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Legislation Brief No.1 – Service Charges

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14th December 2023

In Tanfield’s Legislation Brief no 1, Mark Loveday looks at what practitioners can expect from the service charge provisions of the Bill and some of the headline changes. You can find more articles and links to the draft legislation on our Leasehold & Freehold Reform Hub.

 

Service Charges

 

Summary of Proposals

1. The Leasehold and Freehold Reform Bill was published on 27 November 2023[1]. This Legislation Brief deals with the provisions in the Bill relating to service charges in residential leases[2]. They appear in Part 3 (clauses 26-38 and Sch.8).
2. The relevant changes can be summarised as follows:

• Clause 27 makes significant changes to the form of service charge demands. In future, they must be in prescribed form.
• Clause 28 standardises the form of annual service charge accounts. There will be an implied term in every lease that service charge accounts must be provided within six months of the end of each service charge year, and they must be certified by a qualified accountant.
• Clause 28 also includes a separate statutory duty to provide a service charge report within a month of the end of the service charge year.
• Clauses 31-32 contain complex provisions aimed at controlling landlords’ insurance commissions and discounts. They also deal with enhanced rights to information about insurance under the schedule to the 1985 Act.
• Clause 33 requires landlords and management companies to publish lists of their standard administration charges and provide a copy of the summary to each tenant.
• Clause 26 brings fixed or ‘escalator’ service charges within the statutory protection of the Landlord and Tenant Act 1985. This mitigates the outcome of the litigation in Arnold v Britton [2015] UKSC 36; [2015] 2 WLR 1593.
• Clause 29 consolidates various rights to information and replaces them with a single obligation for landlords to provide information about services, repairs, maintenance, improvements, insurance, or management.
• Clause 30 replaces the criminal offences in the 1985 Act with new sanctions for non-compliance that can be imposed by the property tribunals.
• Clause 34 deals with litigation costs. This topic will be dealt with in a separate Litigation Brief.
• Clauses 35-38 and Sch.8 make minor changes to other statutory provisions.

Background

3. The main limitations on variable service charges in residential leases appear in s.18-30I Landlord and Tenant Act 1985[3] and in the Landlord and Tenant Act 1987. In Daejan v Benson [2013] UKSC 14 at [42], Lord Neuberger explained that ss.18-20 of the 1985 Act are “directed towards ensuring that tenants of flats are not required (i) to pay for unnecessary services or services which are provided to a defective standard, and (ii) to pay more than they should for services which are necessary and are provided to an acceptable standard”.

Pre-legislative material

4. In limited circumstances, pre-legislative material is relevant as an aid to interpretation of unclear statutory provisions[4].
5. The service charge provisions of the Bill were not preceded by any relevant pre-legislative material. No formal public consultation was conducted before the announcement of changes to the service charge regime[5], and the trio of 2020 Law Commission reports[6] did not deal with this topic at all. Although there were regular ministerial promises to legislate in this area[7], the contents of these ministerial statements are unlikely to be treated by the courts as an admissible aid to interpretation. The same applies to the 2023 King’s Speech, which included the following general commitment:

“My Ministers will bring forward a bill to reform the housing market by making it cheaper and easier for leaseholders to purchase their freehold and tackling the exploitation of millions of homeowners through punitive service charges [Leasehold and Freehold Bill].[8]”

The DLUHC Guidance accompanying the Bill[9] included the following limited reference to service charges:

“Require transparency over leaseholders’ service charges – so all leaseholders receive better transparency over the costs they are being charged by their freeholder or managing agent in a standardised comparable format and can scrutinise and better challenge them if they are unreasonable.”

