In the current economic climate we are seeing both landlords and tenants increasingly focus on service charge. We are also seeing service charge companies offering to review tenants' leases to identify where tenants could challenge service expenditure. That's putting a bigger spotlight on what expenditure is service charge recoverable. Here we highlight some current trends we are seeing.
Service Charge Exclusions
Common Parts Repairs
Scrutiny of how improvements and replacements are dealt with in leases is increasing. As this could catch anything from core maintenance to wholesale redevelopment, there is more focus on the following:
Exclusions of costs which are not directly incurred for repair and maintenance (i.e. wholesale redevelopment or works that are not strictly necessary for repair and maintenance); and
more precise wording of the type of replacement or improvement costs which are service charge recoverable:
- the cost of replacement or improvement where it is more economically viable than repair (e.g. the cost of replacing old kit for new is cheaper than repairing the current kit),
- repair or maintenance is not practicable because the underlying parts or equipment are obsolete (e.g. with old air con units where technology and/or regulation has moved on),
- the replacement item is now the current version of the same kit (i.e. upgraded kit), or
- improvement or replacement would be cheaper once installed (i.e. would cost less to run and perhaps comes with a product guarantee that can be enforced medium term).
The key test is whether the improvement or replacement is (a) necessary or the only option (obsolete kit) or (b) more economically viable short or longer term, thus reducing service charge expenditure.
Be careful what is included and excluded from the service charge so the position is clear. Avoiding vague or non standard terms is prudent: improvement and replacement are established terms, but 'refurbishment' for example is quite wide ranging. It could straddle both improvement benefitting tenants and wholesale redevelopment.
Both landlords and tenants will be increasingly aware of the introduction of green leases and green lease clauses. We do not discuss green leases in full here but recommend our recent blog.
Although the recent changes in England and Wales on energy efficiency do not apply to Scotland, the interface between green lease clauses and service charge expenditure is coming under increased scrutiny north of the border. Green lease clauses can perhaps be split into two categories: (a) statutory compliance and (b) landlord (or tenant) requirements.
Statutory compliance: the easier category. It's generally established practice that costs for complying with statute for common parts are service charge recoverable. Whilst there is no Scottish equivalent to the new English & Welsh EPC regulations, many landlords are including this provision to future proof their leases. That is generally accepted by tenants.
Landlord (or tenant) requirements: this is perhaps more contentious, particularly because there is no market standard green lease. Many landlords have their own requirements either portfolio wide and/or asset specific. Tenants may therefore have different provisions across their lease portfolio. Whilst there is no market standard, the improvement versus repair and maintenance provisions discussed above should be borne in mind. Even if the green lease provisions improve energy efficiency and thus decrease costs and there is an argument they should be service charge recoverable, that does not mean that a tenant will necessarily accept that with a short term lease or where the improvement is introduced towards the end of the lease.
Sharing data: one area we are seeing push back on is the tenant obligation to share data with the landlord on energy and utility consumption. Whilst such information assists the landlord in planning energy efficiency improvements, collection of data could be an admin hassle and cost to the tenant. This data may also be sensitive to certain tenant classes. For example, restaurant or fast food providers may be reluctant to share data if it alerts their competitors to new technologies they have developed which are more energy efficient or productive. A landlord obligation to keep such data confidential and / or anonymise the data is increasingly common.
Service Charge Caps
A new trend is exclusions from caps, driven by the rise in energy costs. Usually that is utility costs, but what then happens to that cost? Is that a tenant cost payable on the 'standard' lease basis (e.g. NIA or fair and equitable)? Or are such costs excluded from the service charge, making them a landlord shortfall? The implications for both landlords and tenants can be significant, so careful consideration is needed.
Be very careful – and specific – about what expenditure is included and excluded from the service charge expenditure and/or tenant caps.