Challenging your Articles of Association to tackle non payment of service charges

Who are the real rogues? Changing your Articles of Association to tackle non-payment of service charges could be a dangerous tactic, says Bruce Maunder-Taylor

There are some blocks of flats run by resident-controlled management companies in which one leaseholder is claimed to be holding everybody else to ransom and who in turn claims victimisation by the Board of Directors.

To voluntary unpaid directors of a Residents’ Management Company (RMC) with no capital assets of its own, no profits to rely on, and only a self-balancing service charge account, any legal proceedings that result from this situation can be a nightmare – as they can be for the leaseholder who feels victimised.  In a typical case of this kind, the RMC will issue County Court proceedings for recovery of whatever is owed; the matter will be referred to the FTT for a determination; the matter will return to the County Court (if not settled); and substantial costs – often running into tens of thousands of pounds – will have to be paid.  This does not only apply to recovery of service charges but also to alleged breaches of a lease and other litigation affecting residential block management.

In an attempt to tackle this problem and avoid litigation, there is now an emerging tendency for solicitors to advise RMCs to change the Articles of Association (the rules which govern the management of their company) to enable the RMC to collect money from the shareholders, either collectively or individually, if the directors decide to make a demand.  The expectation is that if one resident, who is accused of being a ‘rogue’ leaseholder, puts the company to substantial cost, the Directors can legitimately demand those costs from that leaseholder as a shareholder or member of the Company and expect to recover them that way.

Test case The ability for a company to do this was tested all the way to the Court of Appeal in the case of Di Marco –v- Morshead Mansions Limited in 2008, when it was decided that whatever is payable by way of service charges through the lease is quite separate and distinct from what is payable through the Articles of Association of the Company. The Court determined that this is the case even if the sums being demanded are, effectively, service charges.  In the case of Morshead Mansions, it is understood that a General Meeting of the Company is now held each year for the majority to vote on a budget necessary to manage the block of flats. No service charges are collected through the lease mechanism and all funds are collected through the Articles of Association from the shareholders of the Company (every lessee being a shareholder).  If anyone wishes to challenge the demand, it is not a service charge, therefore the leasehold legislation does not apply and the FTT has no jurisdiction.

There are also some RMCs which still collect service charges through the lease, but have varied the Articles of Association so that they can demand from a particular leaseholder, a group of leaseholders or all leaseholders, litigation or other costs, sometimes on a collective basis, sometimes on an individual basis.  As far as is known, individual demands have not been tested in the Courts, but the threat of using such a provision in the Articles of Association is, frankly, frightening and tends to bring a rapid conclusion to the dispute. 

Open to abuse The problem is that these provisions in Articles of Associations are open to obvious abuse if used unfairly and threaten to put us back to where we were with rogue landlords before the Landlord and Tenant Act 1985 and subsequent legislation.  This time, the leasehold sector could be faced not with rogue landlords, but with alleged rogue Directors of RMCs.

It is now not uncommon for RMCs to find themselves in a financially embarrassing position when dealing with a difficult leaseholder issue as they do not often have the financial resources to see the dispute all the way through. Lawyers with or without expert witnesses are expensive, and the litigation process is not only two layers (County Court and FTT), but now often includes mediation as well, imposed as a third layer.  There are many ordinary people (leaseholders as well as Directors of RMCs) who find this surprising and unacceptable.  It means they start looking for alternatives. 

Is Commonhold the answer? It had been hoped that Commonhold tenure would help to resolve this matter as the Commonhold provisions effectively allow for the budget to be agreed by the Commonhold members at a General Meeting, by majority decision, and that decision is then enforceable.  However, to transfer from a freehold block of flats with each flat held on lease to Commonhold tenure requires unanimous agreement, which is rarely achievable.  Unless and until Parliament changes the unanimity rule  (for example, at present to vary all leases under S.37 of the 1987 Act requires 75% in favour and not more than 10% against), then Commonhold tenure is out of reach of most blocks of flats. That leaves changing the Articles of Association of the Management Company in the way described above, and putting a lot of power in the hands of the Directors who do not need to see majority decisions unless the Articles of Association also provide for that.  On the other hand, if one individual or a small group of leaseholders is putting everybody else to vast expense on what ought to be unnecessary litigation, what other choice is there?

Bruce Maunder Taylor is senior partner of Maunder Taylor. Tel: 020 8446 0011