UPPER TRIBUNAL (LANDS CHAMBER)

UT Neutral citation number: [2010] UKUT 346 (LC)

LT Case Number: LRX/83/2008

 

                            TRIBUNALS, COURTS AND ENFORCEMENT ACT 2007

 

LANDLORD AND TENANT – service charges – payments on account – use of a reserve fund – loans to service charge account by landlord – legal fees– cost of paying insurance premium by instalments – management charges – ss 20B and 20C Landlord and Tenant Act 1985 – appeal allowed in part 

 

         IN THE MATTER OF AN APPEAL FROM A DECISION OF THE LEASEHOLD

           VALUATION TRIBUNAL FOR THE LONDON RENT ASSESSMENT PANEL

 

 

BETWEEN                                     REDENDALE LIMITED                                  Appellant

 

                                                                           and

 

                                                           (1) MR SALIM MODI                                                   

                                                       (2) MR KANTILAL MODI                           Respondents

 

 

                                                           Re: 5 Brentview House

                                                                  North Circular Road

                                                                  London NW11 9LE

 

 

                                                         Before: A J Trott FRICS

 

 

                                 Sitting at: 43-45 Bedford Square, London WC1B 3AS

                                                               on 31 August 2010

 

 

 

 

 

 

 

Mr Jeremy Kanzen, with the leave of the Tribunal, for the Appellant

Mr Salim Modi in person and, with the leave of the Tribunal, for the Second Respondent

 

 

The following cases are referred to in this decision:

 

St Mary’s Mansions Ltd v Limegate Investment Co Ltd and Others [2003] 1 EGLR 41

The Tenants of Langford Court v Doren Limited, Lands Tribunal reference LRX/37/2000 (unreported, BAILII: [2001] EWLands LRX_37_2000)

 

                                                                    DECISION

Introduction

1.           This is an appeal by Redendale Limited against the decision of the Leasehold Valuation Tribunal for the London Rent Assessment Panel dated 20 February 2008 upon an application made by Mr Salim Modi and Mr Kantilal Modi (the respondents) of 5 Brentview House, North Circular Road, London NW11 9LE.  The appeal concerns whether certain items of expenditure constitute “service charge” for the purposes of section 18 of the Landlord and Tenant Act 1985 and whether the relevant costs were reasonably incurred and/or were of a reasonable standard.  The appellant also opposes the respondents’ application under section 20C of the 1985 Act.  The appeal relates to the five service charge years ending 25 March 2004 to 2008. 

2.           Permission to appeal was refused by the LVT on 25 June 2008.  The appellant applied to this Tribunal for permission to appeal on 29 June 2008.  Permission to appeal was granted on 24 July 2008. 

3.           Mr Jeremy Kanzen, a director of the appellant company, appeared for the appellant with the leave of the Tribunal.  He called Howard Morris FCA as a witness of fact.  Mr Salim Modi appeared in person and, with the leave of the Tribunal, for the second respondent (his father). 

Facts

4.           I derive the facts in this case from the decision of the LVT, from a partially agreed statement of facts by the parties and by reference to documents contained in separate trial bundles produced by the parties. 

5.           Redendale Limited is the holding company for the freehold interest in two blocks of flats, Brentview House and Sheila House.  The company is owned in equal shares by each of the sixteen flat owners in the blocks.  The tenants bought out the head lessee in 2001 and, because they could not raise the necessary capital themselves, proceeded to approach developers with a view to allowing them to exploit the development potential of the loft space in return for a major refurbishment of the existing blocks.  Although there were apparently several false starts on the development, with developers failing to complete a deal, the development is now at the construction stage and each tenant (for no capital contribution) will receive new double glazing, major internal and external refurbishment, an additional room to each flat and will benefit from a new lift in each block. 

6.           Redendale Limited has a savings account that was originally funded from an insurance payment of approximately £60,000 following a subsidence claim.  It used this account to make interest free loans to the service charge account which were then (partially) repaid in subsequent years. 

7.           It was agreed that the historic performance of the managing agents employed by Redendale had been unsatisfactory.  When Redendale acquired the property the managing agents were London and Provincial Properties but they were bought out by HML Mandells in about December 2006.  HML Mandells left Redendale “in a position of neglect” (appellants’ statement of case) and the appellant, its accountant Mr Morris and the respondents tried but failed to obtain relevant information about service charges from them.  At sometime after March 2008 HML Mandells were taken over by HML Hathaway who continued to be the appellants’ managing agent until Redendale appointed Gateway Property Management Limited at or around July 2009. 

The Lease

8.           The second respondent surrendered his old lease dated 8 July 1959 to the appellant in exchange for the grant of a new lease dated 24 October 2001.  Under the new lease the lessee covenanted to pay a ground rent of £20 per annum and, as further rent, the “Lessee’s Proportion” (5.88%) of the “Annual Expenditure” and the “Insurance Rent”.  The “Service Charge” is defined under clause 1.32 of the lease as “the Lessees Proportion of the Annual Expenditure” (and therefore excludes the Insurance Rent).  Annual Expenditure means:

“1.3.1    All costs expenses and outgoings whatever incurred by the Lessor during a Financial Year in or incidental to providing all or any of the Services; and

1.3.2      Any VAT payable on such sums costs expenses and outgoings …”

9.           “Services” are defined in clause 1.31 of the lease as meaning:

“… the services facilities and amenities specified in Part 2 of Schedule 3 and shall be deemed to include not only those expenses and outgoings which have actually been paid or incurred by the Lessor during the year in question but also such reasonable proportion of expenses and outgoings of a periodically recurring nature (whether recurring regularly or irregularly) whenever paid or incurred including the sum or sums by way of reasonable provision for anticipated expenditure as the Lessor or the managing agents (as the case may be) may in their discretion allocate to the year in question as being fair and reasonable in the circumstances;”

Part 2 of Schedule 3 sets out the lessor’s obligations, including an obligation to repair and maintain the structure of the building and the common parts.  The Lessor’s insurance covenants are not part of Schedule 3 but instead are dealt with under clause 8 of the lease.  The cost to the lessor of complying with its insurance covenants is recoverable as Insurance Rent.

