With the retail property world in something of a state of flux with the recent spate of company voluntary arrangements (CVAs) and subsequent rent rebalancing by both companies under a CVA and – increasingly – their neighbours, in October last year John Lewis went even further. It announced that it was seeking to withhold up to 20% of service fees at some shopping centre locations, in protest at “unacceptable” increases in annual service charges over the past few years.
While there is little doubt that John Lewis will have looked at every detail in its leases, this new avenue of potential cost saving may be of interest for other retail tenants. With that in mind, there are a number of key points to be considered when negotiating a new lease (or heads of terms for a new lease), focusing on the service charge element – and some potential ways to reduce service costs at the outset.
It is important to get this right. While residential service charges are subject to extensive legislation, there is no statutory regime for commercial service charges, save for the six-month time limit for landlords to claim against former tenants for all rents under the Landlord and Tenant (Covenants) Act 1995.
In addition, while not a statutory protection, the RICS 2018 professional statement Service charges in commercial property details mandatory requirements, core principles and best practice for RICS members and RICS regulated firms. Though not binding on landlords, this can be used as guidance for best practice when negotiating the lease.
We will look at leases from a tenant perspective, based on the assumption that the property to be let is within an estate that is solely for commercial use. Where the estate is mixed use (ie commercial and residential), note that there are statutory protections in respect of service charge payable by residential tenants, and so many aspects of the service charge may be open to challenge by residential tenants where the provisions are not properly drafted.
It is worth noting that “estate” could mean a wider building, row of shops, town centre, retail park or shopping centre.
Agree an annual rent inclusive of service charge
Depending on the nature of the property and the estate, you may consider seeking to have the service charge included in the main rent.
In doing so, you should ensure the lease is drafted so that it is clear that the service charge is included in the rent, and thus there is no separate obligation to pay for services, and that there are covenants on the part of the landlord to carry out the services to the common parts that you would expect to be carried out in the event that the service charge was not included in the annual rent.
Consider the method of apportionment
Thought should be given as to how the service charge should be apportioned in the event that a service charge is payable. A number of methods could be used, including reference to floor area, a fixed percentage, or a fair proportion, to name but three.
All three methods may result in a different service charge being payable and, in reality, you should consider which apportionment method is best suited to the estate that the property is located within before negotiating the lease accordingly.
Consider the services that are appropriate to the estate
Service charge clauses will often have a long and exhaustive list of services that will be provided in exchange for payment of the service charge. You should consider whether they are appropriate to the type of lease you are agreeing. For example:
- Would a row of shops with some limited shared parking outside require its own 24-hour security guard, or promotional material to be prepared for the site?
- Is there a need for a sinking fund – do the facilities being provided warrant one, or is the estate relatively new? If there is a need, can you recover money put into the sinking fund but unspent at the end of the term?
- Is there a limit on management fees? Does the small development warrant an international property management firm and the associated fees for its management?
There is also likely to be a “sweeper clause” for the landlord to provide services that may not be listed in the lease (who knows what the future holds for retail estates?). You should make sure that any sweeper clause has a reasonableness requirement referring to the nature of the estate, that the provision of the services ties in with good estate management principles, and that they are provided in an economic manner.
Consider appropriate exclusions from the service charge
Much will depend on the nature of the estate or shopping centre, but the tenant should consider what should not be included in the cost of the service charge, and should instead be the responsibility of the landlord. Some more usual exclusions to consider would be:
- Areas of the wider estate from which the tenant does not derive any benefit.
- If there is a car park, with car park charging in operation, the tenant should seek to ensure that any income derived from it is offset against the service charge liability (and the cost of any maintenance where controlled by a third party). It is also worth considering, with the advent of electric vehicles, whether electricity costs for charge points provided by the estate should be excluded from the service charge.
- Any income from concessions at the estate should be offset against the service charge, if possible.
- Depending on the age of the estate, where there are warranties, or where an issue requiring remediation is an inherent defect in the construction of the estate or where there is insured or uninsured damage, the cost of repair should not be payable under the service charge.
- Dealing with any other units that are unlet/that will be the sole beneficiaries of the works.
- Refurbishment/development of the estate.
- Any costs relating to the landlord’s promotion of the estate for its own benefit.
- Promotion of the estate and promotional activity within it – thought should be given as to whether benefit would be derived and what is appropriate.
- Damage by causes excluded from the repair liability for the property itself, to ensure that the cost is not recovered indirectly through the service charge.
Ensuring that there is the ability to challenge the service charge
Any service charge clause should allow the tenant to require evidence of the expenditure by the landlord and, during negotiation of the lease, the tenant should seek to include the ability to object to a cost being allocated to it where it feels it is inappropriate or excessive. As a minimum, there should be the ability to challenge where there is a manifest error. If possible, the tenant may seek to ensure that the end of year statement is drawn up by an independent, suitably qualified third person.
You should also seek to ensure that there is an obligation for the landlord to act reasonably in relation to the service charge. While Finchbourne Ltd v Rodrigues [1976] 3 All ER 581 implies that service charge costs must be no more than reasonable, this decision has been open to interpretation by the courts in some instances, and therefore it would be prudent to address this in the lease itself.
Capping the service charge
The tenant may agree a service charge cap with the landlord at the outset of negotiations. This will set a figure that both agree will be the maximum amount charged to the tenant in respect of the services. This should be carefully considered, and the lease reviewed to ensure that the cap is the maximum amount that can be charged, and not the fixed service charge in each year (unless this is intended).
This will help for budgeting purposes, however, the tenant should be careful to ensure that there remains the ability to recover any overpayment where the cap is based on an estimate. In addition, the landlord may seek to tie the cap to the retail price index/consumer price index, or as a percentage of the annual rent. Again, this should be carefully reviewed, if possible with a worked example in the lease to confirm that the correct method of calculation is used.
Look out also for any quasi-service charges that may not be covered, for example a centre marketing charge that may be defined in the lease as a promotional charge, separate to the service charge, and thus not falling within the cap.
Peter Blakemore is an associate in the commercial property team at Brabners LLP
