Ensuring landlords’ rights are not lost

One of the biggest risks to professionals involved in residential property management arises from the collection of service charge payments.

The Landlord and Tenant Act 1985 sets out  the basic principles in relation to the recovery of residential service charges. Property managers whose duties include the collection of service charges need to be mindful of the provisions of this Act. One of the most important provisions is section 20B, which specifies the timeframe within which payment must be demanded from tenants.

Section 20B of the Act is intended to offer protection to both landlords and tenants regarding to the payment of service charges. A failure to comply with this section could result in a property manager becoming liable to the landlord for any shortfall in the service charge recovered from tenants.

Section 20B – what does it require and what is its purpose?

Section 20B states that, for a landlord to recover the costs of works or services, it must either:

  • serve a demand for payment on the tenants within 18 months of incurring such costs or
  • notify the tenants in writing within 18 months of incurring such costs that the costs have been incurred, and that the tenants will be required under the terms of their leases to contribute to the costs by the payment of a service charge.

If a landlord fails to comply with section 20B, it cannot recover the costs from the tenants. This section is intended to avoid the situation where tenants are faced with a demand for payment of costs of which they were not aware, years after the costs were incurred.

The landlord is able to protect its position by issuing a written notice to the tenant under section 20B(2), informing the tenant that they will subsequently be required to pay for the costs incurred. This notice essentially stops the 18 month clock running. Any subsequent costs would then in principle be recoverable, even if demanded more than 18 months after they were incurred.

Because the landlord may lose the ability to recover costs if it does not serve a demand or notice under section 20B, it is vital for anyone managing a property on behalf of a landlord to understand when a cost is actually “incurred” for the purposes of the Act. Whilst this may appear to be a relatively straightforward concept, the issue has been the subject of serious debate and recent judicial comment.

When is a cost “incurred”?

The 18-month clock starts ticking from the time that a cost is “incurred” by the landlord. In Jean-Paul v The Mayor and Burgesses  of the London Borough of Southwark the Upper Tribunal (Lands Chamber) held that a cost is only incurred by a landlord within the meaning of section 20B when payment is made. The Tribunal drew an important distinction between incurring a liability, ie an obligation to pay, and incurring a cost, ie making a payment.

The Court of Appeal arrived at broadly the same conclusion in OM Property Management Ltd v Burr. In that case, the court held that costs are “incurred” on the presentation of an invoice or other demand for payment, or upon payment by the landlord.

One difficulty that can potentially arise is that when a cost is incurred in a legal sense does not necessarily correspond with when it is considered incurred from an accounting perspective. This can cause confusion in identifying when the 18-month clock starts ticking for issuing a section 20B (2) notice. With this confusion follows the risk of disputes between the landlord and the tenants as to whether the landlord can recover the costs, and the further risk that the landlord will look to the property manager to pay any disputed amount.

Often, in trying to decide whether a landlord has suffered loss flowing from the failure to serve section 20B notices in time, a landlord and its advisers will simply look at whether any deficit appears in the relevant accounts, ie whether there is a shortfall between the sums received from the tenants for service charges and what the landlord actually paid out in works and services. However, caution should be exercised if looking solely at the accounts, as they will not necessarily reflect when a cost was “incurred” in the legal sense ie upon presentation of an invoice or when payment is made.

The reason for this is that service charge accounts are often prepared on an ‘accruals’ basis. Broadly, this means that the accounts make allowance for the costs of work or services that have been provided in the accounting period (eg a utility bill for electricity), but for which an invoice has yet to be received, and therefore payment has not been made. As such, the accruals basis of accounting recognises  that, for accounting purposes, a cost is incurred on the actual provision of work or services to the landlord, not when the invoice is presented or when payment is made. Care should therefore be taken when considering what the correct date is for the 18-month period to commence, as the service charge accounts may not reflect when relevant costs are incurred in the legal sense.

The issue of when costs were incurred and whether a property manager was liable to  a landlord for failing to serve section 20B notices in time was recently considered in the unreported case of Freehold Managers (Nominees) Limited v Countrywide Residential Lettings Limited, in which RPC acted for the property manager.

The facts of Freehold

Freehold was the owner of a residential block of flats. Countrywide was Freehold’s managing agent for the property until November 2009, when management passed to a different company.

For the period of its management, Countrywide was responsible for collecting service charges from the tenants of the flats. The Leases provided for payment of an interim service charge based on estimated expenditure for each 12 month accounting period and, where the total expenditure exceeded the estimate, payment of an additional amount.

In the accounting years ending 31 August 2008 and 31 August 2009, the total expenditure exceeded the amounts collected from the tenants through the interim service charge. However, Countrywide did not serve demands for the balancing payments on the tenants pursuant to section 20B(2) within 18 months of the accounting year-ends. Freehold claimed that it had suffered loss as a result of Countrywide’s failure to serve the relevant notices and relied on the deficits that appeared in the 2008 and 2009 accounts in order to quantify its alleged loss.

The Court held that, in order to ascertain whether Countrywide had been negligent, and whether Freehold had suffered loss as  a result, Freehold needed to establish when the costs it said it could not recover from the tenants had been incurred. In accordance with established authority, this was when the costs were paid or, possibly, when Freehold or Countrywide had received invoices for  the costs. This could not be established simply by looking at the liabilities recorded in the accounts, as these had been prepared on an accruals basis. Despite Countrywide having set out the correct legal position in  its defence, Freehold did not adduce any evidence as to when relevant costs had been incurred and so could not establish the date by which any section 20B notices should have been served. Freehold was accordingly unable to establish whether Countrywide’ failure to serve section 20B notices had in fact caused it any loss. Freehold also faced the potential difficulty that it, or its new property manager, may still have been able to serve section 20B notices after Countrywide had ceased to manage the property, in 2009.

Comment

In deciding the date by which a demand or notice needs to be served under section 20B, and whether a property manager has failed to serve a demand or notice in time, landlords and their advisers need to carefully consider when any costs that may form part of what appears to be a shortfall in the service charge were incurred. The fact that a deficit appears in the service charge accounts, particularly where the accounts have been prepared on an accruals basis, will not automatically mean that a landlord has suffered a loss for which its property manager may be liable.

In general, it is likely that costs will be incurred for the purposes of section 20B at a later date than the date on which the work or services  to which they relate are performed. This will normally give property managers more time than they may think to recover those costs for their landlord clients and any manager taking over the management of a residential property should take care to ensure that they do not miss the deadline for issuing notices in relation to costs incurred on the watch of the previous managers, in relation to which they might assume the deadline has already past.  It remains best practice to serve any notices required under section 20B sooner rather than later.