Service charge – what is it?

A service charge regime is designed to regulate how, in multi-let commercial properties, a commercial landlord can recover their costs for providing the services necessary to operate and maintain a building.

The service charge regime is set out in a lease between landlord and tenant and will regulate how the charge is paid to the landlord and what that charge will be spent on. Typically, that will require tenants to make monthly or quarterly contributions in advance throughout the course of a service charge year, based on an estimated service charge budget. A yearly reconciliation will then take place at the end of the service charge year once the actual costs of providing the services are known.

Industry regulation – current guidance

Whilst a service charge regime is not uncommon in the letting of commercial property, what may not be as commonly well known is that there is industry guidance that ought to be complied with. The Royal Institution of Chartered Surveyors (RICS) introduced "Service Charges in Commercial Property, 1^st edition" from 1 August 2019. The guidance was widely accepted in the property industry and implemented a standard for management of service charges in commercial property, including mandatory core principles that RICS members and regulated firms engaged in this area must comply with, such as:

• creating a duty of care to certify service charge accounts with integrity;
• ensuring all service charge costs are transparent at the outset;
• recognising the responsibility of commercial tenants to make payment of all advance contributions promptly;
• providing guidance on when property managers should issue reconciliation documents, such as budgets and actual expenditure accounts (these should be issued at least 1 month prior to the service charge year and within 4 months of service charge year end); and
• Disputes, where possible, should be resolved through alternative dispute resolution

The guidance was a welcome step in the right direction for landlords, managers and tenants in improving the management of service charges in commercial property and reducing landlord and tenant disputes over service charge matters.

Industry regulation – proposed reforms

However, since the guidance was issued, a number of external factors including the coronavirus pandemic, the high levels of inflation in the UK economy and the global energy crisis have strained landlord and tenant budgets alike, with both parties seeking clarity on service charge to understand the impact on their cash flow.

Recognising that, RICS have now issued a proposed consultation on the 1^st edition and have proposed an updated 2^nd edition" to update and improve the industry standard. This includes updates to:

• Professional standard – property managers must now use best endeavours to achieve the standards of performance and degrees of competency set down in the proposed update;
• Timeliness – budgets and service charge year end accounts to tenants now must be issued within the timescales identified by RICS (one month prior to service charge year commencing and within four months of service charge year end). If these timescales are not met, managers will require to provide as much information as practicable on the budget/actual expenditure and when the budget or account will be issued; and
• Introduction of a Service Charge Exception – Service Charges can now include enhancement of the fabric, plant or equipment, so long it has been fully communicated to tenants and the expenditure is evidenced, following an analysis of reasonable options and alternatives and with consideration of a cost-benefit analysis over the term of tenants' leases.

The changes proposed, if implemented, will place property managers under a reinforced duty to ensure they appropriately share and collate service charge budgets and accounts in short order. This is a welcome development and will provide both landlords and tenants with clarity on their actual expenditure, and the impact that will have on their cash flow.

However, the proposed updated guidance cannot retrospectively apply to existing leases and, whilst it is recommended that any existing lease be interpreted, in so far as possible, with the updated standard, that may not always be possible. That is likely to result in parties continuing to dispute their service charge liability.

The consultation is open for responses until 29 October 2024 and is available here. We would encourage commercial landlords, tenants and property managers to consider and respond to the consultation.

Dentons Property Disputes team has a wealth of experience on advising on service charge disputes to ensure commercial landlords, tenants and property managers can protect and understand their position.