Enforcing service charge payments

Effective management of service charge arrears is essential for all Resident Management Companies (RMCs) and, by extension, the leaseholders that are dependant on them to provide services, writes Stan Gallagher, Barrister, Tanfield Chambers.

As with any landlord, an RMC is obliged to perform the landlord’s covenants whether or not some or all of the leaseholders are actually paying their service charges: See Yorkbrook Investments v Batten (CA). However, unlike external landlords, a RMC will have no funding other than what it collects as service charge. Arrears therefore threaten the RMC’s solvency. Enforcing payment of service charges is more difficult these days. Consider the twin peaks of:

The further statutory constraints (but as yet not the wholesale abolition) of the right of forfeiture for the non-payment of service charges by residential leaseholders; and The concurrent (but not exclusive) jurisdiction of the First-tier Tribunal (the FTT) to determine service charge disputes. Unlike the Civil Courts, the FTT has very limited powers to award costs.

The traditional form of long residential lease is the product of the days when the landlord’s principal remedy for unpaid service charges was to forfeit the lease. Broadly, the right of forfeiture (as moderated by rights of relief against forfeiture) amounts to a security for compliance with the tenant’s covenants: generally, forfeiture will only be relieved on terms that fully compensate the landlord for the breach, for example a forfeiture for non-payment of service charges generally only will be relieved if the leaseholder pays all outstanding service charges, together with the landlord’s costs of the proceedings. The result being, where forfeiture is available, that it is the defaulting leaseholder, not the service charge fund or the landlord, who ultimately bears the landlord’s reasonable costs of any enforcement proceedings.

Make No Provision

The conventional form of a lease is not designed to operate in the now common circumstances where forfeiture is not readily available. A typical lease will either make no provision at all for the recovery of the landlord’s legal and other costs of enforcement, or else, the lease will only provide for the landlord’s cost of enforcement to be recovered from the service charge, rather than borne solely by the defaulting leaseholder.

If legal costs cannot be avoided by avoiding litigation in the first place, the objective of the RMC must be to try and recover its costs from the defaulting leaseholder. Recovering these costs as part of the service charge (which will only be possible if the leases make clear provision for it) is very much a second best outcome: in this eventuality, each leaseholder, including the defaulting leaseholder, will be liable to pay their proportionate share of the landlord’s costs. This is unfair and likely to be a source of resentment among those leaseholders that have paid their service charge in the first place.

Unfortunately, ensuring that the enforcement costs only fall on the defaulting leaseholder is not always possible to fully achieve. A strategy is to try to get into the position to either forfeit the lease, or at least serve a section 146 notice as soon as possible after it becomes clear that the leaseholder is, without good reason, refusing to pay. In order to forfeit a lease for the non-payment of service charges (unless the lease reserves the service charge as rent or additional rent) a notice under section 146 of the Law of Property Act 1925 (the LPA) must first be served on the tenant. Section 146(3) of the LPA imposes an obligation on the leaseholder to pay the “reasonable costs and expenses properly incurred by the lessor in the employment of a solicitor and surveyor or valuer or otherwise in reference to any breach giving rise to the right of re-entry or forfeiture”. Hence, the earlier the landlord can get to the stage of validly serving a section 146 notice (and if need be taking the ultimate step of forfeiting the lease) the better in terms of maximising the costs that can be recovered from the defaulting leaseholder.

However, there are hoops to be negotiated. Section 168 of the Common hold and Leasehold Reform Act (the 2002 Act) imposes various statutory pre-conditions to serving a section 146 notice:

-The complained of breach has been finally determined by the FTT; or -The tenant has admitted to the breach; or -The breach has been the subject of a determination by a court, or an arbitral tribunal in proceedings pursuant to a post dispute arbitration agreement.

In cases, where the lease reserves the service charge as rent and provides that it is recoverable as if rent, there is no need to serve a section 146 notice as a precursor to forfeiture proceedings in the event of non-payment. However, such service charges nevertheless fall within the statutory definition of “service charges” (section 18(1) of the L & T Act 1985) and are therefore subject to statutory protection. Consequently, forfeiture of the lease for a non payment of service charges reserved as rent is subject to restrictions on forfeiture that are imposed by section 81 of the Housing Act 1996. These largely mirror the requirements of section 168 of the 2002 Act. Unpaid Service Charge

An admission by the leaseholder is sufficient. In all cases of unpaid service charge, the RMC should consider whether there is a dispute as to liability, as opposed to an inability to pay. Further, if there is a genuine dispute as to some elements of the service charge (e.g. the costs of major works) there may be no dispute as to other unpaid elements (e.g. the insurance and the porter’s wages may not be in dispute) and the leaseholder may be prepared to admit these undisputed items. The strategy should always be to identify at an early stage whether there is a genuine dispute and, if so, to limit the scope of any proceedings accordingly.

The next point to seek to obtain admission/further admissions once the claim had been issued in the County Court. Experience shows that many claims commenced in the County Court are either admitted or result in a default judgement. The County Court procedure will require the leaseholder to issue a notice of intention to defend (if not judgement will be entered for the landlord in default). If the claim is defended, it is likely, though not inevitable, that it will be transferred to the First-tier Tribunal

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A determination by the FTT may be enforced as if a judgement of the County Court with the permission of the County Court. It is necessary therefore to apply to the County Court if it is intended to enforce the FTT decision as if a judgement of the County Court. Once granted the usual options for enforcement of a County Court money judgement is open to the landlord, for example by a statutory demand (as a precursor to bankruptcy proceedings), or by obtaining a charge on the leasehold flat.

Broadly, serving a statutory demand is likely to be highly effective if the leaseholder has little equity in the flat or other assets (in which case the mortgagee as a secured creditor will rank above the landlord in a distribution). Caution Is Required

For a variety of reasons, not least in terms of recovering costs, once a judgement has been obtained, the best means of enforcement may prove to be the section 146 and forfeiture route. However, caution is required. It is unusual to get as far as forfeiting a long residential lease, and doing so may be regarded by the courts as an extreme step. Further, depending on the circumstances, there may be potential complications, including, circumventing a debarring order that may have been made under section 20C of the L & T Act 1985. The up-shot is that specific legal advice should be obtained before bringing forfeiture proceedings.