What are Service Charges?
Service Charges are a key feature of leases where the premises, which are let to tenants, then make up parts of a larger building or estate.
In these kinds of situations it will often make more sense for the landlord (or its agents) to manage the common areas of the building or estate, rather than attempting to share out the responsibilities between the various tenants.
Passing on Service Charge costs to tenants
Service Charge provisions allow landlords to pass on their costs of running and maintaining shared parts of the building or estate to the tenants.
Landlords will want to ensure that they have the right to recover the full range of costs that they incur in respect of services provided for the benefit of their tenants.
Typically a lease will include a list of the types of services which can be charged back to tenants; alongside the obvious issues such as repairing common parts, the list should address matters such as payment of the fees of the Landlord’s agents in connection with managing the property.
It is also sensible for landlords to include a general ‘sweeper provision’ so as to capture any costs not specifically mentioned under the other headings in the list because without this provision any costs not specifically mentioned will not be recoverable from the tenants. This ensures that landlords have additional flexibility as it is not always obvious at the outset what costs might be incurred in the future.
Landlords should also consider the day-to-day running of Service Charges and consider whether they have the expertise to manage this themselves or whether they need professional assistance in keeping track of costs and invoicing tenants.
Should Service Charges be an open-ended liability for tenants?
Service Charges can be a major issue for tenants too because they represent a potentially open-ended liability – if the landlord’s costs are higher than expected then the tenant’s payments will be too, and in extreme cases the Service Charge can be higher than the rent itself and can cause serious financial difficulty for tenants.
Firstly, tenants will be anxious to ensure that they are only paying a fair proportion of the costs for the whole of the building or estate. Each tenant’s proportion should be based on the area of their unit as a proportion of the total area of all of the units – this ensures that a tenant is not disadvantaged if the units are not all the same size.
Secondly, tenants will want to know that they cannot be called upon to cover additional costs if there are any vacant units; tenants will want to ensure that the landlord remains obliged to provide the services and that any shortfall as a result of vacant units falls upon the landlord.
Thirdly, tenants will want to satisfy themselves as to the likely level of Service Charge costs going forward.
The problem in this respect is that past levels of costs are not necessarily indicative of future issues – for instance the costs might have been static for several years but if major works become necessary further down the line then the costs could increase substantially and without warning.
Tenants or their advisers should check past Service Charge accounts and discuss whether any major works are planned, but this is not a complete answer.
Negotiate to limit Service Charges
Tenants may wish to consider negotiating to limit their liability by means of a Service Charge Cap, which is a clause stating that in any one year the tenant’s obligation to pay the Service Charge shall not exceed an agreed figure.
This at least gives the tenant some reassurance that their liability will not exceed the specified level, although some tenants will be concerned that, by agreeing an upper limit, this might be seen as encouraging the landlord to incur costs up to that level every year.
It also, however, leads to the potentially difficult question of the level at which the cap should be set:
Landlords will want to ensure that the level of the cap gives adequate scope for reasonable levels of increases in costs throughout the lease term, and will want the agreed figure to be linked to the RPI in order to ensure that inflation does not reduce the effectiveness of the Service Charge over time.
Tenants will want to ensure that the level of the cap represents a viable upper limit and that this would be affordable to them.
Take legal advice to fully understand Service Charges
As with all of the main drafting issues in relation to commercial leases, the key is that both landlords and tenants need to ensure that they understand how the Service Charge provisions will work; the competing interests of the parties mean that there is often a balance to be struck and the parties should satisfy themselves that they have reasonable safeguards in place to protect their interests.
Tallents’ commercial property department has experience in advising both landlords and tenants regarding all aspects of commercial lease negotiations and the landlord and tenant relationship. In the event of a dispute then our specialist litigation solicitors can help guide clients through the process.
For more information please contact Tom Gibbons on 01636 671881 or at firstname.lastname@example.org.