6. It is against this background that one can turn to the Bill itself.

Clause 26: Fixed or ‘escalator’ service charges

7. Although the vast majority of service charges are variable (i.e., the amount payable by a leaseholder varies according to the costs or estimated costs incurred by the landlord in each service charge year), that is not always the case. For example, the leading case of Arnold v Britton [2015] UKSC 36; [2015] 2 WLR 1593 involved a fixed or ‘escalator’ provision which increased the service charges by a fixed compound amount each year. As a result, the leaseholders of some fairly modest holiday chalets on the Gower peninsular became liable for fixed annual service charges rising to £1,025,004 by the year 2072[10],. The lessees had no statutory protection against these onerous liabilities under the 1985 or 1987 Landlord and Tenant Acts, because the charges did not meet the definition of a variable ‘service charge’ in s.18(1) of the 1985 Act. The Supreme Court felt it was unable to interfere with the clear contractual obligations in the leases – although it strongly hinted that parliament might intervene[11].
8. Clause 26(2) partially mitigates the effects of Arnold v Britton by amending the definition of “service charge” in s.18(1) of the 1985 Act. It makes a new distinction between “service charges” and “variable service charges”, and clauses 26(3) and (4) then apply the two new definitions to various parts of s.19-30E of the 1985 Act.
9. Despite the complex drafting in clause 26, lessees with fixed or ‘escalator’ service charges will acquire few additional rights under the 1985 Act. They will be able to apply to the appropriate tribunal[12] for a determination of liability to pay their service charges under s.27A of the 1985 Act[13], and the new statutory accounting and service charge demand procedures will apply to them as well (see below). But many significant protections in the 1985 Act, namely s.19 (reasonableness), s.20 (consultation requirements) and s.20B (time limit on making demands) will continue to apply to variable service charges alone.
10. In practice, the more significant remedies extended to this small but important category of leaseholder may well be under the Landlord and Tenant Act 1987. The definitions of “service charge” in s.24(2A) and 35(8) and s.42(1) of the 1987 Act are tied to the definition of “service charge” in s.18(1) of the 1985 Act and remain unaltered by the Bill. Leaseholders with fixed or escalator service charges will therefore be able to apply to the tribunal to appoint a Manager ‘for cause’ on the ground that there has been a demand for an “unreasonable” service charge (s.24(ab)). Fixed or escalator service charges will also be held on the statutory trust (s.42), which means that the landlord will only be able to spend moneys received on management costs. There may also be grounds to apply to vary the leases by introducing a variable service charge provision (s.35).
11. It should be said the reasoning behind the different treatment of variable and non-variable service charges in clause 36 of the Bill is not altogether clear. One could largely delete the references to “variable” service charges from the 1985 Act without affecting the rights of all categories of lessee. Moreover, the drafting makes it unclear whether Arnold v Britton-type lessees will be able to apply for a variation of their leases to substitute a conventional variable service charge[14]. These issues could usefully be addressed at committee stage.

Clause 27: Service charge demands

12. Section 21 of the 1985 Act has had a tortuous history. As originally enacted, it gave lessees the right to request a summary of relevant costs. The Commonhold and Leasehold Reform Act 2002 introduced three requirements:
    • A replacement obligation for landlords to provide regular service charge statements of account (s.21).
    • A right for leaseholders to withhold service charges until that obligation was met (s.21A).
    • A requirement that demands for payment must be accompanied by a summary of rights and obligations in prescribed form (s.21B).

The first two amendments were not brought into force. For many years, s.21B therefore sat (slightly uncomfortably) alongside the formal requirements for service charge demands in ss.47 and 48 of the Landlord and Tenant Act 1987. Sections 21B of the 1985 Act and ss.47 and 48 of the 1987 Act proved popular grounds for objecting to payment of service charges. They have led to much litigation[15].

13. Clauses 27(2) and (3) of the Bill repeal all these provisions and replace them with a single new s.21C of the 1985 Act. This contains a simple requirement that service charge demands must be in prescribed form. We have yet to see the regulations which will prescribe the new form of demand. But if a demand is not in prescribed form:

• There is no obligation to pay until that requirement is met.
• There is a new sanction for non-compliance: see the new s.25A (below).

