Service charges ruling puts onus on lease agreement drafting

Out-Law News | 13 Nov 2020 | 4:23 pm | 3 min. read

A new ruling by the Court of Appeal in London has confirmed that service charge certificates which could be certified by a commercial landlord itself, rather than by a third party, are conclusive as to the amount of service charge that a tenant has to pay under a commercial lease, a property law expert has said.

Richard Bartle of Pinsent Masons, the law firm behind Out-Law, said, though, that the ability of landlords to rely on self-certification of service charge certificates in such circumstances will always depend on how the certification provisions in commercial lease agreements have been drafted.

Bartle was commenting after the court considered the scope of a certification provision relied upon by Sara & Hossein Asset Holdings Limited (S&H) to bring claims for arrears of service charges against its former tenant of retail premises in Liverpool, Blacks Outdoor Retail Limited (Blacks). Pinsent Masons acted for S&H in the case.

Bartle Richard_November 2019

Richard Bartle

Senior Associate

The approach to interpretation adopted by the Court of Appeal here was not particularly surprising. The highest courts have repeatedly said that it is not the function of courts when interpreting contracts to save a party from an imprudent term it has agreed. The function, and the purpose of contractual interpretation, is to identify what the parties agreed

Bartle said: "Many commercial leases contain a clause that prohibits a tenant from deducting and setting-off, and sometimes counterclaiming, against the rents due under the lease. What that means in practice is that the rents are payable in full when liability arises under the lease, even if the tenant itself has valid claims against the landlord, which it would otherwise be able to exercise a right of set-off against."

"Commercial leases also often contain an obligation imposed on landlords to provide tenants with a certificate at the end of a service charge year. The tenant will usually have paid an estimate of the yearly service charge in quarterly instalments during the service-charge year, so the certificate therefore in effect ‘reconciles’ the service charge at year-end. If the instalments overestimated the total amount of service charge due for the year, the tenant will get a refund. If the instalments underestimated the amount of service charge due, the tenant will have to pay the balancing sum to the landlord," he said.

"The effect of a service charge certificate will always depend on how the certification provisions are drafted in the lease. There are various formulations which draftsman of commercial leases use. In this case, the certificate allowed the landlord itself to ascertain the total costs and the sum payable by way of service charge. Under the terms of the lease, the certificate here therefore had to contain 'the amount of total costs and the sum payable by the tenant'. Critically, the lease in this case also provided that 'in the absence of manifest or mathematical error or fraud [the] certificate shall be conclusive'," he said.

"Whilst it is perhaps slightly more common to see such power to determine service charge liability conclusively given to a landlord’s surveyor, it is by no means uncommon for landlords to be given such power as part of this process. These clauses are often referred to as 'conclusive evidence' clauses. Most of the legal cases involving them have been about contracts of guarantee," Bartle said.

The Court of Appeal ruled that S&H could rely on its service charge certificate in this case to determine Blacks' liability for service charge based on an interpretation of the commercial lease agreement that Blacks had signed with the landlord. It held that if the landlord is entitled to determine the 'total cost' of the service charge that must necessarily mean both the identification of services and expenses due under the lease, and the total costs incurred in respect of those services and expenses.

The court acknowledged that its findings could mean that a landlord, which could rely on this sort of certification provision, could be "judge in his own cause" in determining a tenant's liability for service charge, but said that this was, in this case, a product of commercial contract negotiation and therefore not something the court would interfere with.

Bartle said: "The approach to interpretation adopted by the Court of Appeal here was not particularly surprising. The highest courts have repeatedly said that it is not the function of courts when interpreting contracts to save a party from an imprudent term it has agreed. The function, and the purpose of contractual interpretation, is to identify what the parties agreed."

"As with all points of interpretation, what a clause means will hinge on the precise language used in the contract and the admissible factual background at the time the contract was negotiated. Each certification clause in each individual lease must therefore be interpreted on its terms, and accordingly care must be exercised before drawing too many general conclusions about this case," he said.

"That said, three general conclusions can legitimately be drawn. Firstly, there is now binding case law that there is nothing to prevent the enforcement of so-called 'conclusive evidence' clauses in this particular landlord-and-tenant context. Secondly, where a landlord, or its surveyor, has a power to conclusively determine the total service charge due, it will often be able to seek a quick resolution of any claim against a tenant for service charge arrears, either by a summary judgment application or by using the simplified ‘Part 8’ court procedure; that itself is likely to mean that more claims settle. Thirdly, careful thought will need to be given to the drafting of the certification provisions in commercial leases going forward, particularly where there is no service charge cap," Bartle said.