An In-depth Guide to Leasehold Service Charge

Leasehold Service Charge Overview

What is Leasehold?

Leasehold refers to acquiring a lease from the freeholder to use the residential property for a set period. The duration of these leases varies between 40, 90, 120, or as high as 999 years. The leaseholder pays service charges to landlords to help them cover the cost of their offered services.

To acquire the leasehold, a leaseholder makes a legal deal with the landlord. This deal sets down the legal responsibilities and rights of both parties. The agreed contract may give the right to manage to one of the parties, in the usual case leaseholder. Leasehold is a complex process. If the with various terms of the lease are not fulfilled, it may result in forfeiture of the lease. It is advisable to consult an expert for these matters like service charge accounting and certification. 

What is Service Charge?

Service charges are payments to be made to landlords to help them cover their costs while providing services to a building. These charges usually fulfil the costs related to the general maintenance of the building, repairs, insurance along with other services. Other services include central heating or air-conditioning, lifts, porters, laundry and cleaning, shared spaces, and much more (if offered).

The service charge collected may also be utilised to cover the costs of management services provided by the landlord or by any managing agent. Various types of service charges are explained below, which need proper tracking and monitoring to avoid any legal penalties.

The agreement of lease provides information on what the landlord is liable or not liable to charge to a leaseholder. Additionally, it tells about the proportion of the charge that you might be required to pay. The landlord might hire a management company to ensure the provision of services, for which all the leaseholders have to pay for their services. 

If you wish to make alterations or for sub-letting, some landlords might charge you with ‘administration charges’ for granting permission. These administration charges are worked out separately, and we will discuss this in detail below.

Fixed or Variable Service Charges:

Initially, the rent payments included the fixed costs of services, but these costs can rise due to the increase in inflation every year. The landlords wanted to recover all of their costs every year, so instead, they wanted to be able to charge based on the actual costs or estimated cost. This gave rise to the service charges levied based on the actual or estimated cost of the services provided and, therefore, these can vary from year to year. Such charges are known as variable service charges.

The Structure of the Service Charge

The lease explains the dates of the service charge period and frequency of payment of service charges during a period. These payments might be due every six months, or quarter. In some cases, the landlord may charge after the costs have been run-up. The lease will also provide information on the proportion of the service charge the leaseholders are liable to pay.

For instance, the lease may tell you that you might be required to pay a proportion of the charge depending on the square footage of the flat as one part of the entire building. In some cases, the share of the charge you are liable to pay may depend on a percentage of the total service charge. There might be other cases where the lease might advise the leaseholders to pay a ‘fair’ or ‘just’ share of the total service charge.

When do you have to pay the leasehold service charge

The lease will also set out details about whether you will be required to make advance payments or not. If the lease requests advance payments, it will also tell whether these depend on the cost of a year prior or for the coming year. It’s important to remember that you might be liable to pay a final charge due at the end of the year.

For instance, the actual costs have not been covered by the payment done by you or any other leaseholder.  If this happens, your landlord will issue a bill requesting for your share of the deficit. Also, if the total payments made by the leaseholders exceed the actual costs incurred by the landlord, the surplus is then:

• Utilised to decrease the next year’s charge (or)
• Paid into a reserve fund or refunded.

Consequences for Leaseholders

Problems may arise for leaseholders if they do not make advance payments according to the rules stated in the lease. The landlord has to purchase and provide all the services to cover the costs for the leaseholders. Thus, leaseholders should make advance payments of service charge if requested. It should be done before the landlords have to pay for the services they have to provide in order to avoid the property running into trouble due to the services not being provided on time.

The landlords may ask leaseholders to pay any shortfall at the end of the financial year if they know what the actual cost is. Leaseholders are requested to pay for the deficit at the end of the year when the actual costs exceed the service charges paid. Similarly, if the service charge paid by the leaseholders exceeds the actual costs incurred, the landlord may refund the difference.

Limits on Service Charges.

Service charges may increase or decrease every year. However, the landlord is liable to charge the amount by which they only recover justified costs. If you feel you have been overcharged for services, you have the right to challenge this by filing an appeal to the tribunal.

What do you need to know about Reserve or Sinking Funds?

It is normal to observe that most of the landlords might insist on their leaseholders to pay money in advance towards a reserve fund. This tactic is to create single or multiple reserves or sinking funds. These funds are collected to ensure that the costs of irregular and high maintenance work can be met easily. For instance external decorations or structural repairing of the building.

