A guide to service charges

What are Service Charges?

Service charges are payable by the leaseholder to the landlord (or their agent) for the services the landlord is obliged to provide under the terms of the lease. Your lease will determine how your service charge is calculated and what it can be used to pay for. Typically, this will include maintenance and repair of the communal parts of your building(s)/estate as well as managing agents fees, insurance and the costs of keeping a building/estate legally compliant (e.g health, fire and safety).

Your lease should say:

• how service charges are calculated
• how charges are divided between leaseholders
• whether there is a sinking or reserve fund

Do I have to pay them?

In short, yes. When you signed your lease you became contractually obliged to pay service charges. The penalties for not paying are extreme. Under section 146 of the law of property act 1925, your flat could be re-possessed (by terminating the lease). The lease will state when the service charge is due. Most modern leases allow for the service charge to be payable in advance of the landlord incurring the costs, based on an estimate of costs in the coming year. Some leases, usually older ones, allow recovery in arrears, that is the landlord has to incur the cost first.

How are service charges calculated?

As mentioned above, the lease may state that the landlord estimates what he is going to spend in the coming year and bases the service charge on that estimate.

Reporting Service Charge Expenditure

Section 21 of the Landlord and Tenants Act 1985 states that the landlord or their agent must make available a summary of the service charge costs within six months of the end of the service charge year. Leaseholders have the right to request a summary of service charge expenditures. Sometimes the lease requires that this account is audited or certified by an accountant or other professional.

If the end of year account shows that the landlord has spent more than he estimated the lease will normally allow him to recover the shortfall from the leaseholder via a” balancing charge”. If he has spent less than he estimated the lease may state that a credit for the overpayment should be carried forward as a credit to the leaseholder’s next yearly payment. Occasionally the lease may say it is returned to leaseholder or transferred to the “reserve fund”.

Reserve fund

Also known as a “sinking fund”, some leases allow the landlord to demand a contribution towards this via the service charge. The purpose is to build up a fund to pay for future larger scale works, such as repainting/redecorating the whole building or replacing window frames. This means leaseholders will not face such a large one-off bill when the work becomes necessary. Unless they agree to the contrary with their own buyer, the leaseholder will not receive any of this contribution back if they sell their premises.

Challenging Service Charges

Section 19 of the Landlord and Tenants Act 1985 states that Service charges are only payable to the extent that they are reasonable, and works are to a reasonable standard.

A leaseholder can challenge the reasonableness of a service charge if it does not comply with above, ultimately, by applying to the appropriate Tribunal. In England, this is the First-tier Tribunal (Property Chamber) and in Wales it is the Leasehold Valuation Tribunal. They have power to make a ruling whether, or how much of, a service charge is reasonable or payable.

Service charge demands – What they should include

When a landlord demands a service charge it must contain the landlord`s name and address, an agents name and address is not sufficient. The demand must also include a “summary of leaseholders’ rights and obligations”. This includes details of such matters as a leaseholder’s right to apply to the Tribunal, as outlined above. The law states that if the demand does not comply with either of these requirements, the leaseholder has a legal right not to pay unless and until the service charge is demanded in the proper manner.

A copy of the summary of leaseholders’ rights and obligations can be downloaded here. It’s even in the prescribed 10 point font as required under the legislation (I warned you I was a nerd).

Holding Service charge funds

Section 42 of the Landlord and Tenants Act 1987 states that any service charge contributions are held on trust by the landlord, for the leaseholders. This means, in practice, that the money can be held in one or more account such as a bank or building society to be used for the purposes set out in the lease. If the landlord becomes insolvent such money is protected for the benefit of the leaseholders from any other creditors seeking payment.

Section 156 of the Commonhold and Leasehold reform act 2002 expanded on this as follows .

After section 42 of the 1987 Landlord & Tenants Act, section 42A and 42B was added which is summarised as follows:

• 42A
• Service charges must be held in a designated account.
• Leaseholders have the right to assess compliance
• Leaseholders can withhold payments if they believe there is non-compliance.
• 42B
• Failure to comply with section 42A can result in a fine as an offence will have been committed.

Limitation period on recovery of service charge costs

Section 20B of the Landlord and Tenant Act 1985 states that a landlord cannot recover service charge costs that were incurred more than 18 months before they are formally demanded. The exception to this rule is if he writes to the leaseholder within 18 months of incurring the costs (called a section 20B notice) informing them that costs have been incurred, the amount of them, and that they will be demanded in due course. Case law has indicated that costs are “incurred “when the landlord pays them or becomes liable to pay them; for instance, through receiving an invoice from a contractor or supplier.

Major Works and consultation

If a landlord proposes to carry out works that will cost any one leaseholder more than £250 or is looking to enter into a long term qualifying contract (Longer than 12 months) that will cost any one leaseholder more than £100, the landlord is required to go through a consultation procedure under section 20 of the Landlord and Tenant Act 1985.

A section 20 process is made up of three distinct stages

1. Notice of Intention to Carry Out Works” upon all lessees. The Notice must generally describe the proposed works, state the reasons for considering the proposed works, and invite leaseholders to make written observations within 30 days
2. At the expiration of the 30 day consultation period, at least two estimates should be obtained: “Notice to Accompany the Statement of Estimates” must also be served in conjunction with the Statement of Estimates, which sets out the hours and place where details of the estimates may be inspected, inviting lessees to make written observations on the estimates within 30 days, specifying the address to which those observations should be sent.
3. Award of contract – If at the expiration of the consultation period, the chosen contractor did not provide the lowest estimate, then a “Notice of Reasons” must be served upon all lessees

Section 20 of the Landlord and Tenants is the subject of a great deal of case law and is a subject of discussion in its own right.