In this week’s Legal Update we look at whether landlords and their agents should arrange for an accountant, independent or otherwise, to certify or audit a service charge account. The current standard (which must be followed by any RICS or ARMA member agent of landlord) is set within the following guidance issued by the Institute of Chartered Accountants in England and Wales (“ICAEW”).

ICAEW Technical Release Residential Service Charge Accounts (TECH 03/11)

At the present there is no statutory requirement for the preparation and content of service charge accounts but the accounts should comply with the provisions of the lease which may stipulate matters such as:

• the way in which service charges are to be accounted for;

• who shall certify or approve the accounts (Certified Accountant or perhaps an Auditor);

• the costs that can be recovered; and

• the periods of time for which accounts should be prepared.

As will be seen in the second part of this article a failure to follow the rules whether in the lease or the published guidance can present a landlord RMC or RTM Company with difficulty in recovering expenditure incurred.

TECH 03/11 recognises the importance of the lease. Paragraph 2.8 of the guidance states that: “the service charge statement should include any certificates, statements and signatures that are required by the lease and care should be taken to ensure that any certificates or statements follow the exact terminology used in the lease.”

The guidance sets out the procedures to be adopted in undertaking a factual report or an audit. It also confirms two circumstances when it is possible to avoid the need to audit (as distinct from certify) service charge accounts even when the lease states that an “audit” is required. These are as follows:-

1. If the lease is dated before 1980 then reference to an “audit” of the accounts is, since the Auditing Standards and Guidelines 1980, generally construed to mean what we now refer to as “certified” and not what is now known as the more onerous task of an audit.

2. If an audit is specified in a post 1980 lease, but it is considered to be disproportionate to the circumstances of the property (for example a relatively small property where the lessees are all members of the RMC) the landlord/managing agent may seek an agreement by all leaseholders to an alternative less costly examination of the accounts. However, beware to ensure that all leaseholders are recorded as in agreement.

More information on the preparation of service charges can be found by reviewing the TECH 03/11 guidance here.

RICS Code of Practice

The RICS Code of Practice (3rd edition) was effective from 1 June 2016 and applies to the management of residential leasehold properties in England and Wales. Part 7.12, “Service Charges, ground rent and administration charges” determines that:-

If the service charges are payable by the leaseholders of more than four dwellings, the summary [of account provided under section 22 Landlord and Tenant Act] must be certified by a qualified accountant as a fair summary sufficiently supported by accounts, receipts and other documents which have been produced. A qualified accountant means a person who is eligible for appointment as a statutory auditor under section 1212 of the Companies Act 2006.

The RICS Code of Practice - Service Charge Residential Management Code (3rd Edition) can be viewed here.

The following are two examples of recent cases in the Upper Tribunal where a failure to follow correct accounting processes as dictated by the respective leases have come back to haunt the respective landlords.

Powell & Co Investments Ltd v Aleksandrova and another [2021]

The Upper Tribunal ruled on whether a statement by a Chartered Accountant was sufficient to trigger the leaseholder's contractual liability to pay service charges where the lease included the following two provisions:

• that the leaseholder would be liable to pay the year-end service charge "upon the production of a certified account"; and

• that the leaseholder's liability "shall be certified by a Chartered Accountant to be appointed by the Lessor".

The 2019 service charge accounts were produced but the only certificate was provided by the landlord's managing agent, who was not a chartered accountant. The accounts also contained a one-page document referred to as the "Accountant's report of factual findings". This was prepared by accountants, but was addressed to the managing agents only and did not express any assurance on the service charge accounts other than two factual statements based on a limited review of receipts.

The UT ruled that the obligation to pay depended on any account setting out the liability of the leaseholder first being certified by a Chartered Accountant and stating:

• the individual leaseholder's share of total expenditure

• the payments made on account, and

• the resulting shortfall or surplus.

Although there was no requirement for an audit of the accounts, the landlord's accountant's report was deficient as it failed to certify the liability of the leaseholder and so the service charge was not yet due.

Wigmore Homes (UK) Limited -v- Spembly Works Residents Association Limited

A similar result was seen in the UT decision in this case where the landlord lost out for not providing annual accounts in the right form. You can find full details in our September 2018 Legal Update “You really must comply with the lease!” here.

The moral of the story

It will come as no surprise that the first port of call is the lease. Note what requirements it sets out and then start from there.

Both the above decisions act as a stark reminder for landlords and managing agents that where the lease contains provisions requiring a specific step, or steps, to be taken in relation to a task, here the accounting for monies spent, then the terms of the lease must be strictly followed to ensure a leaseholder's liability to pay service charges is properly triggered. Where the lease is relatively quiet on the issue then compliance with the RICS code of practice and the ICAEW guidance should be a minimum.

Service charge provisions are crucial to landlords, enabling them to recover the costs of managing a property; failure to follow the set procedure for service charge demands and accounts will potentially leave a landlord exposed to reasonableness and liability claims which could otherwise be easily avoided.

It is recommended that landlords regularly review their lease terms and ensure that the necessary processes are in place to meet all requirements set out.

Disclaimer

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