This week we’re reporting on an interesting case which looked at whether on account service charge demands were unreasonable due to a claimed failure by the landlord to set them off against them credits for prior service charge demands.

Background

The case in question, Brett & Brett -v- Harlow Court Limited [2022] UKUT 52 (LC), was an example of a lessee owned block where, over a lengthy period, the contractual service charge machinery had not been followed. For so long as all parties got along well the irregularities of approach passed without objection, but they laid the foundations for substantial accounting problems when the parties fell out.

Mr and Mrs Brett had, since 2011, been the leaseholders of 14 Harlow Court, Wray Common Road, Reigate, a block containing 18 flats, all of which are on long leases. In 2013, the leaseholders acquired the freehold through a collective enfranchisement and the freehold was held in the name of Harlow Court Limited. Mr Brett was originally a director of the freehold company but, in 2016, he resigned after a disagreement over the way in which the service charge accounts and the company’s own accounts were being kept.

The relevant lease terms provided for an end of year reconciliation of the service charge accounts and for the Bretts to pay any deficit between the expenditure actually incurred and the payments made on account during the financial year.  In the event of a surplus at year end, the lease provided that “the difference (being the unexpended surplus) shall be accumulated by the Lessors and shall be applied in or towards the Annual Cost in the next succeeding or future Accounting Period or period[s] as aforesaid…”. 

The Bretts had, over a course of 3 years, applied to the First-Tier Tribunal (FFT) for determinations as to the payability and reasonableness of various service charges. As a result, the factual and procedural background is lengthy and complex.  Suffice to say, the first application was brought by the Bretts in 2018, and at that time the FTT held that certain costs demanded as service charges were not legitimate service charge costs (although some of the costs were payable under the lease as running costs for the company, by reason of the Brett’s shareholding in the freehold company). A third application was issued in 2020 after the Bretts had sold their flat and paid the charges demanded, for the years 2018-19, 2019-20 and 2020-21, which was the subject of this current appeal.

The 2020 application

The Bretts’ case before the FTT in 2020 was essentially an accounting exercise which focussed on whether the landlord had correctly recorded its expenditure and properly distinguished between the different capacities in which it was entitled to collect funds from the leaseholders and its own shareholders - e.g. whether as service charges or shareholder contributions. The landlord had not revised the accounts following the 2018 FTT decision, deciding it would simply require moving company funds to service charge funds which, when the leaseholders and shareholders were one and the same it was not a worthwhile exercise. The landlord had undertaken a comprehensive accounting exercise and, where a credit was due to leaseholders on their service charge accounts it was applied towards a deficit on the company’s own accounts to cover costs that it was no longer entitled to recover through the service charge. This had been explained to the leaseholders and all except the Bretts had agreed with this approach.

The Bretts further contended that, due to the disallowances made by the FTT in 2018, later service charge demands were too high and therefore unreasonable.

By the time of the hearing only the demand for 2020-21 was in question. The FTT refused to determine the reasonableness of the demands for 2018-19 and 2019-20, as it was of the view that it would be pointless to do so because any surplus in those years will have been applied to future costs and would benefit the new leaseholder, not the Bretts (who had, by this point, sold their flat).

The FTT’s decision

The FTT acknowledged that the sums disallowed by the earlier FTT’s 2018 decision exceeded the amount demanded on account for 2020-21.  In addition, when the on account demand was made, strictly, there were credits on the Bretts’ service charge account which actually exceeded the amount being demanded for the full 2020-21 year.  The FTT asked itself whether that meant that the amount demanded on account for 2020-21 was greater than what was reasonable.

The FTT noted, as a lessee-owned freehold company, the landlord’s only other source of funds was from the leaseholders as shareholders, as distinct from service charge costs. As such the landlord had to make adjustments retrospectively so the costs disallowed by the FTT in 2018 as service charges could be reallocated as company costs, paid by the shareholders. However, the resulting credits due on the service charge account were not represented by actual funds, because the monies had already been spent.  The landlord still required ongoing service charge income to pay ongoing costs.

The FTT decided that, whilst not in accordance with the lease, the approach adopted by the landlord was entirely pragmatic and sensible. The FTT said that there was little point in relieving lessees of their obligation to make regular modest payments towards ongoing service charges until their notional credits are used up, if at the same time those same people receive a company bill (as shareholders) for a very large sum which must be paid immediately, especially as most leaseholders had agreed with the approach adopted.

However, the FTT went on to say that the lease required that any surplus funds unspent at the end of the service charge year must be accumulated and applied towards future costs. The FTT found that the monies paid on account prior to 2019-20 had all been expended (including those disallowed by the FTT in 2018), albeit not on service charge expenditure (rather, on funds held not to be payable as service charges, but as company costs). There was, however, a surplus from the 2019-20 year, which the FTT considered should have been applied towards the 2021 budget which would have reduced the demand sent to the Bretts for that year. On that basis, the FTT considered it reasonable to deduct from the sums due from the Bretts for the 2020-21 year the amount of the surplus from the 2019/20 year.

The appeal

The Bretts appealed the decision, and the two matters for the Upper Tribunal (UT) to consider were :

1. Whether the interim service charges demanded were unreasonable due to the credit to the service charge account as a result of the FTT’s 2018 decision, which made it unreasonable for the landlord to demand further sums when the Bretts had not consented to the re-designation of the credit as a payment to meet company expenditure; and

2. Whether the FTT was correct to find that, insofar as the disputed demands were unreasonable, the resulting credit would accrue to their purchasers in accordance with the lease rather than being repayable to the Bretts.

The UT’s decision

The UT dismissed the appeal on both grounds.

On the first ground, the UT found that the FTT was entitled to reach the conclusion it did.  It could have decided that a line ought to be drawn under the previous lax approach to accounting and that all sums collected in the past under an inappropriate label should be reattributed and credits given where required in the service charge account, but it was not obliged to take that approach. Further, it was entitled to take into account that there were no significant funds in hand which could have been used to reduce the payments on account, because the money collected had been used for its intended purposes. Most importantly, funds were required to meet anticipated routine expenditure, and nothing was to be gained by a more complicated accounting exercise. 

On the second ground, the UT confirmed that the FTT’s jurisdiction under section 27A of the Landlord and Tenant Act 1985 is a declaratory one which does not allow the Tribunal to order the repayment of sums paid in excess of the relevant statutory service charge limit.  Therefore, even if the appeal had succeeded on the first ground, the UT said it would have dismissed the second ground and held that any remedy to recover sums found to have been overpaid by the Bretts would have had to be pursued in the County Court and could not have been the subject of an order for repayment made by the FTT.

Conclusion

The FTT and UT’s decisions in this case are clearly practical ones in all the circumstances, where a lessee owned freehold company has no other funds available to it. However, caution should always be taken and this case should not be taken as a precedent not to follow the strict accounting requirements set out in the lease. Whilst the UT reached its conclusion on these particular facts and on this particular lease, it does not follow that this will be the outcome in every case. Therefore the message is clear, make sure you talk to your legal advisors and accountants to ensure your accounting exercise is right, to avoid costly challenges later.

We trust that you find the above helpful, but please feel free to contact a member of the  team on 01435 897297 or info@kdllaw.com should you have any queries whatsoever.

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