The new RICS Professional Statement, Service charges in Commercial property 1st edition September 2018, goes live today and is effective for all service charge periods commencing from 1 April 2019. This document replaces the existing RICS Service Charge Code and its increased regulatory importance for RICS surveyors and regulated organisations gives it elevated status. The new Statement has been endorsed by property bodies, which represent all sides of the property industry.
What continues to drive this Statement and its previous iterations is the RICS’s desire to stamp out bad landlord’s practices of exploiting tenants through unfair and opaque service charge regimes.
The Statement contains important obligations and best practice for RICS surveyors and regulated organisations and its influence will drip feed into lease drafting.
The delay between the Statement being published and it becoming effective gives surveyors adequate time to become accustomed to the new requirements and for accounting procedural changes.
This professional statement is applicable across the United Kingdom. There are instances where different conditions may apply in Scotland and Northern Ireland and they are highlighted in the Statement.
The Statement includes mandatory requirements and best practice. RICS expects that its members engaged in activity relating to service charges will comply with the whole document. It is not acceptable simply to comply with the mandatory obligations and, if members depart from the best practice requirements, they should do so only for justifiable reasons.
One concern for RICS surveyors is what happens if their client or employer refuses to comply with the new Statement, but they still have their regulatory duties to comply. This does not appear to be addressed specifically, although as mentioned the Statement acknowledges departures from best practice for justifiable reasons.
Importantly, the Statement cannot override the terms of an existing lease. Nor will a failure to comply with the Statement negate or limit a tenant’s liability to pay service charge under the lease. The RICS says that the Statement can identify the best way forward in interpreting the lease to ensure effective management of services.
Aims of Statement
The aims and objectives of the Statement are to:
- improve general standards and promote best practice, uniformity, fairness and transparency in the management and administration of services charges in commercial property
- ensure timely issue of budgets and year-end certificates
- reduce the causes of disputes, and to provide guidance on the resolution of disputes if they arise and
- provide guidance to solicitors, their clients (whether owners or occupiers) and managers of service charges in the negotiation, drafting, interpretation and operation of leases, in accordance with best practice.
The Statement contains provisions with varying regulatory importance. At the top of the tree are the 9 Mandatory requirements that must be complied with.
Here are some examples of the mandatory requirements. All expenditure that the owner and manager seek to recover must be in accordance with the terms of the lease. Owners and managers must seek to recover no more than 100% of the proper and actual costs of the provision or supply of the services.
The owner and manager must ensure that service charge budgets, including appropriate explanatory commentary, and an approved set of service charge accounts showing a true and accurate record of actual expenditure, are provided annually to all tenants. A service charge apportionment matrix for their property must also be provided annually to all tenants.
Service charge money must be held in one or more discrete bank accounts.
It is not all landlord’s obligations - where acting on a tenant’s behalf, practitioners must advise their clients that, if a dispute exists, any service charge payment withheld by the tenant should reflect only the actual sums in dispute.
RICS members and regulated firms must comply with the mandatory obligations.
Core principles and Best practice
There are 24 Core Principles, which support the mandatory requirements. RICS acknowledges that some of the Principles may be difficult to quantify, and rarely, strict compliance may not always be possible. The appropriate level of compliance may be based on the professional judgment of all parties as to what is appropriate and reasonable considering all the circumstances.
So what do the Core Principles cover? Here are some examples.
All costs should be transparent so that the parties are aware of how they are made up. Management fees should be on a fixed-price basis with no hidden mark-ups.
The basis and method of apportionment of costs should be demonstrably fair and reasonable.
When issuing statements of accounts and/or certifying expenditure, managers should do so in a non-partisan spirit, acting as experts. In addition to the manager’s certificate, annual statements of expenditure should be supported by an independent review of the service charge accounts. Also the Industry Standard Cost Classifications should be used in reporting budget and actual expenditure.
All new leases should make provision for either party to require the resolution of disagreements through alternative dispute resolution.
Perhaps controversially, managers should issue budgets to tenants, including explanatory commentary and apportionment matrix, at least one month prior to the start of the service charge year. Detailed statements of actual expenditure, together with accounting policies and explanation, should be issued within four months of the service charge year-end.
There was objection to having this rigid timeframe for provision of information, although it is not a mandatory requirement and as with everything else is subject to existing lease terms.
There is an interesting principle on value for money. The manager should procure quality service standards to ensure that value for money is achieved at all times. The aim is to achieve effective value for money service, rather than merely the lowest price. This is sensible.
Some of these Core Principles will impact on lease drafting and in particular exclusions from what should be charged to tenants through the service charge.
So according to the Principles tenants should not be charged for:
- Initial costs incurred in relation to the original design and construction of the fabric, plant or equipment.
- Any improvement costs above the costs of normal maintenance, repair or replacement. However, service charge costs may include enhancement of the fabric or plant, where such expenditure can be justified on a cost-benefit analysis.
- Future redevelopment costs.
- Costs and fees relating to the owner’s investment interest, such as asset management and rent collection and matters between the owner and an individual tenant.
- Costs attributable to void premises and the owner’s own use of the property.
Underpinning these Principles are over 25 pages of best practice recommendations. The extent to which they should be complied with depends on issues such as the size, nature and type of property, the aggregate of the total service charge costs and the amounts payable by individual occupiers.
However, it is the Mandatory requirements and Core principles that are the key regulatory element for surveyors acting for landlords or tenants.
Surveyors and lawyers should be looking at the service charge provisions in lease standards with a view to achieving compliance with the new Professional Statement. As mentioned, the Statement cannot override existing lease terms.
The Statement’s authors cite the City of London Law Society’s service charge provisions for office and shopping centre use as examples of provisions specifically designed to comply with the principles and provisions of the Statement. The provisions are available from the City of London Law Society’s website.
Finally, Appendix D of the Statement contains commercial property service charge handover procedures, which will be helpful in a purchase situation.