Alexandra Anderson explains how the date when costs are incurred can make a big difference to landlords, tenants and managing agents
Key points
- Property managers need to comply with the time limits set out in Section 20 of the 1985 Act, to ensure they do not miss the chance to recover service charges
- The 18-month deadline for issuing notices under section 20(B) only starts to run when a cost is incurred
- Where costs are accounted on an accruals basis, those costs will not be treated as having been incurred until they are paid
Those involved in managing residential properties will know that any delay in collecting service charges can lead to claims. But the deadline for claiming charges may be later than you think.
The Landlord and Tenant Act 1985 sets out the basic principles in relation to the recovery of residential service charges. One of the most important provisions is section 20B, which specifies the timeframe within which payment must be demanded from tenants. A failure to comply with this section could result in tenants refusing to pay their service charges and landlords looking to the managing agents to make good any shortfall in the service charge account.
Section 20B
Section 20B states that, for a landlord to recover the costs of works or services, it must either:
1) serve a demand for payment on the tenants within 18 months of incurring such costs; or
2) notify the tenants in writing within 18 months of incurring such costs that the costs have been incurred, and that the tenants will be required under the terms of their leases to contribute to the costs by the payment of a service charge.
If a landlord fails to comply with section 20B, it cannot recover the charges incurred from the tenants. This section is intended to protect residential tenants, by avoiding the situation where tenants are faced with a demand for payment of costs of which they were not aware years after the costs were incurred.
The landlord is able to protect its position by issuing a written notice to the tenant under section 20B(2), informing the tenant that they will at some time in the future be required to pay for the costs incurred. This notice essentially stops the 18-month clock running. Any subsequent costs would then in principle be recoverable, even if the demand for payment is issued more than 18 months after the costs were incurred.
Because the landlord may lose the ability to recover costs if it does not serve a demand or notice under section 20B, it is vital for anyone managing a property on behalf of a landlord to understand when a cost is “incurred” for the purposes of the Act. While this may appear to be a straightforward concept, the issue has been the subject of debate and recent comment by the courts.
Date incurred
The 18-month period during which a section 20B notice can be issued starts to run from the time that a cost is “incurred” by the landlord. In Jean-Paul v The Mayor and Burgesses of the London Borough of Southwark [2011] UKUT 178 (LC); [2011] PLSCS 178, the Upper Tribunal (Lands Chamber) held that, for the purposes of section 20B, a cost is only “incurred” by a landlord when payment is made. The tribunal drew an important distinction between incurring a liability, where the landlord has an obligation to pay, and incurring a cost, where the landlord has to make a payment.
The Court of Appeal arrived at broadly the same conclusion in OM Property Management Ltd v Burr [2013] EWCA Civ 479; [2013] 2 EGLR 84. In that case, the court held that costs are “incurred” either on the presentation of an invoice or other demand for payment, or on payment by the landlord.
This seems clear enough, but complications can arise where the time at which a cost is “incurred” in a legal sense does not correspond with when it is “incurred” from an accounting perspective. The fact that the two dates may not be the same can cause confusion in identifying when the 18-month period starts to run. With this confusion follows the risk of disputes between landlords and tenants as to whether the landlord can recover service charge costs, and the further risk that the landlord will look to the property manager to pay any disputed amount.
When trying to decide whether it has suffered loss flowing from the failure to serve section 20B notices in time, a landlord will usually look at whether any deficit appears in the relevant accounts, to see whether there is a shortfall between the sums received from the tenants for service charges and what the landlord actually paid out. However, caution should be exercised if looking solely at the accounts, as they will not necessarily reflect when a cost was “incurred” in the legal sense.
The reason for this is that service charge accounts are often prepared on an “accruals” basis. Broadly, this means that the accounts make allowance for the costs of work or services that have been provided in the accounting period (for example, the utilities, such as electricity and water), but for which an invoice has not been received and therefore for which no payment has been made. The accruals basis of accounting recognises that, for accounting purposes, a cost is incurred on the actual provision of work or services to the landlord, not when the invoice is presented or when payment is made. Care should therefore be taken in respect of when the 18-month period starts to run, as the service charge accounts may not reflect when relevant costs are “incurred” in the legal sense.
Importance in practice
These issues were recently considered in Freehold Managers (Nominees) Ltd v Countrywide Residential Lettings Ltd, heard in January by Judge Saggerson in Central London County Court. Freehold was the owner of a residential block of flats. Countrywide acted as managing agent for Freehold until November 2009, when management passed to a different company. For the period of its management, Countrywide was responsible for collecting service charges from the tenants of the flats. The leases provided for payment of an interim service charge based on estimated expenditure for each 12-month accounting period and, where the total expenditure exceeded the estimate, payment of an additional amount.
In the accounting years ending 31 August 2008 and 31 August 2009, the total expenditure exceeded the amounts collected from the tenants through the interim service charge. However, Countrywide did not serve demands for the balancing payments on the tenants within 18 months of the accounting year-ends. Freehold claimed that it had suffered loss as a result of Countrywide’s failure to serve the relevant notices and relied on the deficits that appeared in the 2008 and 2009 accounts in order to quantify the losses it was claiming.
The court held that, in order to ascertain whether Countrywide had been negligent, and whether Freehold had suffered any loss as a result, Freehold needed to establish when the costs it said it could not recover from the tenants had been incurred. In accordance with established authority, this was when the costs were paid or, possibly, when Freehold or Countrywide received invoices for the costs. This could not be established simply by looking at the liabilities recorded in the accounts, as these had been prepared on an accruals basis.
Freehold did not adduce any evidence as to when the relevant costs had been “incurred” and so could not establish the date by which any section 20B notices should have been served. Freehold was accordingly unable to establish whether Countrywide’s failure to serve section 20B notices had in fact caused it any loss. Freehold also faced the potential difficulty that the managing agents who took over from Countrywide in November 2009 might still have been able to serve section 20B notices, where costs had actually been incurred less than 18 months before that date.
How to proceed
When deciding the date by which a demand or notice needs to be served under section 20B, landlords and their advisers need to carefully consider when any costs that may form part of what appears to be a shortfall in the service charge were incurred. Where the accounts have been prepared on an accruals basis, the fact that a deficit appears in the service charge accounts will not automatically mean that a landlord is unable to recover that cost from their tenant, or that their property manager is liable for any shortfall.
In general, it is likely that costs will be incurred for the purposes of section 20B at a later date than the date on which the work or services to which they relate are performed. This will give property managers more time than they may think to recover those costs for their landlord clients and any manager taking over the management of a residential property should take care to ensure that they do not miss the deadline for issuing notices in relation to costs incurred on the watch of the previous managers, for which they might assume the deadline has already passed. It remains best practice to serve any notices required under section 20B sooner rather than later.
Alexandra Anderson is a partner at City law firm RPC
