UK: What Happens To Provisions For Future Works Paid By A Tenant If It Exercises Its Break Option Part Way Through A Service Charge Year?

The recent case of Friends Life Management Services Ltd v A&A Express Building Ltd [2014] EWHC 1463 (Ch) provides a useful insight on whether payments made in advance by a tenant can be used in relation to works carried out in the same service charge year but after the lease has ended by operation of a break clause.

The facts

Friends Life Management Services was the tenant of part of a commercial building. The lease was successfully terminated by operation of the break clause on 24 March 2010. Service charge was payable by the tenant in advance of the landlord's anticipated costs for the service charge year which ran from 1 January to 31 December. When calculating the service charge costs, the landlord was entitled to include a sum by way of provision for anticipated expenditure in any future service charge year.

Provisions for future expenditures had been made between 2006 and 2009 totalling GBP 875,000. The landlord eventually carried out major works to the premises costing around GBP 1 million but the works did not start until late 2010, after the lease had been terminated, and continued into 2011.

What can be charged by the Landlord in the last service charge year?

The Court found that the last service charge year ended on 31 December 2010 and not on the date when the lease was terminated. As such, costs actually incurred by the landlord in 2010 could be included in the last service charge account. In other words, the tenant would have to pay for works carried out after the break date, insofar as these works were payable by the landlord during the last service charge year. In this case, the parties agreed that the costs incurred would be apportioned so that the tenant would only pay a proportion relative to the period up to the end of the lease.

The landlord argued that the service charge should also include a provision for anticipated works in 2011 on the grounds that it would have been able to do so had it not been for the tenant exercising its break. The Court rejected this argument on the basis that the landlord was not able to do so in the last year of the contractual term and that the position was no different whether the lease had been terminated early by operation of the break clause or by effluxion of time.

What happens to the provision for future expenditures already paid by the Tenant?

The landlord argued that the provision built up over previous years should be credited against the costs actually incurred in the last service charge year. If the provision exceeded these costs, the latter would be reduced to nil but the balance would not have to be repaid to the tenant. The tenant on the other hand contended that the provision should be credited against the service charge payable in the last service charge year and if it exceeded this amount the balance ought to be repaid by the landlord.

The Court held that the whole provision had to be brought into account in the last service charge year. The works for which provision had been made should be matched with the costs actually incurred in 2010 for those works. If the whole provision was not used, the balance should be credited against other costs actually incurred by the landlord. If there remained any excess after that, a proportion should be repaid to the tenant having regards to the time in which the tenant remained in occupation during the last service charge year.

Impact of the case

Landlords need to be aware that, subject to any express provision to the contrary, they are likely to have to repay any unspent service charge provision to the tenant at the end of the lease. They may therefore want to consider lease expiry dates and break dates when planning major works to ensure that the costs relating to these works is incurred in the final service charge year so that they can be charged to the Tenant.

An issue that the Court did not address in this case is whether the tenant is entitled to the full amount of unspent monies if the lease had previously been assigned and successive tenants contributed to the service charge provision. This is something that a tenant assigning its lease shortly before the end of the term or break date may want to consider and provide for in the assignment.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.