The difference between sinking and reserve funds is often an area of confusion, and it is a commonly assumed that their description and purpose is virtually interchangeable. Leases invariably contain references to sinking or reserve funds in one form or another, and knowing the difference is of crucial importance as misuse of either fund could potentially reduce the contributions to be paid by the leaseholders by the First-Tier Tribunal. This legal update intends to provide more clarification.

Sinking Funds vs Reserve Funds

There is an importance difference between sinking funds and reserve funds.

Sinking funds are generally used to cover specific costs which might only occur once or twice during the length of the lease term.

Reserve funds are in essence practical planning and considered a measure of good management  designed to ensure leaseholders help contribute towards unexpected expenses. In other words, the reserve fund is formed to meet the anticipated future costs of maintenance and upkeep in order to avoid fluctuations, or an anticipated large, one-off increase in the amount of service charge payable each year. The reserve fund helps landlords and management companies to prepare for, and manage, unexpected expenditure that the service charge budget could not account for. Sinking funds differ from the reserve fund as a mean of collecting extra funds for specific costs that occur occasionally.

When can a Sinking or Reserve Fund be collected?

The short answer is, only when the lease allows for it. A landlord or management company cannot collect funds towards a sinking or reserve fund unless the lease expressly provides that such a contribution must be made by the leaseholders. This will be a matter of construction of the lease terms on a case by case basis.

Many leases provide for such sums to be collected in advance to create one or more reserve or sinking funds, the purpose being to cover the cost of irregular and expensive works. Usually leases fail to state the precise or estimated figure to be contributed each year, and it is then left to the landlord or management company to determine the contributions. However, they must be reasonable and these, just like any other service charges, can be challenged by leaseholders making an application to the First-Tier Tribunal.

Where there is a reserve fund, it is generally accepted that landlords and management companies should think about meeting repair and maintenance expenditure from the reserve fund first before sending out demands for further contributions through the service charge.

How should funds in Sinking and Reserve Funds be held?

The case of Caribax -v- Hinde House Management Company [2015] UKUT 0234 (LC) reminds landlords and management companies of the importance of complying with section 42 of the Landlord and Tenant Act 1987 and hold reserve and sinking funds in trust. In other words, the reserve and sinking funds should be held in a separate bank account to the service charge monies.

In that case, the landlord was permitted under the terms of the lease to build up a reserve towards certain specified items of expenditure and the lease provided that the reserves should be transferred to a “specially designated trust fund” in accordance with section 42 of the Landlord and Tenant Act 1987. The lease further provided that the cost of those specified items should be met first from the reserve/trust fund. In this case, whilst the landlord had built up reserves it had never established a specially designated trust fund.

Whilst there was no specific trust fund established, the Upper Tribunal found that a reserve fund was apparent in the landlord’s accounts and therefore the landlord was required to use that for repairs and maintenance before requesting further sums from its leaseholders.

Landlords should make sure that reserve and sinking funds are properly set up, in compliance with the lease, and held on trust as required by Section 42 of the Landlord and Tenant 1987.

For more information, please contact Kevin Lever at Kevin.Lever@kdllaw.com or on 01435 897297.

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