The second edition of the Royal Institution of Chartered Surveyors (“RICS”) Code of practice on Service Charges in Commercial Property (“the Code”) came into force on 1 October 2011 to help to eliminate service charge disputes between landlords and tenants. The management of service charges can be controversial in leases as many tenants continue to be disappointed in the way service charges are dealt with. Although the Code is not compulsory, it aims to remove conflict by providing best practice when it comes to the management of service charges and by improving the relationship between landlords and tenants.

The first edition of the Code had been drafted predominately for service charge guidance on larger commercial properties. The second edition builds on the first and now applies to all commercial properties. It promotes the following:

  • Better communication between landlords, their managing agents and tenants;
  • Transparency by providing tenants with budgets, end of year accounts, explanations of expenditure and movement outside the budget;
  • Timeliness providing guidance on the issue of accounts;
  • Fairness on what can be charged as a service charge and how such costs should be allocated; and
  • Efficiency in resolving disputes without resorting to court proceedings.

The Code affects landlord, tenants, managing agents and their respective representatives. The Code has a concept of “manager” which includes the owner, manager, managing agent and management company, and makes it clear that it does not matter who under the lease or in practice deals with the service charge management. Whoever is the “manager” must manage in accordance with the Code.

The Code is still voluntary. It does not bind landlords unless the lease incorporates the Code. The key provisions under the Code are as follows:

  • The landlord will agree not to make a profit from the service charge, to procure services on an appropriate value for money basis and to ensure all costs are transparent;
  • Costs incurred in the initial construction, fit out and improvements are not to be billed to the service charge account unless they are more cost effective than repair costs. It is surprising to see that costs relating to inherent defects are not specifically excluded;
  • A landlord must apportion service costs fairly and reasonably. It must pay apportionments to void units and any shortfall due to concessions that may be granted to particular tenants and credit to the service charge account;
  • Industry-standard cost categories must be used when preparing service charge accounts;
  • Service charge budgets should be issued at least one month prior to the service charge period;
  • A certified account as a true and accurate record of expenditure is to be produced within four months of year end. A full audit is no longer required due to being costly and time consuming;
  • Service charge monies are to be now held in a discrete bank account and all interest earned on such account to be credited to that account;
  • Sustainability and environmental issues should be considered by parties as part of any cost-benefit analysis of which services or improvements to provide; and
  • Alternative dispute resolution should be used by parties to resolve disputes rather than court proceedings even if no such provisions are included in the lease. The President of RICS will nominate a person to conduct such process if the parties are unable to agree.

Although not as extensive as the obligations on landlords/managers, the Code places obligations on tenants requiring prompt payment of service charge contributions. Tenants are not to withhold any undisputed part of service charge payments. However, these provisions have the status of best practice guidance only and a breach can only be enforced against the tenant if such provisions are provided for or incorporated in the lease itself.

Even though the Code does not impose legal obligations, failure by members of RICS to adhere to its principles may be considered negligent and in the event of a dispute it is likely that the court will consider compliance or otherwise with the Code. The Code aims to create a balance between the interests of a landlord and tenant. It encourages the inclusion in the lease of relevant provisions to reinforce the Code from a contractual point of view.

Many will argue that the implementation of the Code in new leases will take time and is unlikely to remove all service charge conflicts between landlords and tenants as it merely provides best practice guidance. However, it is a step in the right direction by providing guidance on fair service charge management, and management of tenant’s expectations. The Code may well help to reduce conflicts between landlords and tenants on what is often a vexed area in leases.