Structuring the ownership of mixed use buildings requires care both initially and then during the management of the building. In a recent case, an investor in the residential parts of a mixed use building faces a significant service charge shortfall that was avoidable.

Residential tenants benefit from a statutory requirement that their service charge must be reasonable (section 19 of the Landlord and Tenant Act 1985). The relevant provision also states that residential service charges demanded before the cost is incurred (e.g. on account service charge payments or contributions to a sinking fund) must be reasonable too. The question was – when the lease says the residential undertenant will pay a percentage of what has been paid by an intermediate landlord, is it presumed reasonable?

The case in question was Balkhi v Southern Land Securities Ltd and clearly the Upper Tribunal were unhappy with the quality of the evidence they had to analyse. The outcome was what we expected and said “it is not sufficient for the [intermediate] landlord merely to say: I have paid this sum to the freeholder and so it is reasonable for me to recover it from you”.

Instead, where a residential tenant challenges the reasonableness of the amount demanded, it will be for the intermediate landlord to justify the reasonableness of the figure claimed. The Tribunal advises that the landlord may need to seek assistance from the superior landlord to do this. Ideally the intermediate lease would contain express wording providing for this assistance and limiting the charge to a reasonable amount. If not, then before paying anything intermediate landlords should obtain as much service charge information as possible from the superior landlord in advance, in order to arm themselves against potential challenges from their residential tenants.

The facts of the Balkhi case involved a sinking fund for a mixed use building in Mayfair. The fund was to be put towards future external redecoration. The intermediate landlord paid towards the fund without seeking justification (even though the intended size of the fund almost doubled) and then demanded proportionate contributions from their tenants. However, the Tribunal did support contributions to the initial smaller sinking fund originally required. The evidence of the service charges due as presented to the Tribunal very obviously left something to be desired.

Managers of mixed use developments need to be clear and well organised and must also consider the requirements to consult on service charge expenditure if it is to be fully recoverable.