The provisions apply to both fixed and variable service charges. Note that clause 27(4) effectively disapplies s.47 of the 1987 Act as well. The aim is plainly to provide standardise the format of demands in accordance with the Guidance Notes above.

14. Clause 27 will probably have the most widespread practical impact of any provision of the Bill. Many hundreds of thousands of service charge demands each year will now have to be in prescribed form. This will require expensive and extensive revisions to management systems operated by managing agents and landlords. Depending on what is included in the regulations and the prescribed forms, the postal costs alone could increase substantially. Against this, the regulatory regime is simplified and made consistent for all kinds of service charges and all forms of residential lease.
15. Two comments can be made at this stage. First, some leases include specific contractual requirements about the form of demands for payment. It is likely the amended provision will supplement, rather than replace these contractual requirements[16]. There therefore a risk of confusion and duplication. Secondly, there is often an overlap between the requirements of ss.47 and 48 of the 1987 Act. But clause 27(4) of the Bill does not disapply the information requirements of s.48 in the case of service charge demands.

Clause 28: Accounts and annual reports

16. The machinery of service charges is not standardised, and there are a bewildering variety of procedures in common usage. Some leases specify the form of annual budgets and accounts, but some do not. Some require certification by the landlord, management company, managing agent, accountant, auditor (or indeed other third party[17]). Some prescribe a time by which budgets or accounts must be produced. In some cases, these steps are a condition precedent to liability to pay a service charge, but in other cases they are not[18]. Disputes about the form of accounting are commonplace.
17. At present, the form of service charge accounts and annual statements is only regulated indirectly. Service charge accounts are generally prepared in the form recommended by TECH 03/11 and a requirement to provide accounts in this form is incorporated into the RICS Residential Service Charge Management Code (3^rd Ed)[19]. The Code has ministerial approval under s.87 of the Leasehold Reform Housing and Urban Development Act 1993, and it is widely used by tribunals as a benchmark for good practice.
18. As already explained, the 2002 attempt to mandate a form of regular service charge accounts and statements was unsuccessful. The replacement s.21 of the 1985 Act was never brought into force.
19. Clause 28 of the Bill is more ambitious. New ss.21D and 21E of the 1985 Act make two changes.

Implied term (accounts)

20. Section 21D introduces a mandatory requirement for annual accounts and certification by a qualified accountant. The chosen mechanism is to imply a term into leases of dwellings with variable service charge provisions. It is worth setting out the implied terms in full:

 

“(a) that, on or before the account date for each accounting period, the landlord must provide the tenant with a written statement of account in a specified form and manner setting out—

(i) the variable service charges arising in the period which are payable by the tenant and each connected tenant, (ii) the relevant costs relating to those service charges, and

(iii) any other specified matters;

(b) that the landlord must ensure the statement of account is certified by a qualified accountant as being—

(i) in the accountant’s opinion, a fair summary of the relevant costs, and

(ii) sufficiently supported by accounts, receipts or other documents provided to the accountant.”

 

Under s.21D(4), the “account date” is six months after the end of the relevant service charge year. This avoids any problems with s.20B of the 1985 Act. The requirements apply to service charges payable by both leasehold flats and leasehold houses, but only where a block or an estate has four or more dwellings: see s.21D(1)(b).

21. The aim is again plainly to provide better transparency and to standardise the format of accounts in accordance with the above Guidance.

