Friends Life Management Services Ltd v A & A Express Building Ltd [2014] EWHC 1463 (Ch) is a complicated service charge accounting dispute, but it should serve as a warning to landlords and tenants of the need to consider how service charge accounting should apply when a lease comes to an end in the middle of a service charge accounting year. The analysis of the lease by the court may be instructive in other cases of disputed liability after termination.
Facts
The tenant had a 15 year lease running from March 1998, but it ended its lease early on 24 March 2010 by the exercise of a tenant’s break right. The termination date was only part of the way into a new service charge accounting period. Under the lease, the service charge financial years ran from January 1 to December 31. Questions arose as to the tenant’s service charge liabilities down to the termination date and, in particular, as to how the landlord should deal with a built-up reserve fund. The landlord had been collecting annual amounts from the tenant as a provision for anticipated expenditure in future financial years. It had an accumulated provision of £875,000, of which the tenant’s contribution (being the major occupier in the building) was about £795,000. After the lease had ended, the landlord set about carrying out major works on the building, some of which were carried out in the 2010 financial year (i.e. in the year in which the tenant’s lease ended), and some in the 2011 financial year. The landlord’s accounting showed that it was using the accumulated provision to pay for those works. The main arguments in the case were based on the tenant’s liability for service charge in the year of the break (financial year 2010), and the way in which the accumulated provision should or could be brought into account.
Analysis by the court
The court conducted a detailed analysis of the mechanics of the service charge clause, as follows:
- First, the court held that the last accounting period applicable to the tenant was not, as argued by the tenant, an apportioned period down to the break date, but was the whole of the 2010 calendar year. Accordingly, costs incurred in that year would fall within the service charge for that financial year, but costs incurred in the 2011 financial year could not be included.
- 2010 costs could not include a provision for 2011. Even though it had been the case in the past that, in one financial year, the landlord would make a provision for the next financial year, it was not permissible for the landlord to include in the 2010 financial year (the year in which the break occurred) a provision for anticipated expenditure in the 2011 financial year. This could not be done in the last financial year of the contractual term, and therefore it could also not be done in a financial year in which a break has been exercised.
- Once relevant service charge costs had been ascertained for the 2010 financial year, the landlord was then required to set against those costs its provision for anticipated expenditure, keeping none of it back for 2011.
- Following ascertainment of the 2010 service charge costs, did the tenant pay a whole year’s service charge in the year of its break? The court held that it did not: it was to pay a “fair and reasonable proportion”. The court considered whether the obligation to pay a fair and reasonable proportion required a straight time-based apportionment (e.g. 83 days of the year to 24 March 2010), or whether fairness required the landlord to assess what expenses had actually been incurred in that part of the financial year. There was no express direction to apportion on a time basis, but the court said that the correct apportionment provision to imply was a time based one. Apportioning on a time basis was a normal and straightforward exercise. Elsewhere in the lease, the parties had contemplated an apportionment of the reserved annual rent.
- Having assessed the tenant’s apportioned final year contribution, if the crediting of the landlord’s provision for anticipated expenditure resulted in an excess, did the landlord keep that, or repay it to the tenant? It seems implicit in the decision that any excess would be returned to the tenant, but the key question on the facts was the point at which the credit was to be given. The tenant wanted it to be given after having worked out its final year apportioned liability. However, the court felt that the correct approach was to work out the 2010 financial year service charge costs, apply the provision at that stage so as to reduce those costs, and then apportion. The final computation of the tenant’s final year liability was left to the parties to agree on the basis of the court’s declared interpretation of the lease.
Comment
A landlord is usually reluctant to agree to repay to a tenant a proportion of advance on-account service charge payments immediately after a tenant’s break right has taken effect. The landlord will want to make sure that any refund given to the tenant is appropriate, taking into account actual expenditure and actual receipts in the service charge year in which the break takes effect. While the landlord may be happy to apportion the tenant’s liability on a time basis, it will need to do so having taken a look at the whole picture in that service charge year. At the same time, the tenant will want to make sure it is getting an appropriate proportionate benefit from any reserve or sinking fund built up by the landlord. Whether, and to what extent, the tenant is entitled to any credit for that will depend on the drafting of the lease.
It is fair to say that not a lot of drafting thought goes into the mechanics of the service charge collection and accounting procedures where a lease terminates mid-year: hence, the need for judicial interpretation in this case. For simplicity, the service charge should probably be expressed to accrue on a day-to-day basis, so that it is clear how service charge is to be apportioned in relation to periods other than whole years, and the lease should clearly state that, where part only of a service charge year falls within the term (whether by reason of effluxion of time, or break), the tenant should only be liable for a proportionate part of the service charge based on the number of days of that service charge year falling within the term.
The apportionment provision relied upon in this case was the obligation to pay a “fair and reasonable proportion” of service charge costs. This has usually been viewed solely as a means of dividing up service charge costs between tenants (e.g. on a floor area or other reasonably proportionate basis). It seems it may also be used to apportion liability on a time basis, to enable a tenant’s final service charge contribution to be apportioned down to the lease termination date.