10.        Part 1 of Schedule 3 is headed “Service Charge” (although this term is separately defined under the lease, see paragraph 8 above).  This part of the schedule provides for an “Interim Payment” which is defined under clause 1.17 as:

 “… such three monthly amount as in the opinion of the Lessor or its managing agents fairly represents one quarter of the Annual Expenditure for the current Financial Year.” 

Paragraph 1 of Part I of Schedule 3 states that:

“The Lessee will pay to the Lessor the sum of £1,000 … per annum payable quarterly in advance in respect of the Interim Payment by equal instalments on the usual quarter days in every year … or such other figure as the Lessor may designate as being a fair estimate of the Lessee’s Proportion of the Service Expenditure for the coming year.”

“Service Expenditure” means:

“2.     … such sum as the Lessor may reasonably expend or desire to expend in relation to the Building or any part thereof on:

2.1          carrying its obligations under Part 2 of this schedule [3] or carrying out any other work on the Building in relation thereto which it may reasonably deem necessary and desirable;

2.2          management administration audit professional advice and assistance (including if such may be the case a reasonable fee charged by the Lessor or its servants for the time spent on administration);

2.3          any anticipated expenditure as the Lessor or managing agents (as the case may be) may in their discretion allocate to the year as being fair and reasonable.”

11.        The remainder of Part 1 of Schedule 3 deals with the production of a Service Expenditure Statement which details Service Expenditure and the Lessees’ Proportion thereof.  It is to be produced as soon as practicable after 30 June every year and shall give credit for the Interim Payment and provide details of any shortfall.  Any unexpended balance is to be carried forward as credit to the next period while any shortfall is to be paid by the lessee within 14 days of the receipt by him of the Service Expenditure Statement.  That statement shall contain sufficient particulars to show the amounts spent on each major category of expenditure and shall be certified by a member of the Institute of Chartered Accountants that it is a fair summary of the Service Expenditure and is sufficiently supported by accounts, receipts and other documents which have been provided to him. 

12.        Under the lease the Financial Year means the period from 1 July to 30 June in the following year (this is consistent with the requirement under Schedule 3 for the lessor to produce a service expenditure statement as soon as practicable after 30 June in every year).  The year end date adopted by Redendale, however, is 25 March.

Statutory Provisions

13.        Section 18 of the Landlord and Tenant Act 1985 defines the meaning of “Service Charge” and “relevant costs”:

“18(1) In the following provisions of this Act “Service Charge” means an amount payable by a tenant of a dwelling as part of or in addition to the rent –

(a)    which is payable, directly or indirectly, for services, repairs, maintenance, improvements or insurance or the landlord’s costs of management, and

(b)    the whole or part of which varies or may vary according to the relevant costs. 

(2)         The relevant costs are the costs or estimated costs incurred or to be incurred by or on behalf of the landlord, or a superior landlord, in connection with the matters for which the service charge is payable.

(3)            For this purpose –

(a)    “costs” includes overheads, and

(b)    costs are relevant costs in relation to a service charge whether they are incurred, or to be incurred, in the period for which the service charge is payable or in an earlier or later period.

14.        Section 19 sets out the limitation of service charges by reference to their reasonableness:

“19(1) Relevant costs shall be taken into account in determining the amount of service charge payable for a period –

(a)    only to the extent that they are reasonably incurred, and

(b)    where they are incurred on the provision of services or the carrying out of works, only if the services or works are of a reasonable standard;

and the amount payable shall be limited accordingly.

(2)     Where a service charge is payable before the relevant costs are incurred, no greater amount than is reasonable is so payable, and after the relevant costs have been incurred any necessary adjustment shall be made by repayment, reduction or subsequent charges or otherwise.”

15.        Section 20B sets out the limitation of service charges by reference to the time limit on making demands:

20B(1)   If any of the relevant costs taking into account in determining the amount of any service charge were incurred more than 18 months before a demand for payment of the service charge is served on the tenant, then (subject to subsection (2)), the tenant shall not be liable to pay so much of the service charge as reflects the costs so incurred.

(2)        Subsection (1) shall not apply if, within the period of 18 months beginning with the date when the relevant costs in question were incurred, the tenant was notified in writing that those costs had been incurred and that he would subsequently be required under the terms of his lease to contribute to them by the payment of a service charge.”

 

16.        Section 20C deals with the limitation of service charges and the costs of proceedings:

“20C(1)   A tenant may make an application for an order that all or any of the costs incurred, or to be incurred, by the landlord in connection with proceedings before a court, residential property tribunal or leasehold valuation tribunal, or the Lands Tribunal, or in connection with arbitration proceedings, are not to be regarded as relevant costs to be taken into account in determining the amount of any service charge payable by the tenant or any other person or persons specified in the application. 

(2)        The application shall be made –

…

         (c)     in the case of proceedings before the Lands Tribunal, to the Tribunal;

…

(3)        The court or tribunal to which the application is made may make such order on the application as it considers just and equitable in the circumstances. 

