Service charges are paid by leaseholders to enable freeholders to carry out their own covenants (promises) within the lease, which is mainly that of maintaining the common areas of the building and placing buildings insurance.

The mechanisms of controlling service charges such as:

  1. Who shall certify or approve the accounts;
  2. The costs that can be recovered;
  3. The periods of time for which accounts should be prepared;
  4. Whether service charges are recoverable in advance or arrears of provision of works or services, collected regularly or as costs arise;
  5. How the budget is set and the service charge is apportioned;
  6. Whether there is a sinking or reserve fund (and a building surveyor can put together a capital expenditure report which will highlight how much is to be placed in these funds each year);
  7. Whether the service charges are fixed or variable

Originally service charges were included in rental payments. However, due to the escalation of cost and inflation, landlords wanted to ensure they recovered all their costs every year. The result has been variable service charges, meaning that they can go up or down each year, according to the costs incurred or to be incurred, i.e. how much the actual or estimated cost of services will be. Some leases however still have fixed service charges, meaning the charge cannot be altered, no matter how much the leaseholders actually have to pay.

Administration Charges

Many leases allow landlords to recover payments from leaseholders that are neither ground rent or service charges and historically these were not regulated. This led to the inevitable abuse of landlords charging way whatever they liked. The (then) LVT had no jurisdiction in the area of determining the ‘reasonableness’ of those costs, so leaseholders had tremendous difficulty in challenging them.  So, under Schedule 11 (s158) of the Commonhold and Leasehold Reform Act 2002 came the new legal category to protect leaseholders – ‘Administration Charges’ and landlords could charge ‘administration costs’ for the following:

  1. The consideration of and granting of approvals under the lease for structural alterations, sub-letting or selling;
  2. Late service charge payment;
  3. Providing information such as Replying to Pre-Contract Enquiries that usually arise in connection with the sale of leasehold properties;
  4. Charges that may arise from a breach or alleged breach of covenant.
  5. The landlord providing documents (or any other party such as a managing agent providing them);
  6. A breach (or alleged) breach of the lease terms.

Administration charges will either be ‘fixed’, which means they are calculated according to a formula or ‘variable’. If leaseholders want to challenge the reasonableness of fixed charges the only way they can do so is to apply to the First Tier Tribunal for a lease variation on the grounds that either the calculation formula is unreasonable or the administration charge specified in the lease is unreasonable. If they feel the variable charges are unreasonable then under s158 Schedule 11 of the 2002 Act, leaseholders have the right to ask the First Tier Tribunal whether they are payable. The request can be made before or after payment because the FTT doesn’t presume that simply because the charge has been paid that the issue of reasonableness doesn’t arise. If the Tribunal determines that the charge is payable it may also determine:

  1. Who should pay it;
  2. Who it should be paid to:
  3. The amount;
  4. The date it should be paid by;
  5. How it should be paid.

The first of the two main statutory authorities for regulating variable service charges and provide a framework for supporting tenants rights under the terms of their leases came with the Landlord and Tenant Act 1985, specifically under two sections which can be found here.

The Landlord and Tenant Act 1987 is the second statutory authority for regulating variable service charges, specifically under two sections which can be found here.

Note: The service charge provisions of the above do not apply to fixed service charges.

Best Practice Guidelines

There are ‘best practice’ guidelines for handling service charges contained within the ICAEW Technical Release TECH 03/11 which are laid down by the Institute of Chartered Accountants for England and Wales (ICAEW), the Association of Chartered Certified Accountants (ACCA) and the Royal Institution of Chartered Surveyors (RICS) and whilst not included in property management legislation, freeholders and agents face financial and legal issues if they fail to adhere to them.

The guidelines are as follows:

  1. All monies that leaseholders pay are trust monies under s42 of the Landlord and Tenant Act 1987 (contributions to be held in trust) which means they must be held in ring-fenced bank accounts;
  2. Landlords and managing agents are not required to have separate bank accounts for each individual property or scheme, unless the lease requires one;
  3. It is a breach of trust if those monies are a) used by one scheme to fund the requirements of another and b) pay the freeholders’ bills. Therefore the funds must be able to be clearly and separately identified.
  4. .All lessees paying variable service charges should receive an annual service charge statement from their landlord or residents’ management company (including right to manage companies (RTMCo’s) within six months of the end of the accounting year so tht leaseholders are provided with the full details of service charge costs following the service charge period;
  5. The annual service charge statement should include an income and expenditure account and a balance sheet and be prepared on an accruals basis;
  6. Where relevant costs can be recovered in the service charges, all annual statements of account should be subject to an examination by an independent accountant before being issued to lessees;
  7. If the service charge statement is prepared on behalf of an RMC or RTMCo then it should be a separate statement to the annual accounts for the company the latter of which are to be filed at Companies House;
  8. Leaseholders can request a summary of costs in accordance with s21 of the Landlord and Tenant Act 1985 (service charge information) which must be provided by the freeholder within one month of the request, or within six months of the end of the accounting period in question, whichever is the latter.
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