Modern leases usually allow landlords to collect service charges in advance, and to make a balancing charge to collect any shortfall at the end of the year. Some leases also enable landlords to collect sums in advance in order to create a reserve or sinking fund to cover future expenditure.
The dispute in Southwark Roman Catholic Diocesan Corporation v Brown’s Operating System Services Ltd [2007] EWCA Civ 164; [2007] PLSCS 44 concerned a provision that permitted the landlord to make reasonable provision for future expenditure as part of the service charge. Additionally, if any payments on account exceeded the annual service charge, the landlord was entitled to retain them on account of future service charges payable under the lease. However, to whom did the “excess and reserve” belong and what would be the position on the premature determination of the lease?
The High Court held that the money belonged to the landlord because the lease did not provide for the money to be returned to the tenant at the end of the lease: Secretary of the State for the Environment v Possfund (North West) Ltd [1997] 2 EGLR 56; [1997] 39 EG 179.
However, the Court of Appeal disagreed. It maintained that the lease contemplated a single pot of money. It did not empower the landlord to set up a separate fund, designed to cover obligations that the landlord would have to meet at some future time. The court distinguished the decision in Possfund on the grounds that, in that case, the lease had made specific provision for the creation of a depreciation fund in respect of a particular item of plant and machinery, and also because the judge was construing the lease in front of him. The judge was not laying down general principles that could be applied to the instant case, and, therefore, it did not follow that a reserve fund will belong to the landlord in the absence of provisions requiring the money to be returned to the tenant.
The sums held by the landlord should have been used to meet service charge expenditure before additional demands were made on the tenant. The latter was not under any obligation to contribute to work carried out after the termination of the lease. Consequently, any unspent money belonged to the tenant, whether the lease ended by effluxion of time or by the operation of a break clause.
Different considerations might arise if a landlord had to forfeit a lease on account of the tenant’s breach of covenant. The landlord might well be aggrieved if it had to return money that it had been holding in anticipation of work to be carried out at a later date but during the expected life of a lease. It was always open to the landlord to include an express provision in the lease to cover this eventuality, failing which it was possible, although it was not necessary to decide this, that the landlord may instead be able to recover any such sums in damages.
Allyson Colby is a property law consultant