Why Reserve or Sinking Funds are maintained?

Our service charge accounting specialists believe that reserve or sinking funds are maintained for two primary reasons. The first reason is to ensure that all the leaseholders or tenants financially contribute to the cost of major works. Major works are required for the maintenance of the building.

The second reason is to help leaseholders by smoothing out the yearly charges and not issuing large one-off bills. Moreover, it is to ease their burden and also help them budget for these costs accordingly.

Even if there is a large, well-maintained reserve fund in place, these reserve funds would be insufficient. These funds must cover the entire costs of major work most of the time that can be expensive.

Most of the time, leases might not reveal any information related to how much a leaseholder is expected to contribute to the reserve fund every year. In this case, the landlord decides the amount to be contributed by leaseholders to their annual reserve funds. He may hire professional services to help him decide it and to a CAPEX.

However, as these contributions are similar to service charges, they can be challenged through appealing to the tribunal if you believe they are not justified.

You should have enough knowledge about how these reserve funds work. It is advisable to understand what amount you should contribute as a leaseholder each year. The amount may depend on the services provided and additional work undertaken.

Basic rules of Service Charges according to the Legislation

In this section, we will explain the basic rules set out for service charges in light of The Landlord and Tenant Act 1985. It lists down all the details about what service charge is along with the requirements to ensure that the service charge is correctly worked out. Furthermore, it addresses questions like how landlords should consult their leaseholders or tenants before signing any agreement for work or service, which then gives rise to a service charge.

According to Section 18 (1) of the Act, a service charge is an amount which tenants or leaseholders are liable to pay as one component or in addition to the building rent. It is an amount that can be paid directly or indirectly for services like repair and maintenance, improvements or renovation, insurance, or the landlord’s cost of management. The whole or part of the service charge may vary year to year, depending on the rise or fall in the relevant costs incurred. Generally, the landlord hires property management companies and professional service charge accountants to avoid complexities of legislation and to carry out their responsibilities effectively. 

Demands for Service Charges

The leaseholders or tenants are liable to pay any service charges to their landlords if they have received a demand for payment and if it has been issued in line with the legislation. The demand must be in writing and must mention your landlord’s name and address. It is vital for service charge collection to make sure these are issued correctly.

Video: Service charge 18 month rule

Learn more about the 18-month service charge rule in this explanatory video below

Service charges in light of Section 21

According to Section 21 of the Landlord and Tenant Act, the leaseholders or secretary of a recognised tenants association have a legal right to request a summary of the service charge account from the landlord. The leaseholders need to ensure that they send the request in writing directly to the landlord or the managing agent.

The landlord must provide a summary of the service charge accounts within one month or within six months of the end of the accounting year whichever is later. It is compliance that landlords have to meet upon receiving the request from their leaseholders.

Here is what the summary should include:

1. Information about how the costs related to the service charge demand
2. The list of all items for which the landlord did not receive any bill for during the accounting period
3. List of items which the landlord received a bill for but has not been paid during the accounting period.
4. List of items which the landlord received a bill for and has been paid during the accounting period.
5. Information about any costs related to work for which an improvement grant has been paid or will be paid.

Inspect your accounts and receipts in light of Section 22

As a leaseholder, you have the legal right to inspect any document related to the service charge to get further details on top of the section 21 summary. Once the summary is received, leaseholders can request the landlord in writing within six months of receiving the summary. It is to let them access and investigate the accounts, receipts, or any other service charge related document that is relevant to the information provided in summary. Moreover, they can also request them to provide a copy of these summaries.

Landlords are liable to provide facilities to their leaseholders in order to be able to do this inspection. Once they receive the request, by providing them access to inspect the documents within one month of receiving the request. They also have to ensure that these facilities should be available for at least two months.

The leaseholders have the legal right to request for a management audit in light of the Leasehold Reform Act 1993. It is if they wish to investigate the service charges further and learn more about the management of the building. They also have the legal right to hire a surveyor under the Housing Act 1996.

Penalties that can be faced by the Freeholder

Landlords can land into a quagmire of fines and penalties if they fail to provide any summary. Moreover, if they fail to give access to investigate information after receiving the request from the leaseholders, they are committing a summary offence by doing so and may face a fine if proven guilty. Landlords can be legally challenged by their leaseholders or the local housing authority in this matter.

What, When, and how to apply to the tribunal?