22. The decision to imply terms has certain consequences:
    • There is no express statement in s.21D that the implied terms replace any equivalent existing provisions in the lease. In many cases, lease provisions require certification by an auditor, or they may require accounts to be prepared within a different time frame. Are these stricter requirements displaced? If not, landlords and managers will be forced to prepare two sets of accounts – one under the existing terms of the lease, and the other under the new implied terms in s.21D.
    • It is unclear whether the courts or property tribunals will treat the landlord’s compliance with the implied terms as a condition precedent to the lessee’s obligation to pay their service charges. The word “must” in the draft is not necessarily determinative. That issue will require early litigation to sort out, particularly in borderline cases (e.g., if the accounts are a day late).
    • Allied to this, ‘enforcement’ of the implied term is unclear. The draft s.20D includes no express sanctions for non-compliance, and it is not brought within the new sanctions in s.25A (see below). Theoretically therefore, enforcement would be by an application by the leaseholder for specific performance through the courts. That may not really be what is intended.
    • It is probable that in many cases landlord and management companies will be unable to receiver the extra costs of complying with these requirements through the service charges. Clause 28 and s.21D do not have any implied costs recovery right. This is all the more surprising, since clause 29 of the Bill proposes a new s.21G(6) implied right to recover costs in other contexts.

Statutory duty (annual reports)

23. The second proposal under clause 28 of the Bill is a statutory duty to provide leaseholders with an annual report about their service charges. This is to be set out in a new s.21E of the 1985 Act. The form of annual statement is unclear, this being left to regulations. But unlike the accounts, the annual report must be sent to lessees within a month of the end of the accounting period: see s.21E(5). There is no requirement for the report to be certified by a qualified accountant.
24. The sanction for default is set out in the new s.25A of the 1985 Act (below).
25. There is obvious scope for duplication with annual accounts. Moreover, there is no express power to recover the costs of a report through the service charges: again, contrast with s.21G(6) of the 1985 Act.

Clause 29: Right to obtain information on request

26. Access to information about relevant costs +is a recurrent theme in tribunal proceedings. Outside of disclosure orders during tribunal proceedings, there are relatively few direct means for leaseholders to request information. Under s.21 of the 1985 Act, there is a right to request a summary of relevant costs and under s.22 a leaseholder may ask to inspect supporting documentation following the provision of a s.21 summary. Failure to comply with either obligation is an offence: see s.25.
27. Clause 29(3) of the Bill sweeps away ss.22, 23 and 24 of the 1985 Act and creates a new standalone statutory right to information. The right, contained in a new s.21F and s.21G of the Act, will largely be set out in regulations. The regulations will specify the relevant categories of information about service charges and information about services, repairs, maintenance, improvements, insurance, or management. They will also set out the time for compliance, etc. As already explained, s.21G(6) includes an implied right for landlords and management companies to recover the costs of supplying this information through the service charges. Failure to comply will not be an offence, but it will be the subject of penalties under Clause 30 of the Bill.

Clause 30: enforcement

28. The 1985 Act includes penal provisions dealing with any failure to comply with s.21, 22 and 23. Non-compliance is an offence punishable in the magistrates’ court with a fine. Given the proposed replacement of all three of these provisions, the existing penal provisions are also repealed by clause 29.
29. Clause 29 introduces a new s.25A of the Act, which decriminalises the sanctions and applies a new enforcement regime to the modified requirements.
30. The new enforcement regime allows an application to be made to the appropriate tribunal for an order that the landlord complies with the relevant provision within 14 days, that it pays damages to the applicant (limited to £5,000) or other consequential orders. There are three provisions aimed at preventing the landlord from adding damages or its costs to the service charges: see s.25A(7) to (9).
31. As far as the application of the new sanctions is concerned, they apply to:
    • Failure to make demands in proper form under s.21C(1) of the 1985 Act.
    • Failure to provide a report on service charges under s.21E.
    • Failure to provide information under ss.21F and 21G.

Clause 31-32: Insurance

32. The existing rights of leaseholders in relation to building insurance appear in s.30A and the Schedule to the 1985 Act. A recurrent theme in disputes about insurance costs has been the ability of landlords and management companies to retain commissions and discounts on insurance. The position with various kinds of insurance commissions was dealt with in Williams v Southwark LBC (2001) 33 HLR 22. Broadly speaking, the Upper Tribunal in Williams distinguished between (1) commissions or discounts provided by insurers to landlords in return for claims handling etc, and (2) commissions or discounts earned by landlords for placing business with a particular insurer. The former did not have to be credited to leaseholders, whilst the latter did[20].
33. The Guidance accompanying the Bill states that it will:

“Replace buildings insurance commissions for managing agents, landlords and freeholders with transparent administration fees – to stop leaseholders being charged exorbitant, opaque commissions on top of their premiums.”

