Landlord’s objective:

• to limit the services it is obliged to provide to those essential to the maintenance and running of the Property, while reserving the right to charge for additional services; and
• to ensure that all money spent on providing services can be recovered from the tenant/tenants.

Tenant’s objective:

• to make sure the Property is properly maintained; and
• to ensure that the cost of services is reasonable and reflects value for money and that the tenant is not paying for improvements to the Property or unnecessary services.

Services and service charge are really only significant in relation to multi-let properties, such as office blocks or retail parks. Both landlord and tenant will want to make sure that the parts of the development not let to occupational tenants are kept clean and in good repair and properly insured. Depending on the nature of the development, a variety of other services may be necessary or desirable – for example, provision of lighting and air-conditioning, collection of rubbish, provision of security staff.

Basic structure

Service charge provisions usually work as follows:

• There is an agreed set of services, the cost of which the landlord is entitled to recover. There is usually also a list of costs that may not be recovered.
• The landlord will make an estimate of the expected expenditure for each year and the tenant will pay its proportion of the estimate in four quarterly instalments. These quarterly payments are usually reserved as rent.
• At the end of the year, the landlord will prepare a service charge account, which will be certified by the landlord’s accountants.
• If the actual expenditure exceeds the estimate, the tenant will be required to make up the difference by making a balancing payment. If the tenant’s quarterly payments exceed what has actually been spent, the excess will either be credited to the service charge account for the following year or repaid to the tenant, depending on the bargaining position of the two parties when the lease is negotiated.

Guide to good practice on service charges in commercial properties (the “Guide”)

The Code recommends that the parties to a lease should observe the suggestions set out in the Guide to good practice on service charges in commercial properties, the second edition of which appeared in August 2000. Like the Code, the Guide is published jointly by various property industry bodies. Part of the purpose of the Guide is to encourage landlords and tenants to interpret and operate existing service charge provisions more fairly. It is also a very useful checklist for use when negotiating a new lease, both in relation to the categories of expenditure which should be excluded and the mechanism by which the landlord is to account to tenants for what has been spent. The Guide is available at www.servicechargeguide.co.uk

The issues that give rise to most discussion when negotiating service charge provisions are set out below. They are all also dealt with in the Guide.

Tenant’s proportion

The total expenditure on services must be divided between the individual tenants.

Landlords often want simply to refer to a “reasonable and proper” or “fair” proportion. This can work perfectly well and has the advantage of being very flexible if circumstances change. Alternatives are to agree a fixed proportion at the outset or a proportion based on the ratio of the net internal area of each unit to the total net internal area of all the units intended to be let to tenants.

Costs to be excluded

• Initial development

The tenant will want to make sure that none of the costs associated with the initial development (or future redevelopment) of the Property are recoverable through the service charge.

• Improvements

The tenant does not want to feel that its landlord is improving its property asset at the tenant’s expense. It can be difficult to decide where necessary work ceases to be repair and becomes an improvement, for example where major work is required to the roof of a property and the landlord wants to replace it rather than patch it up. Where the work done is what a reasonably minded landlord would do and it does not leave the landlord with something wholly different from what it had at the beginning, the cost is likely to be recoverable as a repair (Postel Properties Ltd v Boots the Chemist [1996] 2 EGLR 60). The courts have recently begun to recognise that it may not be reasonable for tenants with only a few years left of their leases to pay as much towards major repairs as tenants who are likely to be in occupation for longer. There is no clear rule but the indication is that it is reasonable for a landlord to recover only the cost of complying with its covenants until the end of the lease in question. A tenant with two years left to run could not, on that basis, reasonably be required to pay the same as its neighbour with 15 years still to go (Scottish Mutual Assurance plc v Jardine Public Relations Ltd [1999] EGCS 43).

• Dealings with other tenants

None of the costs associated with enforcing covenants against other tenants or dealing with consents to assign etc should be recoverable through the service charge.

• Share of costs attributable to empty units

The tenant will ideally want the landlord to contribute a sum equivalent to the proportion of the service charge costs attributable to any empty (or “void”) units, to make sure there is no shortfall. As a compromise, it should at least be clear that these costs may not be recovered from the existing tenants.

Promotional costs

These can be controversial, particularly on retail developments. Retailers spend huge sums on advertising and are often sceptical about the benefit of the landlord spending extra money on their behalf in promoting a particular shopping centre or retail park. The Guide recommends that the landlord should consult the tenants when planning promotional activities and it may be sensible to deal with this expressly in the lease.

Income received from use of common areas

The landlord may receive income from certain uses of the common areas of a development: examples include charges for car parking, licence fees for barrows and kiosks and income from public telephone/internet facilities. The tenants will argue that if those areas are being maintained at their expense, through the service charge, then any income received should be credited to the service charge account. The Guide supports this approach but, again, it is better to deal with it expressly.

Sinking funds/reserve funds and shortfalls

It might seem sensible for a proportion of what the tenant pays each year to go into a fund to be used to cover the cost of major works. This would arguably spread the cost of such works and avoid the tenant being asked to make disproportionately large contributions in particular years. It could also address any unfairness where some tenants have shorter leases than others (although the courts have begun to do this anyway – see Improvements). In practice, such funds are rare, partly because of the complicated way in which they are treated for tax purposes and partly because of fears about funds being lost if the landlord becomes insolvent.

Without a fund available to cover unexpected expenditure, the landlord will have to rely on a provision allowing it to request additional contributions from the tenant part way through a year. The tenant should make sure that such requests can only be made where it is reasonable and may want to try to restrict the number of times such a request can be made in any year.