Following one of our previous Legal Updates, we have been asked to cover year-end surpluses and what to do with them. As this is a question we often get asked, we today focus on what surpluses and deficits are and how to manage/handle them.

What is a Surplus?

A surplus for the year arises where the service charges demanded exceed the costs for the year. The surplus is the difference between the total income received or receivable and the total actual expenditure. Most leases specify that a surplus should be credited to the leaseholder against the following year’s service charge liability, some are silent on the whole issue of what to do and some specify that any surplus can be transferred into the reserve/sinking funds.

What is a Deficit?

A deficit for the year arises where the actual costs for the year exceed the service charges demanded. Virtually all leases will state that the deficit for the year should be collected from the leaseholders by way of a demand following the provision of the annual accounts detailing how that deficit has arisen.

Balancing Payments/Credits

A lease that provides for payment of interim service charges invariably also provides for the payment of a balancing charge to reflect the difference between the sums paid by the leaseholder on account of the service charges, and the actual service charge payable by the leaseholder for that accounting period (e.g. a deficit).

Occasionally, a lease will provide that such balancing payment is due on demand. Typically, however, leases provide for such balancing payments to fall due following preparation by the landlord of accounts, and the submission to the leaseholder of a demand or certificate based upon those accounts. When that is the case, the preparation of such accounts and accompanying demand will usually be required before the leaseholder becomes liable for any balancing payment.

Sometimes, the interim service charges paid by the leaseholder will exceed the service charge for which the leaseholder is liable in any given accounting year (e.g. a surplus). In principle, the landlord then falls under a common law duty to return the excess payment to the leaseholder, unless the lease provides otherwise. Many leases do make an alternative provision that any such excess payment to be carried over as a credit towards the following year’s service charge or into a reserve fund.

How to allocate Surpluses and Deficits?

The lease will commonly dictate how any surpluses or deficits arising at the end of the financial year should be handled.

Surpluses will typically be either:

• credited towards the following year’s service charge budget;

• credited to the reserve fund; or

• refunded to the leaseholders by their due proportion.

Deficits will normally be either:

• due from leaseholders on demand for their due proportion; or

• recoverable during the following year, in addition to the estimated costs for the year.

In any case, surpluses and deficits should be treated in the manner dictated by the lease, including compliance with any processes in order for deficit demands to be issued.

Practices to avoid

Unless the lease states otherwise, Landlords and their agents avoid using any reserve fund as a ‘float’ for the credit of surpluses and the debit of any deficits. This can lead to costs being irrecoverable due to the provisions of section 20B of the Landlord and Tenant Act 1985, e.g. if the balance of the actual costs incurred for the year are not demanded within 18 months of being incurred, but instead just topped up from reserves. Please see our Legal Updates from May 2018, December 2019 and September 2020 for more information on section 20B “The 18 Month Rule”.

There is no right to apply surpluses to any Reserve or Sinking Fund in the absence of an express provision permitting so in the lease.

Moral of the Story?

As per usual, it all comes down to what the lease says!

Landlords and their agents should make sure that surpluses and deficits are properly set up and dealt with only and entirely in compliance with the express provisions of the lease and, as leases differ from block to block (and occasionally from flat to flat!) a blanket approach to a portfolio is to be avoided.

For more information, please contact Susan Fox, Senior Litigation Executive, on 01435 897297 or susan.fox@kdllaw.com

Disclaimer

This legal update is provided free of charge for information purposes only; it does not constitute legal advice and should not be relied on as such. No responsibility for the accuracy and/or correctness of the information and commentary set out in the article, or for any consequences of relying on it, is assumed or accepted by any member of KDL Law or by KDL Law as a whole.

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