The LVT decision

17.        The only year for which the LVT had audited accounts was the year “commencing 25 (sic) March 2003”.  Apart from these accounts the LVT relied upon the applicants’ [respondents’] evidence about the limited level of repair works undertaken since 2003 due to the proposed redevelopment of Brentview House.  The applicants challenged two items of the 2003/04 accounts: management charges and the amount to be transferred to “Reserves”.  The LVT considered that the management charges were reasonable.  Regarding the transfer to reserves the LVT said:

“1.1     Schedule 3 Part I of the Lease under which the Applicants hold the Premises does not permit the Landlord [appellant] to recover by way of Service Expenditure repayment of loans to it (sic).  Accordingly, the Respondents [appellant] were not entitled to recover from the Applicants the sum of £4,708.06 demanded in the service charge year 2003-2004. ”

18.        For the subsequent years ending 2005 to 2008 the LVT determined amounts for individual items of expenditure based upon the applicants’ evidence and such schedules of estimated service charge expenditure as were available to them.  The determination was generally based upon fixed amounts.  Thus for each of the years ending 2005 to 2008 the LVT allowed £6,000 for insurance, £1,500 for cleaning, repairs and maintenance, £2,450 for management fees (except for the year ending 2008 where it allowed £2,820) and £300 for audit fees.  It allowed £450 for gardening in the years ending 2005 and 2006 but nothing in the subsequent two years.  It accepted the landlord’s figure of £247.83 for bank charges and interest in the year ending 2004 but made no such allowance for the subsequent four years (nor, apart from the year ending 2004, did it give credit for bank interest received).  The LVT disallowed any charges in respect of gas, saying that there had been no communal gas supply at the building since 2002-03 when the communal central heating system had been replaced with individual systems for each flat.  The LVT allowed the sum of £300 for electricity in the years ending 2005 and 2008 and £298.70 in the year ending 2007.  Finally the LVT made no allowance for legal fees in the years ending 2006 and 2007 (although it is not clear from their decision that they were asked to consider this issue).

19.        The LVT assessed the reasonable service charges and the proportion payable by the applicants (at 5.88%) as follows: 

Year	Total	Applicant’s proportion
2003/04	£11,296.54	£664.24
2004/05	£11,000	£648 (sic)
2005/06	£10,700	£629.16
2006/07	£10,548.70	£620.26
2007/08	£10,920	£642.10
Total		£3,203.76

 

20.        The LVT said that the amount paid by the applicants during the five service charge years was £5,429.46 which therefore represented an overpayment of £2,225.70.  The LVT determined that this amount should be repaid to the applicants immediately rather than being carried forward as a credit to the next period. 

21.        The LVT reached the following conclusions in respect of the application of section 20B of the 1985 Act:

“2.8   Section 20B does not relate to service charge payments on account, which are dealt with under section 19(2).  Section 20B is however relevant where the actual service charge expended exceeds the amount reasonably demanded on account.  In such circumstances the Landlord may only recover the additional sums to the extent that they are incurred within 18 months of the actual service charge demand being served on the Tenant. 

To the extent there are any actual service charge demands in excess of those which we have determined are reasonable, and the demand is served on the applicant more than 18 months after the relevant costs were incurred, such excess will not be recoverable from the Applicants.”

22.        The applicants made an application under section 20C of the 1985 Act.  The LVT concluded that:

“2.9   Recovery of Landlord’s costs under section 20B (sic) is not an issue as the Respondents did not appear at the Hearing.”

Issues

23.        The issues between the parties before this Tribunal are whether:

1.           the amounts shown in the statements of service charge expenditure as transferred to/from reserves are properly included as service charge.

2.           the repayment of loans made by Redendale Limited to the service charge account is recoverable as service charge. 

3.           the amounts shown in the statement of service charge expenditure for the years ending March 2006 and 2007 as ‘legal fees’ are properly included as service charge.

4.           the amounts shown for building insurance and ‘bank charges and interest’, which refer to charges incurred by paying the insurance premium by instalments, for each of the years 2004 to 2008 were reasonably incurred or of a reasonable standard.

5.           the amounts shown for management charges for each of the years 2004 to 2008 were reasonably incurred or of a reasonable standard.

6.           various items of expenditure in the years 2004 to 2008 were reasonably incurred or of a reasonable standard.

7.           section 20B of the 1985 Act applies to some or all of the relevant costs such that the respondents shall not be liable to pay so much of the service charge to which that section applies.

8.           the respondents should succeed with their application under section 20C of the 1985 Act.

The case for the appellant

24.        Mr Kanzen explained that Redendale was unaware of the respondents’ application to the LVT until after its decision had been given and a county court summons issued in June 2008 against Redendale for the recovery of the LVT’s award.  Although the managing agents HML Mandells had attended the LVT’s pre-trial review, they had done so without the knowledge or consent of the appellant.  Redendale was not represented at the substantive LVT hearing and therefore the LVT had not had the benefit of a full explanation of the service charges. 

25.        The appellant submitted audited statements of service charge expenditure (giving details of actual expenditure, including insurance) and associated balance sheets for the years ending 25 March 2001 to 2008 (although only the years 2004 to 2008 were in dispute).  These accounts had all been audited by H Morris and Co, Chartered Accountants.  Mr Kanzen and Mr Morris explained that they had had great difficulty in extracting the relevant information from the managing agents to enable the statements of service charge expenditure to be prepared.  They had welcomed the respondents’ efforts to obtain such information from the managing agents. 

26.        Mr Morris said that he had been instructed to prepare the service expenditure statements in the latter half of 2004 at which time the service charge expenditure accounts were already in arrears.  In February 2005 he chased the managing agents and was able to complete the accounts for 2001 to 2003.  Thereafter he prepared the statement of service charge expenditure annually but it had proved difficult to obtain timely information from the managing agents and a lot of time had elapsed between the balance sheet date and the preparation of the accounts.  Mr Morris had to rely totally upon the information from the managing agents.  He thought that they should have been quicker in responding to his queries.  He had “hounded” London and Provincial Properties both on the telephone and in person.  He said that although they appeared willing to help they had not delivered the relevant information.  HML Mandells whilst a bigger organisation, had been no more efficient or punctual. 

27.        Once the information was to hand Mr Morris had prepared the accounts by reference to paid invoices, bank statements and cheque book stubs.  He said that his figures were based upon reliable data that was almost complete.  There were very few omissions and no estimates. 

28.        Mr Kanzen said that the only statement of service charge expenditure seen by the LVT included a large item in respect of gas.  He explained that British Gas had been reading the wrong meter for a while and they had undercharged in the sum of approximately £20,000.  The entry for gas in the statement for the year ending 2003 was therefore unusually high.  But the LVT were not aware of this context and were informed that, at this time, the communal central heating system had been replaced by individual systems for which each tenant was directly responsible.  In the light of this they determined that there should be no charge for gas. 

