How Do Service Charge Provisions Operate When a Break Clause is Exercised?

If a tenant decides to end a lease early under a break clause, what happens to funds built up through the service charge for anticipated works that have not yet been carried out?

This is an interesting question for both landlords and tenants that was recently considered in Friends Life Management Services Ltd v A & A Express Building Ltd [2014].

In deciding the case the High Court set out the way in which the service charge should be calculated for the final accounting period in a commercial lease.

The Facts: Friends Life Management Services Ltd v A & A Express Building Ltd [2014]

The tenant, Friends Life Management Services, had a lease of a commercial building in Manchester, the former northern base of the Daily Express newspaper, which was granted by the landlord, A & A Express Building.

On 24 March 2010 the tenant exercised a break clause to determine the lease and then brought proceedings in relation to the service charge calculation for the last accounting period under the lease.

The service charge clauses in the lease had made provision for the carrying out of future works to the building in addition to covering actual expenditures in the service charge year. The total amount built up over previous years under the anticipated expenditure clause came to around £875,000, of which most was paid by the tenant, it being the main occupier of the premises.

Although the landlord did in fact start the building improvements contemplated under the anticipated expenditure clause later in 2010, it did not complete those works until 2011. The total cost eventually exceeded £1 million.

The landlord considered that it was entitled to keep the entirety of the £875,000 funds that had been built up and that the expenditures anticipated in 2011 could be claimed within the 2010 period. The tenant claimed that the year ended when it exercised its break clause and that none of the costs had been incurred at that date, accordingly the full amount should be repayable.

The High Court’s Decision

The High Court held that the accounting year ended on 31 December 2010 not the break date.

It held that the actual costs incurred during 2010, including those relating to the major works for which the anticipated expenditure fund was created, could be claimed by the landlord with a credit given for the £875,000 fund. However, the costs incurred in 2011 could not be claimed in the accounts for the 2010 service charge year nor could a provision be made in 2010 for the expenditure in 2011.

As the £875,000 was in excess of the expenditures for 2010 the tenant was entitled to recover a proportion of that excess beyond that credited against the expenditures and calculated by reference to its period of occupation on a day to day basis.

Comment

Landlords should note the risk that funds built up for anticipated works may be reclaimable by tenants in their final service charge year if those monies have not been spent and there is not an express clause entitling them to retain those funds.

For specialist advice contact Peter Gourri today by email PGourri@rollingsons.co.uk or telephone 0207 611 4848.