Service charges and careful drafting

Some cases are interesting because the facts are unusual; others are interesting because the facts are ubiquitous. Sara & Hossein Asset Holdings Limited v Blacks Outdoor Retail Limited [2020] EWHC 1263 (Ch) falls into the latter category. It is an appeal against an order dismissing summary judgment based on a commonplace fact pattern and standard commercial lease clauses.

Blacks exercised a break clause for its shop in Liverpool, renewing for one year after the lease expired and then leaving. When it was clear that the tenant would leave, the service charge increased from about £55,000 a year to more than £400,000. The tenant objected and did not pay.

The landlord sued and claimed summary judgment based on two clauses in the lease. As normal, the lease provided for the service charge to be paid in advance on the basis of an estimate, with a balancing payment made at the end of each year following a certificate setting out the final sum. First:

… the landlord shall … furnish to the tenant as soon as practicable … a certificate as to the total cost and the sum payable by the tenant and in the absence of manifest or mathematical error or fraud such certificate shall be conclusive.

Second, the landlord relied on the prohibition against set-off, which was a tenant covenant:

… to pay the yearly rent reserved by the lease at the times and in the manner required … and not to exercise or seek to exercise any right or claim to withhold rent or any right or claim to legal or equitable set-off or counterclaim (save as required by law).

Remember that the application was for summary judgment. The prospect of a quick and cost-effective decision is appealing to litigants, but the threshold is a high one. The crucial question is whether the defence has a realistic (as opposed to a fanciful) prospect of success. Although there is no probability test, the case must be more than arguable. The court has to determine this without carrying out a mini-trial. If the defence can show its case is realistic, summary judgment will not be awarded.

Necessary or unnecessary work?

There were two limbs to the tenant’s defence and counterclaim, albeit with a degree of overlap.

In some cases it has been argued that the works were unnecessary or did not constitute repair within the meaning of the repairing covenant. If this was correct in the case of Blacks, the costs should not have been included in the service charge at all. If the costs should not have been included in the service charge then the prohibition against set-off was not engaged. The counterclaim for damages included additional complaints such as failure to progress the works with reasonable speed and failure to remove scaffolding promptly.

Before considering the tenant’s defence it is worth stressing that any lease must be read and construed as a whole. This particular lease provided for any dispute about the percentage of the total service charge payable by the tenant to be referred to an independent expert. Contrast that with the service charge itself, which was decided by the landlord.

Case law is clear that parties can reserve a point to an expert for determination – even points of law, if the document is correctly drafted. The challenge for the landlord in this case was that the service charge was not determined by an expert, but by the landlord itself. In practice, the certificate was prepared by the landlord’s surveyors, but this did not assist the landlord’s case because they were not acting as independent experts, but as the landlord’s agents.

Essentially, you cannot mark your own homework. There is a fundamental distinction between a contract assigning matters which might be disputed to an independent expert, and a contract allowing one of the parties to the contract to determine conclusively whether that party has complied with its own obligations under the contract.

Applying that concept in this case, the judge decided that the lease meant the landlord’s certificate was conclusive as to the amount of the cost. It was not conclusive as to whether that cost should have been incurred in the first place (whether it formed part of the service charge at all). If the cost should not have been incurred the tenant did not have to pay and could legitimately set-off. This meant that the tenant did have a defence it was entitled to raise at full trial and the appeal was dismissed.

Wider relevance

As ever, the wording of the lease itself is relevant. The prohibition against set-off set out above referred to ‘yearly rent’ and service charge tends to be separately reserved. Blacks’ lease was a renewal of a previous lease granted on the same terms as previously, but with variations. Leases by reference have superficial advantages of speed and economy, but are very easy to get wrong. After the first hearing, but before or at the appeal, the tenant accepted that the prohibition against set-off also applied to service charge rent. With hindsight, more time should have been spent on the drafting, and not only removing inconsistencies in how disputes are settled.

Service charges are often a source of dispute and the Royal Institution of Chartered Surveyors (RICS) has tried to reduce the potential for arguments with a professional statement on service charges in commercial property. Professional statements are mandatory for RICS members. However, that statement post-dates the fact of this case and the previous advisory note on good practice was not followed.

Suzanne Gill is a partner at Wedlake Bell, specialising in advising commercial property occupiers and investors