29.        The need to pay off this high and unexpected gas bill exhausted the service charge account and meant that there was no money to pay the annual insurance premium.  Redendale Limited had a savings account that was funded by the proceeds of an insurance claim.  It was therefore decided that Redendale, which was owned by the 16 tenants, would make two interest free loans to the service charge account for the years ending 2003 and 2004 to ensure that there was sufficient cash flow to allow the managing agents to pay the insurance premium.  These were essential loans to ensure that adequate insurance cover was put in place.  The alternative would have been to demand separately an appropriate sum from each tenant.  This seemed unnecessary since Redendale already had sufficient funds on deposit; funds which were collectively owned by the tenants in any event.  It was not sensible to continue making such loans and thereby depleting Redendale’s savings account.  The loans, which for the two years concerned amounted to over £10,000, were partially paid back (by some £2,000) during the year ending 2006.  The balance of the loans (some £8,000) remained outstanding as at 25 March 2008 and this amount was shown in the balance sheet as a current liability. 

30.        In each of the years 2004 to 2008 an amount was shown in the statement of service charge expenditure for transfers to/from reserves.  Mr Morris explained that where the actual expenditure was less than the service charges received (based upon the estimate of the lessees’ proportion of the service expenditure in accordance with Part 1 of Schedule 3 to the lease) the difference was credited to reserves.  This was the case for the years ending 2004, 2005 and 2008.  Where the actual expenditure was greater than the service charges received (2006 and 2007) the difference was debited to reserves.  In each case the amounts shown as being transferred were a balancing item to equate actual expenditure and the amount of service charge received.  In cross-examination Mr Morris explained that this system of transfer to/from reserves had caused confusion among the tenants and he said that the 2010 statement had been prepared differently to make it clearer and to avoid any misunderstanding. 

31.        Mr Kanzen described the difficulties that Redendale had encountered in trying to obtain insurance cover given the poor claims history of the building.  Redendale had searched for the best deal through insurance brokers and had managed to secure a reduced premium with a new insurer which was prepared to reflect the prospective improvements to the building upon its redevelopment and which did not examine the claims history too closely.  He explained that as the owner of one of the flats himself it was in his interest to secure the best value for money.  The decision was taken to pay the insurance premium by monthly instalments in order to assist the cash flow and liquidity of the service charge account.  The financial cost of this arrangement was recorded in the statement of service charge expenditure under “bank charges and interest”. 

32.        The item headed “legal fees” that appeared in the service charge expenditure statements for 2006 and 2007 related to solicitors’ and counsel’s fees in connection with the proposed redevelopment.  The entry for 2006 (£2,296.10) referred to an invoice from Messrs Fladgate Fielder who had acted on behalf of Redendale in negotiating a development agreement with A3 Developments Limited who subsequently went into liquidation.  The full amount of the invoice was £9,696.10 but Redendale recovered £7,400 of this on account of the failure of A3 to complete central heating works pursuant to an agreement for lease dated 30 May 2003.  This money was already held on deposit by Fladgate Fielder from A3 Developments in connection with the development agreement.  The entry for 2007 (£705) referred to counsel’s advice regarding the tax implications of redeveloping the building.  In both cases Mr Kanzen said that Redendale was entitled to recover the monies as service charge in accordance with paragraph 2.1 of Part 1 of Schedule 3 to the lease.  It was put to Mr Kanzen in cross-examination that these legal costs were only a small proportion of the total legal fees (said to be over £25,000) paid by Redendale in connection with the development agreement and that their inclusion within the service charge had been selective.  Mr Kanzen said that Redendale had decided to stop paying such fees from its saving accounts and to charge them instead to the service charge account. 

33.        Both Mr Kanzen and Mr Morris answered specific and detailed questions about individual items of expenditure.  Mr Morris was satisfied that the expenditure was supported by the source information that he had seen.  This included invoices verified by chequebook stubs and bank statements.  The only exception was the amount of £389.14 for electricity in the year ended 25 March 2008.  Of this amount £178.52 was supported by invoices.  There was a further invoice in the sum of £940.86 of which £773.80 was said to have been brought forward from earlier periods.  The actual charge for the period concerned (14 August to 9 November 2007) was £167.06 which Mr Morris said was reasonable by comparison with 2005 and 2006 although it was double the figure for the equivalent period in the year ending March 2007.  The final amount was the sum of £43.56 for which there was no invoice but which had been included in the managing agent’s printout of expenditure and was also shown on the bank statement.

34.        Mr Kanzen said that demands for the payment of the service charge were made annually in accordance with Schedule 3 of the lease and that therefore the time limit of 18 months contained in section 20B of the 1985 Act did not apply so as to limit the respondents’ liability to pay. 

35.        Mr Kanzen said that the respondents’ application under 20C of the 1985 Act would not prevent the tenants from meeting the landlord’s costs of the proceedings before this Tribunal.  If the application was successful then the costs of the hearing would be met by Redendale which was owned in equal shares by the tenants.  If it was unsuccessful then the same tenants would meet the costs through the service charge.

The case for the respondents 

36.        Mr Salim Modi explained that the respondents had become increasingly frustrated by the managing agents’ failure to provide timely information about the service charges despite several written requests having been made over the years.  The respondents had also written to Redendale Limited direct as landlord but had not received a satisfactory reply.  The appellant was in breach of the 1985 Act in several respects; it had failed to provide credit for, or to refund, overpaid service charges under section 19(2), it had failed to satisfy the requirements of section 21 with respect to requests for a written summary of the costs incurred and had failed to disclose documents timeously under section 22 despite numerous requests having been made.

37.        The respondents challenged the appellant’s claim that the service charge account still owed Redendale in excess of £8,000.  The appellant’s own summary of service charge surpluses/deficits showed that there was a net deficit of only £2,458.68 as at 25 March 2008.  Mr Modi said that the lease made no provision for loans to be made to the service charge account by the landlord or for repayments to be made from it.  Nor did it provide for a reserve fund to be established.  Schedule 3 to the lease unequivocally stated that any excess/deficit in service charge expenditure should be settled on a yearly basis and this is how the service charges should have been dealt with; everything should have been “squared off” and settled annually.