Clause 31of the Bill delivers on the first part of this commitment.

34. Once again, Clause 31 deals with insurance commissions by way of a new s.20G of the 1985 Act. This identifies certain “excluded insurance costs” which may not be included in a variable service charge unless they relate to a “permitted insurance payment”. Although both terms are defined, the categories of “permitted insurance payment” are to be set by regulations. It is therefore possible that the distinction between the kinds of ‘good’ insurance commissions and ‘bad’ commissions in Williamswill be reflected in regulations.
35. A new s.20H of the Act permits the appropriate tribunal to order the return of any sum paid by the tenant in relation to improper commissions and to pay damages. There is no specific requirement for it to credit the service charge accounts of other leaseholders or to reimburse the service charge fund generally.
36. However, in a rare provision that specifically benefits landlords and management companies, a new s.20I provides that a permitted insurance payment (i.e., a ‘good’ commission) may be added to the service charge costs. This is by way of an implied term at s.20I(1) of the 1985 Act. Once again, the right to retain certain commissions reflects the distinction made in Williams.
37. Clause 32 expands on the information to be provided to lessees about insurance under the Schedule to the 1985 Act. Leaseholders may apply to the appropriate tribunal if the landlord fails to provide this information. The tribunal may order the landlord to provide this information and to pay damages.

Clause 33: Administration charges

38. The regulation of administration charges was introduced by the Commonhold and Leasehold Reform Act 2002. Broadly speaking, administration charges are individual charges payable by a specific lessee, as opposed to a service charge, for which the lessee is only responsible for an apportioned part: see definition in para 1 of Sch.11 to the 2002 Act. Examples are interest payable on late payments, charges for consents to sub-letting and alterations, legal costs, etc. Administration charges are regulated under Sch.11 to the 2002 Act in a similar way to service charges, and they are a familiar source of disputes before the property tribunals.
39. The passage in the Guidance referring to insurance appears to conflate the provisions in clauses 31-32 of the Bill (that relate to insurance) with the very separate proposals in clause 33 (that relate to administration charges).
40. Clause 33 of the Bill adds a new para 4A to Sch.11 of the 2002 Act which requires landlords and management companies to publish standard lists of their administration charges and provide a copy to each tenant. An administration charge is payable only if it appears in the schedule. And once again, a lessee may apply to the appropriate tribunal in the event of default in publishing a schedule of administration charges under a new para 4B of the Schedule. The tribunal may order the landlord to publish a schedule within 14 days and pay damages limited to £1,000.
41. To prepare the schedule, the landlord will have to review the specific provisions of each flat lease in case the administration charges differ from one flat to another. This may prove challenging, if the leases are lengthy and the block is a large one.

Clause 34: Litigation costs

42. Costs in tribunals, and in the courts, have produced disproportionate litigation. Although the property tribunals do not generally apply costs shifting[21], a particular bone of contention has been the ability of landlords to rely on contractual rights to recover costs against individual lessees[22]. This has been seen as one-way costs shifting, and unfair to lessees. In truth, these legal costs are merely another form of administration charge. Previous attempts were made to limit these express costs recovery provisions, notably in para 5A(1) of Sch.11 to the 2002 Act. Again, para 5A applications are routine in the property tribunals.
43. The Guidance accompanying the Bill suggests it will “Scrap the presumption for leaseholders to pay their freeholders’ legal costs when challenging poor practice”. Clause 34 is intended to deliver this commitment.
44. The provisions are complex and will be dealt with in a separate Litigation Brief.

