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What is the difference between a ‘sinking fund’ and a ‘reserve fund’? In
practice, the differences are slight. The purpose of a sinking fund is
generally to provide for expenditure that may occur no more than once or
twice during the life of a lengthy lease and be spent on specific items such
as lifts, boilers, air-conditioning, roofs, etc. In essence, it may be better
described as a ‘replacement’ fund. On the other hand, a reserve fund tends
to be established to meet recurring expenditure (eg redecorating costs), so
as to avoid fluctuations in the annual service charge amounts; to that
extent, it may perhaps be better described as an ‘equalisation’ fund.
Whatever the semantic difference between the two, both sinking and
reserve funds may require T to contribute to future expenditure from which
T will derive no benefit (eg if the lease expires before the money can be
spent). As we noted last month, the CA has recently looked at this issue in
the context of a lease where a large surplus had been paid on account by
T. Accordingly, T asked for a service charge holiday, but L refused. T then gave six month’s notice to quit under a break clause in the lease, and
refused to make service charge payment for that final period (on the basis
that L already had sufficient funds). L argued that the lease allowed it to
create a reserve fund, with the money in that fund not being repayable to T
– even if it had not been expended at the expiry of the lease. However, the
CA held that the lease did not provide for the creation of a reserve find, even
though it did allow L to include in the annual service charge a reasonable
provision for expenditure likely to be incurred in the future. But, that was to
be restricted to expenditure likely to be incurred during the currency of the
lease, with any sums remaining unspent thereafter to be returned to T.
As always, these cases have to be decided on the precise wording of
individual leases. It is therefore difficult to give any general guidance and
the fact remains that the distinctions between ‘reserve fund’ and ‘sinking
fund’ still remain undefined (and are probably more imagined than real
from a legal point of view). Certainly, this latest CA decision is an
encouragement to Ts who have contributed on account of future service
charge costs and who find that there is an unused surplus when the lease
ends. But, for the future, the lesson for those who draft and approve
leases is clear – avoid problems, by specifically stating in the lease what
happens to surplus service charge funds. Surprisingly, a large number of
standard precedents completely ignore this issue (and it is not even
mentioned in the new version of the RICS Code of Practice!). See note on
Brown’s v Southwark [2007] EWCA Civ 164 in [2007] SJ 494. © Practical Lawyer
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