38.        Mr Modi calculated that over the seven years ending March 2003 to 2009 the total service charge demanded from all sixteen tenants was £26,704.16 more than the actual amounts received. He said that:

“We have strong reason to suspect that these arrears may be accrued by the controlling officers themselves, meaning that the flat owners who have been paying the service charge (like ourselves) have been subsidising the officer’s non-payment.  Alternatively it could only mean that there are a number of other flat owners who are not happy with the management and are therefore withholding their payments.”

39.        Mr Modi said that between 2004 and 2008 the respondents had paid service charges amounting to £5,429.46.  The lessee’s proportion under the lease was 5.88% of the annual expenditure and the insurance rent which amounted to £4,328.38 for those years, meaning that the respondents had overpaid by £1,101.08.

40.        There should be no allowance for management fees because of the extreme incompetence of the managing agents and their persistent failure to comply with the lease and the 1985 Act.

41.        No reasonable explanation had been given for the fact that the insurance premium in 2003/04 was significantly higher (£5,463.52) than the premium for 2009/10 (£3,965).  Mr Modi concluded that the appellant had not obtained competitive quotes for the earlier years and considered that the insurance premiums should be £3,000 in 2003/04 rising by £150 each year to £3,600 in 2007/08.  The respondents did not accept that the insurance premium should be paid for by instalments, thereby incurring unnecessary finance costs.

42.        There was no provision in the lease under which the appellant could charge legal fees in connection with the development agreement.  These were not properly described as service expenditure for the purposes of Schedule 3 to the lease and were costs that should be met directly by the landlord.

43.        For the years ending March 2005 and 2006 the respondents said that the amounts charged under the item “cleaning, repairs and maintenance” were not supported by invoices and should be reduced accordingly.

44.        The statement of service charge expenditure for the years ending March 2004 to 2006 were provided to the respondents more than 18 months after the expenditure had been incurred.  Mr Modi argued that under section 20B of the 1985 Act the respondents were therefore not liable to pay any of the service charges for those years.

45.        The respondents made an application under section 20C of the 1985 Act on the grounds that the appellant had consistently mismanaged the service charge over many years in breach of its statutory obligations and covenants under the lease.  The appellant had been dilatory in preparing the accounts and neither it nor its managing agents had responded timeously, or at all, to the respondents’ requests for information.  The respondents had therefore been forced to make an application to the LVT and to respond to the current appeal.  They felt that they were unable to continue making payments into what Mr Modi described as a “black hole”.  

46.        The respondents also claimed the reimbursement of the fees incurred by them, namely the application to the LVT, the hearing fee for the LVT and the fee for an interlocutory application made to this Tribunal for disclosure.

Conclusions

(1) Transfers to/from reserves

47.          The appellant has operated a reserve fund under which, in each financial year, any surplus of service charge receipts over actual expenditure is transferred to the fund and any deficit is met by transfers from the fund.  The issue in dispute is whether the lease permits this arrangement. 

48.        In my opinion there are two provisions in the lease which are relevant to this question.  Firstly, the definition of “Services” (see paragraph 9 above) includes expenses and outgoings of a periodically recurring nature whenever paid or incurred including a sum or sums by way of a reasonable provision for anticipated expenditure.  Secondly, the definition of “Service Expenditure” (see paragraph 10 above) means, inter alia, such sum as the lessor may reasonably desire to expend on any anticipated expenditure as it may in its discretion allocate to the year as being fair and reasonable.

49.        The inclusion of a reference to expenditure in the definition of Services seems misplaced; I would expect to see such a reference either in the definition of “Annual Expenditure” or of “Service Expenditure". The latter definition does not refer to making a provision for anticipated expenditure and the definition of Services only extends to the services etc specified in Part 2 of Schedule 3 and not to the anticipated expenditure referred to in the definition of Service Expenditure under Part 1 of that schedule.  Reference to anticipated expenditure in the definition of Service Expenditure would, in my opinion, extend to the Insurance Rent, thereby bringing the respondents’ obligation to pay such rent under the ambit of the payment on account provided for in paragraph 1 of Part 1 of Schedule 3. However, I do not consider that the definition of anticipated expenditure under paragraph 2.3 of Part 1 of Schedule 3 extends to the establishment of a general, and unspecified, reserve fund which is used, in effect, as a balancing mechanism for annual surpluses and deficits in the service charges received.

50.        The wording of the definition of Services is typical of leases which provide for the establishment of a reserve, or sinking fund, to meet future expenditure of a periodically recurring nature, such as repainting or major items of repair or replacement that will not arise every year.  Insofar as the definition of Services includes reference to the Lessor’s obligations under Part 2 of Schedule 3 I consider that it does enable a reserve fund to be established in respect of the anticipated costs of such recurring items. 

51.        The provisions of the lease are similar to those considered by the Court of Appeal in St Mary’s Mansions Ltd v Limegate Investment Co Ltd and Others [2003] 1 EGLR 41. Clause 2(2)(c)(v) of the lease in that case provided:

“The expression ‘the expenses and outgoings incurred by the lessor’ as hereinbefore used shall be deemed to include not only those expenses, outgoings and other expenditure hereinbefore described which have been actually disbursed, incurred or made by the lessor during the year in question but also such reasonable part of all such expenses, outgoings and other expenditure hereinbefore described which are of a periodically recurring nature (whether recurring by regular or irregular periods) whenever disbursed, incurred or made and whether prior to the commencement of the said term or otherwise including a sum or sums of money by way of reasonable provision for anticipated expenditure in respect thereof as the lessor or its accountants or managing agents (as the case may be) may in their discretion allocate to the year in question as being fair and reasonable in the circumstances and relates pro rata to the demised premises.”