Clauses 35-38

45. Clause 35-38 and Sch.8 to the Bill make minor changes to other statutory provisions.

 

[1] https://publications.parliament.uk/pa/bills/cbill/58-04/0013/230013.pdf.

[2] The provisions in the Bill dealing with rentcharges and estate charges payable by the owners of freehold houses will be dealt with separately.

[3] As amended from time to time, notably by the Commonhold and Leasehold Reform Act 2002 and s.112 of the Building Safety Act 2022.

[4] See Bennion, Bailey & Norbury on Statutory Interpretation (8^th Ed) at 24.9.

[5] For example, the 2022 consultation Reforming the leasehold and commonhold systems in England and Wales did not cover service charge proposals in any detail: https://www.gov.uk/government/consultations/reforming-the-leasehold-and-commonhold-systems-in-england-and-wales/outcome/reforming-the-leasehold-and-commonhold-systems-in-england-and-wales-summary-of-responses-and-government-response.

[6] Leasehold home ownership: buying your freehold or extending your lease (Law Com No 392); Leasehold home ownership: exercising the right to manage (Law Com No 392); Reinvigorating commonhold: the alternative to leasehold ownership (Law Com No 394).

[7] For example, Baroness Bloomfield, Hansard HL Deb (20 July 2022) vol 823 and Rachel Maclean MP, Hansard HC Deb (20 April 2023) vol 731.

[8] Hansard HL Deb (7 November 2023) vol 834.

[9] Guidance: Information relating to the Leasehold and Freehold Reform Bill which was introduced to Parliament on 27 November 2023, DLUHC, 27 November 2023.

[10] Arnold v Britton at [99].

[11] Arnold v Britton at [65], [66] and [79].

[12] The First-tier Tribunal (Property Chamber) in England or the Leasehold Valuation Tribunal in Wales.

[13] Clause 26(4) does not change the references to “service charge” in s.27A of the 1985 Act.

[14] On balance, it looks as if the drafting prevents leaseholders from applying for a variation. Under s.35(2)(f) of the 1987 Act, the grounds for making a variation order include where a lease “fails to make satisfactory provision with respect to … the computation of a service charge”. Section 35(4) says this arises where the lease “provides for any such charge to be a proportion of expenditure incurred” by the landlord and the proportions paid by all lessees in the building do not add up to 100%. The difficulty is with a fixed service charge ifs that the lessee’s liability is probably not a “proportion of expenditure incurred”.

[15] See, for example, Tudor Roberts v Countryside Residential (South West) Ltd [2017] UKUT 386 (LC).

[16] This is because the new s.21C(2) states that certain lease provisions relating to non-payment or late payment of service charges do “not have effect”. The maxim Expressio unius, exclusio alterius applies.

[17] See the commercial service charge case of St Mowden Developments (Edmonton) v Tesco [2006] EWHC 3177 (Ch); [2007] 1 EGLR 63.

[18] The term “condition precedent” is not favoured by the courts: Leonora Investment Co Ltd v Mott MacDonald Ltd [2008] EWCA Civ 857. But the meaning is clear.

[19] At para 7.10.

[20] For a more detailed treatment, see Service Charges & Management (5^th Ed) at 5-07 to 5-08.

[21] See the Tribunal Procedure (First-tier Tribunal) (Property Chamber) Rules 2013 r.13 and Willow Court Management v Alexander [2016] UKUT 290 (LC); [2016] L&TR 34.

[22] Sometimes described as “69 Marina clauses” after the decision of the Court of Appeal in Freeholders of 69 Marina, St Leonards-On-Sea v Oram & Anor [2011] EWCA Civ 1258.

 

Mark Loveday

Mark Loveday is a senior member of Tanfield’s property team. He is General Editor of Service Charges & Management (5^th Ed) and a contributor to other legal texts. His “Ask the Expert” column on consumer property issues appears every Friday in the Times Bricks & Mortar Property Supplement.

5 December 2023

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