acted for the Defendants/Respondents. It was a case which raised some significant issues concerning service charges, and how the decisions of the First-tier Tribunal which ordinarily regulates them have to be made.

Facts

The Claimant/Appellant was the management company which ran the services being provided to a large mixed use development close to the centre of Leeds. The Defendants/Respondents were holders of long leases of flats at the development.

The management company made a call for payment under the lessee’s service charge obligations. The overall charge levied under the included components in respect of a number of items. These included an element in respect of payment for a gym and a concierge office, both of which were rented by the management company from the freeholder, and a CCTV system, which was rented by the management company from an external third party.

The tenants objected to the amount of service charge they were being asked to pay. The management company issued proceedings in the county court, and both cases were transferred to he First-tier Tribunal (“the F-tT”), formerly more widely known as the Leasehold Valuation Tribunal. The F-tT has the jurisdiction to assess whether service charges have been reasonably incurred and if it determines they have not to reduce them accordingly.

The F-tT dismissed some of the tenants’ objections to items of expenditure. However, the F-tT decided that the charge levied against the tenants for the gym should be reduced by 50%, the charge for CCTV by 20%, and for the rent of the concierge office by 50%. The management company sought to appeal.

Permission to appeal was initially refused by the F-tT, but given by the appellate Tribunal on paper. The primary ground for appeal was that the charges for the gym, the CCTV and the concierge office were not actually service charges within the meaning of the Landlord and Tenant Act 1985 at all; they were simply fixed costs incurred by the management company and passed on to the tenants and thus the F-tT had no jurisdiction to interfere with them. However, it was also argued that the F-tT had focused its attention inappropriately on whether the charges for the gym, CCTV and concierge office were expensive, rather than whether the costs had been reasonably incurred.  Permission was also given to argue that the F-tT’s reasons for reducing the charges were insufficiently explained.

Issues

The appeal canvassed 3 arguments: what exactly was a “service charge”, and more particularly were these charges in respect of leases within the definition, or were they in fact fixed charges under the lease. Second, even if the L-tT had jurisdiction, had the L-tT applied the wrong test in considering the appropriate level of charge which could be justified. Third and possibly most forcefully of all: had the L-tT given adequate reasons for its decision.

In this article I deal with the first issue.

The leases

The Deputy President described the leases and the charges thus:

“9.       The leases themselves were for terms of 150 years from 31 March 2006 and were granted to the respondents by The Gateway (Leeds) Limited, a company associated with the original developer.  The appellant was also a party to the leases and covenanted to provide the services in return for the service charge contributions payable by the respondents.  Those contributions consisted of four separate charges described as the Estate, the Block, the Reserve and the Security Service Charges, each recoverable in different proportions from the lessees.  Each lessee covenants in clause 3.1 to pay “the Rents”, an expression defined as including not only the ground rent and insurance rent but also each of the four service charges.

10. Each of the respondents’ leases was granted in January 2007.  On 19 December 2007 the landlord granted the appellant the lease of a mezzanine unit in block A for use as a gym.  The evidence now indicates that the gym is approximately 1,340 sq ft in area.  The gym lease, which was for a term of 10 years from 19 December 2007, was at an initial rent of £32,000 a year which was subject to review on 1 April 2009 and annually thereafter.  The Fifth Schedule provided for the rent to be increased annually either by reference to the increase in the retail prices index or by 3%, whichever should prove to be the greater.
11. On 7 January 2008 the landlord granted the lease of a second unit in Block A to the appellant for use as a concierge suite.  The concierge lease is for a term of 20 years from 7 January 2008 at a rent of £24,000 a year subject to annual review on the same basis as the gym lease.
12. The Gateway’s CCTV system was provided under two agreements entered into by the original developer with an equipment leasing company.  No copy of those agreements is now available and the developer has gone into liquidation.  Nonetheless the evidence before the F-tT was that the appellant took over the CCTV system and the associated liability to pay £29,104.16 per annum under the first agreement and £14,122 under the second, in each case by fixed monthly instalments for a term of 5 years commencing on 23 June 2007.”

What is a service charge?  

Under section 27A, Landlord and Tenant Act 1985 the F-tT has jurisdiction to determine whether a service charge is payable and, if it is, the amount which is payable.

Under section 19 of the 1985 Act, a service charge is payable only to the extent that they are reasonably incurred. This is often, but slightly inaccurately, referred to as a requirement that the charges must be “reasonable”.

A “service charge” for this purpose is defined in section 18 of the 1985 Act, as follows:

“18 – Meaning of “service charge” and “relevant costs”

• In the following provisions of this Act “service charge” means an amount payable by a tenant of a dwelling as part of or in addition to the rent

(a) which is payable directly or indirectly, for services, repairs, maintenance, improvements or insurance or the landlord’s costs of management, and

(b) the whole or part of which varies or may vary according to the relevant costs.

