What is a Service Charge?
A service charge is a mechanism within a commercial lease that enables the landlord to recover the costs of running the development from the tenants who occupy the development.
What a Service Charge might include?
A service charge will typically include:
- The cost of maintaining the structure of a building.
- The cost of maintaining any access routes within the development, for example, where the development is not immediately accessible from the public highway, the landlord will want to recover the cost of maintaining the same.
- The cost of maintaining the grassed areas of a development.
- If it is a large development or shopping centre, the cost of providing security, reception, cleaning and maintenance staff.
- The cost of maintaining signage.
It is also common to see a “sweeper” clause that will cover additional items that the landlord may decide to provide.
Landlord v. Tenant
Immediately there is a conflict between the interests of the landlord and tenant when it comes to a service charge.
The landlord will want to ensure that all costs involved with running the development are capable of being passed onto the tenants and the landlord does not have to put his hand into his pocket, this is called the “clear lease” principle. Further, if the landlord comes to sell a development subject to tenancies, any buyer will want to ensure the costs of running the development are fully recoverable under each tenancy.
The landlord will also want to ensure that its obligations only extend to the core services such as maintaining the structure and access road but the ability to recover other services should the landlord decide to provide them, for example, providing and operating any loudspeakers, music or public-address systems.
A landlord will also want to ensure that the service charge provisions in each occupational lease are consistent across the estate.
On the other hand, the tenant will want to establish the level of costs in connection with the service charge at the earliest opportunity. With some developments, the service charge may be as expensive as the rent.
It is difficult for a tenant to evaluate the risks with a service charge and the best advice is to have a surveyor report on the parts of the development the tenant will likely contribute to through the service charge, for example, if an industrial estate, the access road, if a building, the structure of it.
The replies from the landlord under the usual commercial property standard enquiries will reveal previous service charge amounts but these cannot anticipate the future service charges over a 10-year lease.
Solutions for Tenants
There is a fundamental unfairness in service charges as tenants are unable to project the future costs and cannot predict any capital expenditure which may occur in the future.
If a tenant is only taking a short-term lease or is in a strong bargaining position, it may attempt to negotiate a service charge cap. This is a restriction on the amount that can be charged by the landlord in any given service charge year. It may be limited to a specific figure or a percentage of the passing rent. This for obvious reasons is likely to be resisted by a landlord. Alternatively, it could negotiate a service charge cap linked to RPI (or another index), the service charge cap will be reviewed and increased annually following the relevant index.
The drafting in the lease is very important as landlords may attempt to side-step the cap wherever possible.
A note for landlords, if the lease has the security of tenure, a landlord may wish to deal with any such cap in a side letter so that the cap is not carried forward on any lease renewal.
Landlords’ obligations
As explained briefly above, the landlord will want to only be obliged to carry out the core services. In addition to the covenant to provide the services, it is often usual to see a clause that suspends the landlord’s obligation when an extraordinary event or circumstance beyond their control prevents one or all of them from fulfilling those obligations.
The obligation may also be extended with the proviso that the landlord carries out the services efficiently and economically and following the principles of good estate management and using good and suitable materials. The inclusions of this wording provide the tenant with an action to dispute any poor performance by the landlord.
The landlord may attempt to make the provision of services under a lease conditional on the tenant paying the service charge. This makes the enforceability of the landlord’s covenant to provide the services difficult for the tenant and a tenant may wish to resist this. However, from a practical standpoint, on a large development the landlord will still be carrying out the services for the tenant who have paid their service charge and it will only affect the defaulting tenant’s ability to enforce the covenant rather than affect the defaulting tenant’s use of the development.
How much should the tenant pay?
Some leases may link a tenant’s contribution towards the service charge by a % of the total service charge costs or it may simply refer to a fair and reasonable proportion. It can also be linked to the floor are of a
If there are two units on development of identical size, it may be appropriate for each unit to contribute 50%. Whereas if there a two office suites in a building, one on the ground floor and one on the first floor, the ground floor tenant will not want to contribute to any services/parts of the building it does not use but is used solely by the first floor, for example, stairs and lifts.
The Model Commercial Lease website (https://modelcommerciallease.co.uk/leases/) contains a lease of a unit on an industrial estate which has the following provision:
7.1 In calculating the Service Charge for any of the Services, the Landlord’s surveyor may make any adjustment that is fair and reasonable in all the circumstances, taking into consideration the relative degree of the benefit obtained by the Tenant and other tenants at the Estate from those Services, including by dividing the Services into separate categories and applying weighting to those categories to take into account differing uses or operating hours or other relevant factors.
This is a very fair and balanced approach to calculating the service charge under the lease.
Often the landlord’s or the landlord’s surveyor’s determination of the service charge is final and binding so it is advisable to have an expert determination provision allowing the tenant to dispute the final amount payable.
Should any services be excluded?
This is very much dependant on the type of property being let. For new buildings, the tenant will not want to contribute to the structure or remedying any inherent defect, where the landlord should be able to recover such some from the design and build team under a collateral warranty or otherwise. Whereas, for an old building, the tenant will not want to contribute to refurbishment or modernisation.
The tenant may want to also exclude the cost of borrowing on the development, should the landlord need to raise finance for any capital expenditure. The cost of large capital expenditure should be covered by a sinking fund if the development has been managed properly.
It should also be excluded that paying tenants do not have to cover the arrears in the service costs of any defaulting tenant.
What if the tenant does not pay the service charge?
A defaulting tenant may be liable to forfeiture of their lease if the service charge is reserved as rent under the lease and the lease contains the usual forfeiture provisions of “the landlord may re-enter the property (or any part of the property in the name of the whole) at any time after any of the following occurs… the whole or any part of the rents reserved by this lease are unpaid 21 days after becoming payable (whether it has been formally demanded or not)”. Even if the service charge is not reserved as rent if the lease contains the addition forfeiture provision “the Landlord may re-enter the Property… after any of the following occurs… any breach of any condition of, or tenant covenant in, this lease”.
Summary
This article highlights the importance of taking expert legal advice in connection with service charges, whether you are a landlord setting up a service charge scheme or a tenant looking to take a new lease. A service charge will vary on the complexity of each development. Talbot Walker LLP will help you understand your obligations from the outset and avoid wasting time and costs on unexpected disputes in the future.
For further information, please contact Robert Hurst at Talbot Walker on 01264 721 787 or email roberth@talbotwalker.co.uk
This article is for general information only and does not constitute legal or professional advice. Please note that the law may have changed since this article was published.