Service Charge: can landlord certification finally determine a tenant's liability?

The Supreme Court has found in favour of a "pay now, argue later" regime where there was a certification process under a lease for determining the service charge payable by the tenant.

Absent a sinking fund (remember those?), the nature of service charge provisions is that the landlord can end up taking the risk of fronting the cost of services without knowing whether the annual sum paid by the tenant in advance will be enough to cover the overall cost of the services, or in the event of quarterly payments, without guarantee that all tenants will be around after the event to pay at all.

Service charge certification

In a recent Supreme Court judgment, Sara & Hossein Asset Holdings Limited v Blacks Outdoor Retail Ltd, Blacks appealed the Court of Appeal's decision that it was required to pay the sum stated in the landlord's certificate, and could only challenge the certificate in the very limited and defined set of circumstances under the lease (fraud, mathematical error or manifest (obvious) error).

The clause in dispute read as follows:

“The landlord shall on each occasion furnish to the tenant as soon as practicable after such total cost and the sum payable by the tenant shall have been ascertained a certificate as to the amount of the total cost and the sum payable by the tenant and in the absence of manifest or mathematical error or fraud such certificate shall be conclusive."

The landlord's position: "Pay now, argue never"

S&H argued that the only possible literal interpretation of this clause was that the landlord was entitled to certify i) the total cost of services incurred; and ii) the amount of the total cost to be paid by Blacks and that Blacks could only challenge those sums on the limited grounds described above.

This, according to S&H, was also the only commercially sensible construction because it protected the landlord from being embroiled in lengthy disputes over the amount due by the tenant, while having already incurred liabilities to suppliers for services.

The Supreme Court described S&H's position as a "pay now, argue never" regime.

The tenant's position: "Argue now, pay later"

Blacks argued that a literal reading of the clause didn’t fit with the other clauses in the lease, in particular its comprehensive right to inspect S&H's receipts and invoices for costs incurred. Blacks also pointed to the dispute resolution mechanism under which it could refer a dispute arising over the 'proportion' of service charge payable to expert determination (the 'proportion' being calculated with reference to the size of the demise) which meant that the certificate was not 'conclusive'.

There were also 'uncommercial consequences' which were said to arise from S&H's interpretation. The service charge provision excluded certain costs from the scope of Blacks' liability, such as costs caused or necessitated by the landlord's own negligence. If certification was conclusive in the way S&H said it was, S&H would be the judge in its own cause.

Coined as the "argue now, pay later" approach, the Supreme Court was wary of Blacks' interpretation creating the risk of non-payment for the landlord when it required reimbursement for costs already incurred.

The compromise: "Pay now, argue later"

The Supreme Court said that neither party's interpretation was satisfactory and so it tried to reach a compromise — "pay now, argue later".

The Court found that in terms of the lease, the tenant was required to pay the certified sum in the time specified. However, the certification process did not prevent the tenant from pursuing a claim against the landlord over the liability for such costs. This approach addressed the landlord's cashflow concerns while avoiding the 'uncommercial consequences' of S&H's position. Summary judgment was therefore awarded against Blacks, but this did not preclude Blacks from pursuing its counterclaim.

One Judge disagreed with the Supreme Court's overall decision. Lord Briggs emphasised the critical rule of contractual interpretation that Judges cannot take it upon themselves to rewrite the contract in favour of a more commercial alternative where the words in the contract are clear. In Lord Briggs' view, there was no ambiguity in the lease. It was clear in stating that certification was conclusive of the sum payable by the tenant subject to the limited grounds for challenge.

The cases coming through the Courts show that certification can be of real benefit to landlords as a means of regularising the sums due to them. Professionals preparing the certificates, such as surveyors and asset managers, should however be wary of negligence claims which could arise from a certificate that is later challenged. Our blogon surveyor certificates for payment obligations in dilaps disputes may also be of interest to our readers.