Both parties have the legal rights to request the tribunal on whether the service charge proposed or levied is reasonable or not. The legislation does not specifically define what counts as reasonable or unreasonable. Therefore the tribunal will take into account the evidence that is presented by both the parties and make verdicts accordingly.

Any request by both parties will not be entertained if they agree on taking responsibility for paying the charges. Furthermore, if the charges have been declared reasonable by the tribunal after a dispute, it may also contribute to declining.

It is important to know when to apply for any tribunals and in which cases.

You can expect the given list of questions that the leaseholders and landlords can expect from the tribunal:

• Is it or will it be reasonable for the landlord to cover the costs on their own, considering the circumstances?

If yes, then:

Was the standard of the services provided or work undertaken up to the mark?

• How does the landlord evaluate and control the costs along with the procedure of supervising the project?

Tribunal Authority

The tribunal has the authority to decide:

• Whether the service charge is payable or not payable according to the lease
• Which party must pay the service charge and to whom
• The deadline for the payment of the due service charges
• The channel by which the service charge should be paid, for instance, via direct debit or standing order.

There are many other legal considerations to consider when challenging the service charge or the decision taken by the tribunal.

Landlord’s Information Request

Leaseholders must know that they have the legal right to demand personal information about their landlords regarding their identity. To access the information, leaseholders must send in a request in writing to the person who demands the rent. 

This person can be the one who you last paid the rent to or the managing agent of the landlord. Once the person receives the leaseholder’s request, they are liable to provide a written statement. The statement will list down all the details you have requested within 21 days of receiving the request.

What if your Landlord is a Company?

If the landlord is a company (like an RMC), then leaseholders can ask for the information about every stakeholder. Furthermore, they can even ask for the name and address of the secretary of the company by submitting a request. It must be in writing to the concerned person to whom they make rental payments. The company is liable to respond within 21 days of receiving the leaseholder (or tenant) request.

If the freeholder fails to provide the requested information within the time limit?

If the freeholder fails to provide the requested information with no valid reason, they are conducting a summary offence.  The landlord or the managing company may face a legal fine of up to £ 2500 if proven guilty.

What must you know about the Administration Charges?

This section is about the ‘Administration Charges’ and the involved rights in light of the Commonhold and Leasehold Reform Act 2002. The Act defines Administration Charges as an amount that Leaseholders are liable to pay as part of or additionally to rent. This rent can be paid directly or indirectly for the following purposes:

• Granting approvals according to the lease or applications for such approvals
• Accessing the information regarding the service charges on behalf of the landlord or tenant
• Recovering the costs incurred from non-payment of a sum because of the landlord
• Recovering the costs arising due to the violation (or alleged violation) of the lease

Landlords have to ensure that they issue correct and reasonable demands of administration charges to their leaseholders. They must submit a summary that sets out the rights and responsibilities of the leaseholders regarding administration charges with the demand. The leaseholders will not be liable to the administration charges if their landlords do not provide this summary. They are only liable to pay when the demand has been issued along with the summary.

Reasons for Legal Costs

Landlords might charge you if they want to recover legal costs incurred because of legal action taken by the tribunal. Such legal costs may arise due to the following reasons:

• The leaseholders fail to pay an amount that was due to the landlord
• The leaseholders violate the terms of the lease.

If the costs are incurred due to these reasons, leaseholders will pay the amount as an administration charge. Furthermore, leaseholders can challenge if they believe that service charges or administration charges are not justified. However, in some situations, the administration charge cannot be challenged, for instance:

• If the leaseholder has already agreed or admitted responsibility to pay the charge
• The administration charge which has been or will be referred to arbitration. It can be done after a dispute or has already been decided by a tribunal.

What is Ground rent?

This section will discuss how ground rent works and how leaseholders are liable to pay the rent. Leaseholders are required to pay ground rent if the lease states it. Even though leaseholders are liable to pay the ground rent, the landlord must ensure the issuance of early notice.

They may use a form recommended by:

• The Landlord and Tenant Regulations 2004
• Notice of Rent (England)
• The Landlord and Tenant Regulations 2005
• Notice of Rent (Wales).

The landlords cannot force leaseholders to pay the ground rent if they have not issued any early notice. Therefore it is important to know the basic responsibilities of the landlords and tenants act. 

What is the Notice of Ground Rent?

