A recent Court of Appeal judgment considers when residential service charge costs are reasonably incurred and so recoverable from the tenants.
Unlike commercial service charges, residential service charges are subject to a number of statutory controls to protect tenants from unreasonable charges being levied by landlords or charges being made for sub-standard services.
One of those controls, in section 19 of the Landlord and Tenant Act 1985, is that service charges must be reasonably incurred and the works or services to which they relate must have been carried out to a reasonable standard. This section applies to services, repairs, maintenance, improvements, insurance and landlord's management costs.
In London Borough of Hounslow v Waaler  EWCA Civ 45, the Court of Appeal had to consider whether service charges had been reasonably incurred by the landlord.
The local authority landlord had carried out a substantial programme of repairs and improvements to one of its housing estates. It sought to recover substantial costs from those of its tenants who, having exercised the right to buy, had long leases of their flats. In the case of Ms Waaler, those costs were just over £55,000. The works in issue were the replacement of damaged flat asphalted roofs with pitched roofs and the replacement of wooden-framed windows with new metal-framed units. The Court of Appeal accepted that the replacement of the roofs was a repair that the landlord was obliged to carry out under the terms of the leases. Although there is no clear dividing line between repairs and improvements, the replacement of the windows was an improvement as the windows were not in disrepair; there was a design fault with the hinges that was best resolved by replacing the entire windows.
The costs of improvements can be recovered from tenants only if the service charge provisions in the leases permit it. In the case of Ms Waaler, her lease allowed the landlord to recover costs if it carried out improvements. The Court of Appeal had to consider whether, given the level of the costs involved, they were reasonably incurred.
A higher standard of decision making
The Court of Appeal held that it was not sufficient that the landlord's decision to carry out the improvements was rationally made. Reasonableness imposes a higher standard of decision-making. If the landlord, exercising its discretion to carry out improvements, had acted irrationally, the costs could not be recovered. However, even if the decision was rational, it did not follow that the costs would be reasonably incurred.
In deciding whether the costs were reasonably incurred, it was not sufficient to look only at the landlord's decision-making process. The outcome of that decision-making process has to be considered as well. There can be a number of reasonable outcomes from the landlord's decision-making process and the court will not interfere with these, but there can also be unreasonable outcomes.
In the case of Ms Waaler, the Upper Tribunal had held that the landlord's decision led to an unreasonable outcome. The Court of Appeal agreed. A distinction was drawn between repairs which the landlord was obliged to carry out under the lease, and improvements, where the landlord had a discretion. Although the same test of reasonableness applied to the landlord's decision making-process for repairs and improvements, the reasonableness of the outcome for improvements required the landlord to take particular account of:
- the extent of the interest of the tenants,
- their views on the works, and
- the financial impact of proceeding with the improvements.
The Court of Appeal commented that, in respect of repairs, the tenant can form a view at the start of a lease of what repairs are likely to be required and their potential costs. However, with improvements it is quite impossible to quantify the works that may be carried out or their cost. In this particular case, it was the financial impact of the works that made them unreasonably incurred. In other words, it was not reasonable for the landlord, when exercising a discretion to carry out improvements, to create a financial burden on the tenant out of proportion to the value of her flat. Here, it seems, that the costs charged to the tenant represented almost half the value of her flat.
Landlords who are proposing to carry out major works to residential property need to consider carefully the terms of the leases under which the costs will be charged. Where landlords have a discretion, this case makes it clear that they must think carefully about the financial impact of the proposals on the tenants.