52.        The issue in that appeal was whether the lessor was entitled, as a matter of construction of the terms of the lease, to establish a reserve fund (or a sinking fund).  If the answer to that question was “yes” then the second question was a question of fact as to whether or not the lessor had followed the requirements of the lease in establishing that fund.  The Court of Appeal held that if the procedure set out in the lease was followed then a reserve fund could be established.  Giving the judgment of the court Ward LJ said at 45B-E:

“If that procedure is followed, a reserve fund can be established.  Given the nature of the particular dispute before us, it may be necessary to clarify precisely what can stand in the reserve account.  As I have held, the auditor’s certificate must contain, if only in summary form: (1) details of the relevant expense or outgoing actually paid, and (2) if an allocation has been made, details of future anticipated, periodically recurring expenditure.  The question arises as to what is to happen with any overpayments in respect of the former category, the paid expenses.  Let me take a concrete example.  The cost for the servicing and other repairs and the fuel for the boiler for 1999 was estimated to be £27,500.  The actual expenditure shown in the accounts was only £22,399.  There was therefore a surplus of some £5,101.  What is to happen to that surplus?  In my judgment, that sum has to be ‘allowed by the lessor to the lessee’.  The questions framed do not require us to answer how that money is to be ‘allowed’, and to decide whether it must be repaid or whether it is sufficient for it to be placed to the lessee’s credit in the account to be set off against the demands to be made in the next year.  I would be inclined to think that either may be appropriate.  I have taken the isolated case of the boiler.  There may be, and, indeed, upon an analysis of the accounts, there occasionally are, instances where there has been an underestimate.  Underprovisions and overprovisions have to be set against each other and the resulting balance struck in the accounts.  It is that balance only that must either be paid by the lessee or allowed to him, as the case may be.

This, it seems to me, is consistent with the effect of section 42 of the Landlord and Tenant Act 1987.  That provides that service charge contributions are to be held in trust.  Section 42(3) provides:

‘The payee shall hold any trust fund –

(a) on trust to defray costs incurred in connection with the matters for which the relevant service charges were payable (whether incurred by himself or by any other person) and

(b) subject to that, on trust for the persons who are the contributing tenants for the time being.’

The payee for this purpose is the landlord.  As I understand this provision, money received for a relevant service charge must be used to defray the cost of that service charge.  Thus, an overpayment in respect of expenses actually incurred cannot be taken into a reserve account for future expenses that have not been identified and designated as such in the certificate, having first been specifically allocated by the lessor with reference to the project to be undertaken and the amount allocated to it as reasonable provision.”

53.        The certification procedure in the present appeal is contained in Part 1 of Schedule 3 and is summarised in paragraph 11 above.  Neither the service expenditure statements certified by Mr Morris nor, on the evidence before me, the demands for the payments on account, contain any details about anticipated expenditure of a periodically recurring nature for which a reserve fund might be appropriate. Those statements refer exclusively to expenditure that has been incurred.  For that reason and also (i) for the reasons given by the Court of Appeal in St Mary’s Mansions; and (ii) the wording of the lease that any shortfall in service charges should be paid for by the lessee with unexpended balances being “carried forward as a credit to the next period”, I do not consider that any surplus/deficit in the service charges compared with the actual expenditure for the years 2004 to 2008 can be properly transferred to/from a reserve fund.

(2) Loans from Redendale Limited

54.        Mr Kanzen explained that the reason Redendale Limited made two loans to the service charge account was to overcome a cash flow problem that was caused by the unexpectedly high gas bill of some £20,000 that resulted from the gas authority reading the wrong meter.  There is no requirement under the lease that the tenants must fund the service charge account to the extent that it has sufficient cash flow to meet all outgoings as they arise.  The purpose of the Interim Payment is to provide adequate cash flow to meet the estimated expenditure but it remains the lessor’s obligation under the lease to pay for such outgoings initially, including the unexpected gas bill, which at the time it was incurred was in respect of a communal service.  The respondents are responsible for paying the Interim Payment (or such other payment on account as the lessor designates as being a fair estimate of the lessee’s proportion of the service expenditure), the Insurance Rent and the Service Charge.  But any lack of cash flow is a problem for the Redendale and not the tenants. 

55.        Under the lease the lessor is obliged to effect the insurance and the tenant is obliged to pay the Insurance Rent which means “the cost to the Lessor from time to time of complying with the Lessor’s [insurance] covenant...” (emphasis added).  So the appellant was obliged to pay these insurance premiums in the first instance.  They did so but, for the years ending March 2003 and 2004, they did not seek reimbursement from the tenants, choosing instead to treat these payments as loans to the service charge account.  The total loan amount of £10,220.50 remained in the balance sheet until the year ending March 2006 when they were reduced to £8,060.50.  They were still shown in the balance sheet for the year ending March 2008.  In my opinion, and in the light of my decision regarding the reserve fund, the loans should not have been carried forward indefinitely in the accounts as current liabilities.  The service charge account should have been balanced each year either by the tenants paying their proportion of the shortfall or being credited in the next year with their proportion of any unexpended balance.

56.         I accept that the appellant’s actions in creating a reserve fund and making loans to the service charge account were done in good faith and in the interests of the tenants.  They had the effect of dampening the fluctuations in the service charge and avoiding demands for substantial additional payments, such as those that an annual balancing of the service charge account would require in three of the five years in dispute.  For instance, in the year ending March 2003 the shortfall against actual expenditure was almost two thirds the amount of the service charges received.  The appellant’s approach also reflected the problems it faced in recovering all of the service charges it was owed.  Taking the respondents’ proportion at 5.88% of the total owed as payments on account by all the tenants, it can be seen that in every year between 2004 and 2008 the amount demanded was greater than the amount received.  Nevertheless the lease provides for an annual balancing by way of credit or further payment to/from the tenants, except for provisions for anticipated future expenditure of a recurring nature which I have already considered above.

