Key point

  • A service charge fund built up over a number of years by way of provision for future works could be utilised against the cost of works taking place after the operation of a break clause by a tenant, where the works took place in the same service charge year as the break

Facts of Friends Life Management Services Ltd v A & A Express Building Ltd

Like some of the other cases we are considering in this month's update, the dispute in Friends Life Management Services Ltd v A & A Express Building Ltd arose as a result of the exercise of a break right in a lease.

It concerned how the service charge provisions in the lease would operate where a break had been exercised.  Could a tenant subsequently receive credit for monies it had paid via the service charge for anticipated future major works, where those works did not take place until after the operation of the break?

A lease of business premises was terminated on 24 March 2010 after the tenant exercised a break clause.  Under the lease's terms, the landlord provided services to the building and recouped an appropriate proportion of those costs through a service charge mechanism.

Not uncommonly, the tenant had to pay quarterly payments on account of the service charge based on an estimate of the anticipated costs for the relevant service charge year (which ran from 1 January to 31 December). When calculating the service charge costs, the lease allowed for the inclusion in the total expenditure of an additional amount " way of provision for anticipated expenditure in any future Financial Years...", with a view to providing for future major works to the building.

Between 2006 and 2009, provision had been made for such future expenditure. The sums recovered through the service charge amounted to some £875,000 (of which the tenant paid over 90%, as it occupied six out of the seven floors in the building).

Major works were carried out by the landlord, but only after termination of the lease under the break clause. The works were started in autumn 2010 and continued on into 2011. The total cost of the works was over £1 million.

There were a number of issues in dispute.  Two of the key questions are considered below.

What expenditure could be included in the service charge year during which the break operated?

The High Court held that the final service charge year under the lease was the complete year ending 31 December 2010 and not, as the tenant had argued, a shorter period ending on 24 March 2010. In relation to that year:

  • Only costs actually incurred in 2010 could be included.  The landlord had paid the contractors carrying out the works over a period of time which spanned 2010 and 2011.  Sums incurred in 2011 could not be included in the accounts for the 2010 service charge year. 
  • Neither could the landlord include in the 2010 service charge account a provision for future major expenditure for 2011.

What should happen to the £875,000 provision which had been built up?

The landlord argued it could keep the whole of the tenant's proportion of the £875,000. The tenant argued it must all be repaid, because none of the matching costs became payable before its lease ended.

The court held that, under the terms of the lease, the whole of the £875,000 had to be brought into account in the final service charge year of the lease (2010). As this amount exceeded the cost of the works in that year, the tenant was entitled to a percentage of the excess, calculated by reference to their period of occupation in the service charge year. 

Things to consider

In the absence of an express provision entitling a landlord to keep monies paid in anticipation of future expenditure, there is a risk that unspent monies from a tenant will have to be returned at the end of the final service charge year of its lease.

In multi-tenanted properties, landlords should consider forthcoming lease expiries and lease breaks when programming major works. Other tenants may also be mindful of this as any reduction in the anticipated expenditure "pot" could result in an increased liability for them.

The fact that landlords will need to incur expenditure before the end of the final service charge year is likely to mean disruptive works are undertaken with departing tenants in situ (although it would clearly be possible to agree to defer works if tenants are prepared to forego reimbursement).

The case raises interesting questions about the position if a lease is assigned with successive tenants each making significant contributions to the anticipated expenditure "pot". Is the final tenant entitled to all the unspent monies? If a lease is assigned in circumstances where the assignor has contributed significant sums in respect of anticipated expenditure, consideration should be given to whether provision should be made for this as between the assignor and the assignee at the point of assignment.