The unintended costs of tenant control

Readers will be aware that the Leasehold and Freehold Reform Act 2024 became law on 24 May 2024, as part of the “wash up” ahead of the dissolution of parliament in advance of the general election in July. On its face, the Act, which is only partly in force, does two things that may not sit easily together. First, it attempts to encourage the expansion of the right to manage, both through increasing the non-residential limit from 25% to 50% and by reducing leaseholders’ automatic exposure to the landlord’s costs. Second, the Act controls the operation of contractual cost provisions by preventing service or administration charges in respect of litigation costs from being payable unless the tribunal or court gives permission, having found it is just and equitable to do so. Mechanically this is done by section 62 of the 2024 Act introducing a new section 20CA into the Landlord and Tenant Act 1985 and a new Paragraph 5B into Schedule 11 of the Commonhold and Leasehold Reform Act 2002. Unintended consequence These provisions appear to be aimed squarely at 69 Marina clauses (following Freeholders of 69 Marina, St Leonards-on-Sea v Oram [2011] EWCA Civ 1258; [2011] PLSCS 263), ie clauses that sometimes require the payment of costs associated with the preparation and service of notices pursuant to section 146 of the Law of Property Act 1925. These are clauses that unwary leaseholders are often surprised to find provide a fuller costs indemnity in favour of the landlord than they might have been expecting. The provisions will also catch more straightforward costs clauses. The decision to make it more difficult for landlords to demand the costs of chasing arrears is a political one, a considered choice to favour one category of property owner over another. But what if the person demanding the service charge is not a “landlord” in the ordinary sense of the word – what if it is the tenants’ fellow leaseholders, either through an RTM company or a lessee-owned management company, or if the landlord is owned by the leaseholders (for example following collective enfranchisement)? Here it appears the 2024 Act may have an unintended consequence. Traditional landlords willing and able to provide capital can fund disputes and then, if they succeed and have a contractual or statutory entitlement to costs, they can seek them. The difficulty may come with entities entitled to service charges who, by their nature, cannot raise funds independently. RTM companies are the classic example: they are inherently fragile as they have no assets, the model articles do not provide for a call on members, and they are limited to whatever funds they are entitled to under the relevant leases (which may, for example, provide for payment in arrears). RTM companies have never been able to rely on 69 Marina clauses as they are unable to forfeit, but have often met the costs of ongoing litigation (where the lease permits) by way of the service charge.  Under the new regime, even modest (and successful) arrears chasing may prove ruinous to an RTM company or the lessee-owned vehicle that does not have an alternative means of raising funds. Arrears chasing does not form part of a standard management fee and agents will often charge separately for enforcement (indeed, the RICS suggests this is the proper arrangement and an enhanced fee that includes an element of arrears chasing might run afoul of either the lease or section 19 of the 1985 Act); without permission, the cost cannot be recovered from either the service charge or as an administration charge. If a leaseholder wrongly withholds service charges and the RTM company incurs even a modest bill from its agents for arrears chasing, this expense will not be recoverable through the service charge or as an administration charge until the court or tribunal has permitted it (itself, potentially, an expensive and time-consuming process). It may be that, in practice, funds collected for, say, major works are diverted into funding arrears chasing. Such an approach is fraught with risk (including of breach of trust) if the service charge mechanism is subverted. The tribunal refusing to allow the recovery of costs following contested proceedings would be disastrous for most lessee-controlled vehicles (even if such a decision is justified on the facts of the particular case). It is very unlikely solicitors or agents would be prepared to enter into agreements where payment for the substantial work of contested proceedings was conditional on a discretionary order permitting payment through the service charge account or from the defaulting leaseholder. The company will be trapped in the funding gap created by a defaulting leaseholder and the enhanced risk of irrecoverable costs of arrears chasing. The way ahead It may be that advisers, at least of lessee-owned freehold companies who can rely on 69 Marina clauses, will try to suggest administration charges are not litigation costs unless there is litigation afoot – this might be right (and recoverability depends on the lease), but recovery of costs under section 146 clauses requires that the process is squarely aimed at litigation, so it is hard to see how such costs wouldn’t be “litigation costs”. There might be a solution – both the new section 20CB of the 1985 Act and the new paragraph 5C of Schedule 11 of the 2002 Act provide for a power to provide exceptions (or modifications) to the new regime for specific types of landlord. Accordingly, it may be possible to exempt some “landlords” that do not fit the traditional model from the new regime. Such a solution might contain its own problems (for example, lessee-owned management companies that are under the control of the freeholder might become a lacuna in system), but would reduce the difficulties for under-capitalised lessee-controlled management vehicles. An increase in the failure of lessee-owned companies (and the according reversion of management to the freeholder, or a purchaser or the reversion at auction) would appear to be the opposite of the intended effects of the 2024 Act. Richard Granby is a barrister at Tanfield Chambers Photo © Anthony/Pexels