(3) Legal fees  

57.          Charges for legal fees appear in the 2006 (£2,296.10) and 2007 (£705) statements of service charge expenditure.  The appellant argues that the fees, which relate to the negotiation of a development agreement and to tax advice in connection therewith, are recoverable under paragraph 2 of Part 1 of Schedule 3 to the lease.  That paragraph defines Service Expenditure which:

“…means such sum as the Lessor may reasonably expend or desire to expend in relation to the Building or any part thereof on:

2.1 carrying out its obligations under Part 2 of this schedule or carrying out any other work on the Building in relation thereto which it may reasonably deem necessary and desirable.” (emphasis added).

2.2 management administration audit professional advice and assistance…”

58.        I do not consider that these legal fees are recoverable for four reasons.  Firstly, they were not incurred in relation to the appellant’s obligations under Part 2 of Schedule 3.  It may have been desirable and expedient to negotiate the development agreement in view of the long term benefits that it would bring to all of the tenants (see paragraph 5 above) but, in my opinion, it was not necessary since it was not the only way in which those obligations could be discharged.  Secondly, I do not consider that legal fees constitute expenditure “in carrying out any other work on the building”.  The use of the preposition “on” in this context signifies physical, rather than legal, work.  Thirdly, I do not consider that the fees were reasonably incurred in respect of professional advice in relation to the building.  They were incurred in respect of a major redevelopment and refurbishment proposal which, in my opinion, is too remote from the intention of the parties in this paragraph.  Fourthly, the amount claimed, which is apparently significantly less than the total amount incurred on such legal advice, is arbitrary.  I therefore disallow these costs.

(4) Insurance

59.        I am satisfied from Mr Kanzen’s evidence that the appellant took all reasonable steps to effect insurance cover in accordance with its covenants under the lease and in a cost effective manner.  I accept that there were difficulties in obtaining such insurance on favourable terms given the claims history of the building.  I note the successful efforts of the appellant to reduce the premium in the year ending March 2008 pending the redevelopment of the building.  I consider that the insurance premiums for the years 2004 to 2008 were reasonably incurred and I make no limitation on the amounts shown in the statements of service charge expenditure.

60.        The appellant paid the insurance premium each year by monthly instalments, for which a charge was levied by the insurance company.  Thus for the year ending March 2006 the premium was £6,855.98 but the total of the instalments came to £7,335.90, the difference of £479.92 being recorded in the statement of service charge expenditure for that year under “Bank charges and interest”.  Mr Kanzen said that payment by instalment improved the cash flow but as I have said above such cash flow is a matter of concern to the appellant rather than the respondents.  In my opinion it is not reasonable for the appellant to incur, and charge the respondents for, additional finance charges to assist the appellant’s ability to pay the premium.  It was not necessary to incur such charges and, in my opinion, it was not reasonable to include them as service charge.  I therefore disallow these costs for the three years 2006 to 2008 in which these costs are included as service charge expenditure.

(5) Management fees

61.        The appellant acknowledges that the performance of the managing agents was unsatisfactory during the years 2004 to 2008.  In my opinion the services provided by those managing agents was not of a reasonable standard in respect of the provision of information to enable the service expenditure statements to be prepared in a timely manner.  However, I do not accept that, as the respondents argue, there should be no payment in respect of management fees.  I accept that the figures shown in the statements of service charge expenditure are those which were incurred by the appellant and I allow 75% of those figures as being the appropriate allowance for work which was done to a reasonable standard. I therefore allow the following amounts as management fees:

2004:  £2,756.07

2005:  £1,837.38

2006:  £1,378.03

2007:  £1,845.10

2008:  £2,088.57

(6)  Other disputed items of expenditure

62.        The respondents challenge the amounts allowed under the heading “Cleaning, repairs and maintenance” for the years 2005 and 2006.  They argue that the amounts should be limited to those for which copy invoices are available.  For the year ending March 2005 the appellant submitted copy invoices amounting to £2,882.64 (incorrectly summated by the respondents as £2,832.64).  The appellant said that the difference between this amount and the figure of £3,995.89 shown in the statement of service charge expenditure was due to two invoices (audited at the time); one was from London & Provincial Properties for £646.25 and the other was from B Weston for £470.  Copies of bank statements showing these payments were submitted in evidence.  I accept the appellant’s evidence and adopt its figure of £3,995.89 (although, on the figures, this should be £3,998.89).  Similarly, the respondents argue that the amount under this item for 2006 should be limited to £5,867.76 for which invoices are available.  From the appellant’s evidence, to which copy invoices are attached, I calculate the total to be £7,630.26.  The appellant explained that the difference between this sum and the amount shown in the service expenditure statement of £8,325.26 comprised two payments; a maintenance invoice from London & Provincial Properties in the sum of £470 and another from Pipeline in the sum of £225.  Again these were verified by reference to the bank statements.  I therefore allow the appellant’s figure of £8,325.26.

63.        The respondents challenged the figure of £389.14 for electricity in the year ending 2008.  I accept Mr Morris’ explanation of this figure (see paragraph 33 above) and I allow it in full.

(7)  Summary of expenditure allowed

64.        Applying the figures that I have allowed above I set out below a table showing my amended statement of expenditure, the figures determined by the LVT, the respondents’ proportion at 5.88% of the amended figures and the amount demanded on account.

Year Ending 25 March	Lands Tribunal (£)	LVT   (£)	Respondents’ proportion of Lands Tribunal figure (£)	Amount demanded on account (£)
2004	10,377.85	11,296.54	610.22	1,336.92
2005	14,064.51	11,000.00	826.99	1,146.44
2006	17,131.37	10,700.00	1,007.32	1,146.44
2007	13,693.24	10,548.70	805.16	1,146.44
2008	10,623.91	10,920.00	624.69	1,146.44
TOTAL	65,890.88	54,465.24	3,874.38	5,922.68

 

65.        The LVT said that the respondents had paid £5,429.46 over the period 2004 to 2008.  The evidence before this Tribunal supports that figure (although it appears that it was not always paid when demanded).  £100 of this amount was paid in respect of ground rent and this should be deducted to leave a total of £5,329.46.  (The evidence of payment only covers the first two quarterly instalments of the payment on account for the year ending 2008 and it may be that the respondents subsequently paid the full amount. If they have made such further payment then they should receive credit for the additional payment of £573.22.)