Leaseholders are not liable to pay the ground rent unless their landlords have requested them to make payment. The landlord must request the payment by using the prescribed notice of demand form. The notice must include the following information:

• The figure of the Ground rent due
• The due date of making the rental payment
• In case of after due date issuance, the notice must mention the due date in light of the lease terms.
• Leaseholder name
• The duration covered by the demand
• The credentials and address of the person or company who demands rent
• The name and address of the landlord who is issuing the demand notice of ground rent
• Other support information.

What is the Estate Management Scheme Charge?

An Estate Management Scheme is a scheme that lets a freeholder or the managing company have a share of the total management control over properties, facilities, and shared areas and is applicable when the leaseholders have bought the freehold from the landlord. 

The purpose of the scheme is to ensure the appearance and standard of the area are kept up to a certain standard. The scheme may be utilised to maintain and renovate shared gardens or other shared facilities or areas. In such cases, the scheme may allow the landlords to recover specific charges relating to the maintenance.

Like Service Charges, Estate Management Scheme Charges can also be challenged by applying to a tribunal. In case if the leaseholders believe that the charge is unjustified, unreasonable, or have been incorrectly worked out. However, the leaseholders or landlord’s request to challenge the charge will not be entertained by the tribunal if:

• Both the parties have already agreed or admitted responsibility for paying
• The landlord or leaseholder has been referred to arbitration according to an arbitration agreement after a dispute or if a tribunal has already taken the decision

If you are unable to stay Compliant as a Leaseholder

The leaseholders can face legal action by their landlords if they do not pay their due service charges, administration charges, or ground rent. The freeholder has the right to take legal action. They can apply to a court or tribunal, requesting your mortgage company to pay the due charges. 

They may also include these to the amount due on your mortgage and Act according to legal requirements to end the lease. The law allows the landlord to take the above action but cannot take possession until the court orders to do so. The landlords can begin the legal proceedings by issuing a legal notice of seeking possession according to Section 146, the Law of Property Act 1926.

It’s quite rare to observe the landlords taking back the possession of the house or flat from the leaseholders. However, it is common to observe the landlords serving a section 146 notice to force leaseholders to pay the due arrears. Furthermore, they might wish to come under an agreement if the leaseholder has violated the terms of the lease. 

Notable changes in Government Policies

Due to misuse or corruption, the government has introduced notable changes to the existing procedure over time. According to the latest update, the landlords are now required to present evidence of any violation of the lease terms by the leaseholder before they can issue a legal ‘section 146 notice’.

However, your landlord cannot issue a section 146 notice if you have not admitted violating the terms of the lease.  Moreover, the landlord can not issue such a section, if you do not agree that you owe the money. If the tribunal has not made any final decision, it will also prevent the issuance of such section.

If there is an issue regarding the payment of the charges that are due, the landlord also has to apply to the tribunal to confirm that the leaseholder owes the amount while making sure the amount is reasonable. Here are two considerations to keep in mind before your landlord serves a section 146 notice:

• The leaseholder has admitted violation of the terms of the lease and also agrees with the amount that is due
• The tribunal holds the leaseholder guilty for violating the terms of the lease

DISCLAIMER

Our experienced accountants have curated a guide to help you get a comprehensive understanding of the service charges. Furthermore, this guide will cover other various legislations around it. However, this guide does not provide an extensive interpretation of the law. Courts can only provide such interpretations. This guide does not cover every case as some cases are more complicated than others. If you want to have a better understanding of your rights and obligations, you can speak to our service charge accountants.

While preparing this extensive guide, we have kept two main parties under consideration. One, who is liable to pay and secondly, charge variable services charges and administration charges (landlords and leaseholders). We will mention specifically if a particular clause is not aimed at leaseholders or tenants.

Targeted Audience

It is crucial to remember that the guide is specifically targeted at leaseholders, liable to pay the service charge. Moreover, it discusses how the charge may change depending on the costs of works undertaken and additional services provided. This guide is also for any tenant or leaseholder who has been requested to pay administration charges and also pay charges to an estate management scheme.

We would also like you to remember that any reference to the tribunal here means:

• The First tier-tribunal in England; or
• The Leasehold Valuation Tribunal in Wales

Clear House Accountants are Accountants in London with years of experience working in the service charge industry. Our experts provide value-added service charge accounting services, factual reports for service charge accounts, and bespoke services as required by Leaseholders, Landlords, Managing Agents, RTM’s or RMC’s.

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