UK: The Hidden Costs Of Building Safety: New Duty Imposes Irrecoverable Costs On Landlords Dealing With Defects

As the Building Safety Act 2022 (the "Act") continues to make waves across the real estate sector, one quiet, but very important, ripple should not be overlooked. Landlords of residential and mixed-use buildings containing at least two dwellings and being above 11 metres high (or at least 5 storeys) with building safety defects will soon have to fund multiple steps to investigate alternative funding sources before passing any remediation costs to leaseholders under their service charge. The costs of taking these steps may be largely irrecoverable from tenants, leaving landlords with a substantial bill and no certainty that it will secure any funding source to carry out the necessary remediation works.

"No leaseholder living in their own flat will have to pay a penny to fix unsafe cladding"

...said the then Secretary of State for Levelling Up, Michael Gove, in January 2022. The Act delivers on that guarantee and also provides extensive protection to tenants under qualifying leases against remediation costs for non-cladding building safety defects in the form of caps and restrictions to service charge recovery.

However, for tenants of dwellings who do not hold a qualifying lease, that is not the end of story. Section 133 of the Act inserts a new section 20D into the Landlord and Tenant Act 1985 to require landlords to take reasonable steps to explore other cost recovery avenues before asking residential tenants to contribute via the service charge, whether they have a qualifying lease or not. The new duty will not apply to leaseholder-owned or managed buildings or commonhold land. Whilst it does not appear to apply to tenants of the commercial parts in mixed-use buildings, they are likely to benefit (indirectly) as the landlord has to comply with the duty for the residential tenants and (directly) as any costs recovered have to be applied to the service charge for the building as a whole. A tenant of a dwelling may challenge service charge demands in the First Tier Tribunal if such steps are not taken.

Many paths, multiple steps

Whilst the duty is not yet in force, the Government is consulting on the statutory guidance to sit behind it.

For example, when pursuing a developer, the landlord should first seek independent legal advice on the likelihood of recovering remediation costs and whether there is a feasible claim, the likely costs of pursuing an action and the risks of doing so. Pre-action correspondence and negotiation should be attempted with a view to early settlement, but if the costs of litigation are likely to be disproportionate (or the landlord has received "strong legal advice" against litigating), they may reasonably decide not to pursue the claim. If litigation is pursued but unsuccessful, the landlord should consider grounds for appeal and pursue the appeal where reasonable to do so. It is clear that landlords should investigate and pursue the various routes of recovery simultaneously and they should not delay remediation works in the meantime.

Irrecoverable costs for landlords

The Government's Impact Assessment dated 2 February 2023 says "Many leaseholders [are] faced with bills which they could not afford, for problems they did not cause, to pay for work over which they have limited influence. The Government has been clear that this was unfair." The Act increases the recovery routes for alternative funding, but someone has to pick up the legal expenses of pursuing these avenues and landlords are in the frame to do so. The new duty does not discriminate between a landlord responsible for causing the building safety defect (or being part of the corporate group of the developer) and a landlord who acquires the building without any knowledge of the defect.

"Legal expenses" includes the cost of obtaining legal advice, pursuing litigation, arbitration or mediation. Schedule 8 of the Act prohibits landlords from passing legal expenses onto qualifying leaseholders living in their flats, whilst also protecting non-qualifying leaseholders (ie commercial tenants in mixed-use buildings) from inflated service charges due to shortfalls in recovery elsewhere. To give a flavour of the typical expenses, the Government's Impact Assessment looked at 9 case studies. In one example, legal and administrative expenses to pursue a claim against a third party were over £125,000 with only 18% recoverable from leaseholders (46 qualifying/ 4 non-qualifying). The landlord had a legal bill exceeding £102,000 to comply with its new duty to take reasonable steps to secure alternative funding (without any guarantee of doing so). No information was given on the percentage of recovery of legal expenses from the third party.

Unless a landlord receives strong legal advice against litigating at an early stage, it may find itself weighing up the costs of pursuing alternative recovery routes against simply funding the works itself and accepting it may not be able to recover them via the service charge. Because even if a successful claim is brought against a third party, it does not guarantee 100% recovery of the remediation costs or the legal expenses. Whichever way you cut it, the landlord may well face a shortfall.

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.