Intermediate landlords of mixed use buildings have to fulfil the requirements of the Landlord and Tenant Act 1985 when producing service charge accounts to residential tenants. Residential tenants benefit from a statutory requirement that their service charge must be reasonable. When setting up mixed use structures with service charges, it is important to ensure that adequate provision is made for estate service charges which need to be passed down to residential tenants not least to ensure 100% recoverability.
In the case of Balkhi v Southern Land Securities  UKUT 239 (LC) the tribunal considered whether it was reasonable for an intermediate landlord to simply pass down service charges to an undertenant which included a contribution towards a sinking fund.
This case centred around 18 Maddox Street in the heart of Mayfair, London. The building comprised a commercial unit on the ground and basement floors and six residential apartments on the upper four floors.
The freeholder was the Pollen Estate Trustee Company Limited (Pollen Estates). The residential apartments were let on an intermediate lease to Southern Land Securities Limited (Southern Land), who in turn let the apartments to individuals on long leases. The defendant, Mr Balkhi, had a long lease of one of the apartments.
Pollen Estates was responsible for keeping the structural parts of the building in good repair and condition. They were also responsible for decorating, cleaning and preserving the exterior of the building and the costs were recoverable via a service charge.
Southern Land paid the service charge to Pollen Estates, some of which went towards a sinking fund. Southern Land's service charge contribution was 63.56% of the total service charge for the building. In turn, and under Mr Balkhi's lease, he was required to pay 20.04% of this sum.
In 2011, Mr Balkhi began to object to the amount of service charge that was being demanded by the landlord and in particular, the landlord estate charge.
In 2013, Southern Land brought a claim against Mr Balkhi for service charge arrears in the sum of £12,370.27. Mr Balkhi defended the claim on the grounds that the amounts claimed were not reasonable pursuant to Section 19 of the Landlord and Tenant Act 1985, and therefore the sums were unrecoverable.
The case ended up in the Upper Tribunal which focussed on the arguments surrounding the sinking fund. The sinking fund increased over 3 years from £40,000 to £70,000 without any information being provided. Southern Securities argued that the level of sinking fund was reasonable due to the size and location of the property, and the fact that this was the level being imposed by Pollen Estates.
The Upper Tribunal did not agree with this argument and ruled that greater interrogation was required as to why the sinking fund contributions had increased so dramatically. Southern Land were unable to produce any futher evidence to justify the reasonableness of what was being claimed.
As a result, the Upper Tribunal ruled, for the purposes of Mr Balkhi's service charge contribution, that the reasonable amount for Southern Securities to have paid to Pollen Estates was 63.56% of £40,000, not the higher sum of £70,000, which would have amounted to £25,424. The amount payable by Mr Balkhi was £8,549.04 (£12,370,27 less £3,821.23).
Points to note
Check the lease: when making a service charge payment or demand, you should carefully check the terms of the lease to establish if recovery is permitted. Whilst the Landlord and Tenant Act 1985 sets out the basic principles in respect of the recovery of residential service charges, the statute does not override the provisions contained in a lease which relate to which service costs can be recovered.
Compile evidence: if landlords pass down service charges without a breakdown of the costs, tenants should query the amount of service charge and what the charges relate to. Landlords should compile evidence to show that costs are reasonable and when creating a sinking fund, they should also provide evidence as to the appropriate level of the fund and the likely timescale and cost of the works.
Communication is key: service charges must be clear, and landlords at all levels must communicate information about expected works or additional service charges at the earliest opportunity in order to prevent any surprises when service charges are demanded.
Since Balki, there has been another case on residential service charge and the duty to consult where there are tiers of landlords. In Leaseholders of Foundling Court and O'Donnell Court v The Mayor and Burgesses of the London Borough of Camden and others  – the Upper Tribunal held here that an Superior Landlord must consult with undertenants not just its tenant. This is an awkward case to reconcile with a reality where a freeholder often will have no idea of the identity of those actually in occupation where they have no regular dealings. It does however highlight the purpose of the legislation which is to protect the ultimate payor from any nasty service charge surprises