(8)  Section 20B of the 1985 Act

66.        The respondents argue that for each of the three years ending 25 March 2004 to 2006:

“…the landlord has failed to properly notify us of the expenditure within 18 months of it being incurred.  As such, under section 20B of the Landlord and Tenant Act 1985 nothing is payable.”

67.        There is apparently no dispute that demands were made each year to the respondents for the payment of the appellant’s fair estimate of the lessee’s proportion of the service expenditure for the coming year in accordance with paragraph 1 of Part 1 of Schedule 3.  However, no copies of these demands were exhibited in evidence by either party, except for a statement of anticipated service charge expenditure for the year ending 31 March 2010 that was adduced by the respondents.  (The service charge for that year is not in dispute in these proceedings.)  The evidence does contain copies of a payment schedule dated 11 June 2007 as well as copies of applications for payment prepared by the managing agents.  There is also a letter from Mr Kantilal Modi to London & Provincial Properties dated 9 April 2006 which refers to “your application for payment dated 15/3/06”.  Finally, Mr Salim Modi includes a table in his witness statement that gives details of the “Amount Demanded” for each of the years in dispute.

68.        Whereas I am satisfied that the appellant did demand payment on account in accordance with paragraph 1 of Part 1 of Schedule 3, it is not disputed that there was considerable delay in producing to the respondents a Service Expenditure Statement detailing the actual expenditure in accordance with paragraph 3 of that part of the schedule.  The statements for the years ending 25 March 2005 and 2006 were both produced more than 18 months after the year end.  The statement for the year ending 25 March 2004 is dated March 2005 but is said by Mr Modi not to have been received by the respondents until June 2007.  But in each of the years 2004 to 2008 the payment on account which was demanded by the appellant exceeded the lessee’s proportion of the service expenditure (see paragraph 64 above).  Under these circumstances I do not consider that section 20B arises since there were no further service charges owing which could properly have been demanded by the appellant.  (I note that the LVT says that section 20B does not apply to service charge payments on account, which are dealt with under section 19(2). Those sections deal with different issues; section 19(2) is concerned with the reasonableness of payments on account while section 20B is concerned with the time limits on making demands.  In my opinion both sections can apply to payments on account, as the LVT itself acknowledges in paragraph 2.8 of its decision.)

Determination

69.        The LVT determined that the respondents had overpaid service charges in the sum of £2,225.70.  I calculate the overpayment to be £1,455.08 (£5,329.46 less £3,874.38; see paragraphs 64 and 65 above).  Since I have determined a lower figure of repayment than the LVT the appeal is allowed to this extent.  The LVT determined that as the respondents had already paid the appellant in excess of the service charge reasonably payable on account for the (then) current service charge year, the appellant should pay the amount awarded to the respondents immediately.  I agree with this decision although I consider that the appellant should be given a reasonable time to pay. I therefore determine that the sum of £1,455.08 shall be paid within 28 days of the date of this decision by the appellant to the respondents.

70.        The respondents have also made an application under section 20C of the 1985 Act that the costs incurred by the landlord in connection with these proceedings should not be regarded as relevant costs to be taken into account in the determination of any service charges payable by the respondents.  The respondents also ask that they be paid the application and hearing fees (£250 in total) before the LVT together with the £40 fee for making an interlocutory application to this Tribunal for disclosure.

71.        In The Tenants of Langford Court v Doren Limited, Lands Tribunal reference LRX/37/2000 (unreported), His Honour Judge Michael Rich QC said of the discretion given to the Tribunal under section 20C:

“28.   In my judgment the only principle upon which the discretion should be exercised is to have regard to what is just and equitable in all the circumstances.  The circumstances include the conduct and circumstances of all parties as well as the outcome of the proceedings in which they arise.”

72.        In this appeal the appellant has succeeded to the extent of my determination, namely that the repayment of service charges should be less than the amount awarded by the LVT.  But the appellant has not been wholly successful, failing in its arguments about the reserve fund, loans from Redendale, legal fees and paying the insurance by instalments.  For their part the respondents failed in their arguments about section 20B and on a number of detailed points of dispute regarding various cost items. But an application under section 20C does not follow the event and in exercising my discretion I must also have proper regard to all the circumstances, including the conduct of the parties.

73.        Both Mr Kanzen and Mr Morris impressed me as honest witnesses who had done their best to deal fairly and pragmatically with the service charge issues in difficult circumstances.  Mr Modi is understandably frustrated by the history of delay in obtaining information from the appellant and their various managing agents.  But that frustration has, in my judgment, led Mr Modi to use language in his written statement that is exaggerated and inflammatory and which is not supported by the evidence.  I give some examples below:

“2.     …Over the 5 years relevant to this application Mr Kanzen has been a controlling officer of the company and has shown complete disregard for not only the lease, but also the Landlord & Tenant Act, and in doing so has committed numerous criminal offences.

3.       …the company accountant [Mr Morris] who has audited all of the accounts has shown himself to be dishonest and untrustworthy…

4.       The accountant has, over the past year or so, given us cause for suspicion about his integrity and motives.  In colluding to cover up Mr Kanzen’s negligence and ulterior motives, one lie seems to have led to another and he was finally caught out.

5.       The accountant has also included ground rent as an item of service charge…which is further evidence of his incompetence.”

74.        I must record that in giving his evidence before this Tribunal, and in his cross-examination of Mr Kanzen and Mr Morris, Mr Modi behaved reasonably and courteously, making his arguments and presenting his evidence effectively.  But the accusatory tone of his written statement was not helpful.  It detracted from his case and did not assist my proper understanding of the issues in dispute.  In my judgment, his allegations against Mr Kanzen and Mr Morris are both unreasonable and without substance.

75.        Applying the principles for the exercise of my discretion set down in Doren I refuse the application under section 20C and also the respondents’ application for the reimbursement of their fees.

Dated 5 October 2010

 

A J Trott FRICS