(2)                       The relevant costs are the costs or estimated costs incurred or to be incurred by or on behalf of the landlord or a superior landlord, in connection with the matters for which the service charge is payable.

(3)                       For this purpose –

(a) “Costs” includes overheads, and

(b) costs are relevant costs in relation to the service charge whether they are incurred, or to be incurred, in the period for which the service charge is payable or in an earlier or later period.”

Thus, in order to be a service charge, a charge must be both “a payment for services, repairs maintenance, improvements or insurance”, and it must be capable of varying, in whole or in part, according to the costs incurred by the landlord (which for present purposes included the management company).

The management company’s argument

The gist of the argument run by the management company was that the charges incurred were not variable charges at all. They were fixed rents incurred by the landlord under the respective leases of the gym room, the concierge’s room, and the CCTV lease contract. That was an argument which had already been considered and rejected in a previous case in the Upper Tribunal, namely Warwickshire Hamlets Limited v Gedden [2010] UKUT 75 (LC), a decision of HHJ Huskinson).

Nevertheless, in support of its argument the management company relied on a dictum of Sir Stanley Burnton in a recent case, Bolton v Godwin-Austen [2014] EWCA Civ 27 as follows:

“What is rent for the purposes of Chapter II cannot depend on what the money or the obligation is called, since otherwise it would be possible for a lessor to draft himself out of the constraints of section 56.  An obligation to pay the rent payable by a head lessor to his freeholder is not a service charge or part of a service charge.  The definitions of service charge in section 18 of the Landlord and Tenant Act 1985 and of management functions in section 96 of the Commonhold and Leasehold Reform Act 2002 broadly reflect the normal usage of the expression “service charge”, and could not include the payment by a head lessor of his rent.  In my judgment the obligation of a lessee to pay to his lessor the rent payable by the lessor to his freeholder (or head lessor) is itself an obligation to pay rent.”

Management company’s arguments rejected

It is perhaps worthwhile pointing out that the management company did not simply relay its costs for each individual item in dispute on a on a like for like basis. In that case I could see at least some justification for alleging that they were fixed costs payable under the underleases, although even then that seemed a bit far fetched. What it did was include these various elements within a global figure comprising of many elements of expenditure, all being added together and recouped as a global sum under the service charge provisions. However, this was not the main reason the Tribunal rejected the management company’s appeal on these grounds.

The main reasons in rejecting the management company’s appeal on this point can be summed up as follows:

• It was self evident that a draftsman could not turn what was in substance a rent into a service charge or vica versa just by drafting. What Sir Stanley Burnton was dealing with in the Bolton v Godwin Austin case was the ambit of section 56 of the Leasehold Reform, Housing and Urban Development Act 1993. He did not say, and cannot be said to have meant, that a rent can never form part of a landlord’s expenditure which is the recovered through what is properly defined as a service charge.
• Section 18(1) (a) requires the payment to be made directly or indirectly in respect of services, repairs, maintenance etc”. Payment under a lease for the rooms where the gym and the concierge services were carried and payment under the lease of the CCTV equipment were all necessary prerequisites of the management company carrying out or providing those services. Therefore they were directly or indirectly payments for “services” being provided by the management company under the lease.
• The payments were variable, or capable variation over time. The leases of the gym and the concierge’s room all appeared to have rent review clauses and the leases the leases were relatively short term. The CCTV lease too would come to an end in the foreseeable future. Therefore all of these charges would vary of in any event “may vary” within the meaning of section 18(1)(b).

For completeness, one can add that he relevant charges were “costs” within the meaning of section 19(2) and (3), in the sense that they were overheads incurred in relation to carrying out services under the lease.

Conclusion

This was the relatively easy part of the appeal. The management company’s argument on the point had, in my view, a degree of unreality about it because the charges were clearly indirectly incurred but necessary to carrying out the services in issue, and were plainly capable or variation from time to time, because the charges were subject to review, renewal and even renegotiation. That was not, incidentally, my excellent opponent’s fault. Neither side had covered itself in glory in the prep for appeal, and the matter had been passed around a fair bit before it landed on our respective desks just a few days before the actual hearing. As we agreed, had we both been instructed at an earlier stage, the case would almost certainly have been sorted out without an appeal. However, as it was, an excellent day’s argument ensued.

In another piece I shall return to another matter which was in top stark relief and which neither party had really grasped below: in front of the L-tT, upon whom (if anyone) does the burden of proof lie, and how do the parties go about discharging it or what evidence does the L-tT need to form a view? These caused much greater problems, and on these there was a much

David Partington is very experienced in service charge provisions and other landlord and tenant matters. To book David, please contact his clerks, Fran or Talia, on 01132 459762.