The majority of landlords provide services to their tenants and recover the costs of doing that from those tenants by way of service charge. The lease will set out the way in which service charge is to be dealt with i.e. what it covers and how it is calculated. The lease will also set out details of what the landlord can and cannot charge for and the proportion of the charge that the tenant will have to pay.
Service charges are one of the main areas for dispute between tenants and landlords. The recent case of Criterion Buildings Ltd v McKinsey and Company Inc (UK) and another (2021) looked at the proper approach to calculate service charges in relation to commercial premises.
Facts of the case
The matter concerned various leases of office premises at 1 Jermyn Street, near Piccadilly Circus, London. Provisions in the lease enabled the landlord to recover from the tenant and the other occupiers, a contribution towards the costs of providing various services. In most commercial buildings, services can include repair of the structure of the building and the provision of lighting, fire equipment, maintenance of those items etc.
The tenant withheld part of the payment due, arguing that it had been overcharged by the landlord. The landlord brought a claim for the unpaid service charge which amounted to the princely sum of £2.2 million.
What was the issue?
The lease contained a commonly found provision regarding service charge. The tenant was covenanting to pay a “due proportion” of the total costs of the services and expenses specified in the lease.
“Due proportion” was defined as:
“a fair proportion to be determined from time to time by the Landlord taking into account the benefit that was derived”
The Court had to decide whether the landlord had actually demanded a “due proportion” from the tenant. The tenant argued that the landlord had failed to make a proper determination of a due proportion. The reason being that the landlord had determined the “due proportion” based on each tenant’s respective floor areas of the demised parts of the building but had failed to check if the measurements used were accurate. Also, the apportionment involved a large discount in favour of another tenant. This discount was not justified based on the consumption or benefit derived from the services supplied.
Essentially the issue here was whether the Court could get involved with the service charge proportions determined by the landlord.
Decision
It was the tenant who had the burden of establishing the following:
- that the apportionment adopted by the landlord was unfair; or
- that the apportionment did not amount to a due proportion as defined by the lease.
It was held that the landlord was entitled to decide what was a fair proportion. This was said to mean landlords were allowed a subjective discretion when determining a fair proportion and there was no need to create a requirement of objective fairness. In this case the landlord’s apportionment was based on the space occupied by the tenants and this was seen as a legitimate consideration. It also made no financial difference to the landlord how the space was divided and so the landlord could be trusted because it had no hidden agenda. Even if an objective standard was used, the tenant did not identify any objective wrongness.
Essentially a landlord’s subjective determination of the “fair proportion” of its total costs payable by the tenant by way of service charge could not be challenged by the tenant. It was the landlord who was to determine the fair proportion of the service charge. It was not for the Courts. This is, however, subject to the landlord acting rationally. In this case, the tenant had not disputed the rationality of the landlord’s decision.
What does this mean for tenants?
This case emphasises the risk for a tenant where a landlord is the sole decider of any aspect of the tenant’s service charge liability.
In order to avoid being caught by a landlord’s subjective determination, a tenant should consider the following options:
- providing in its lease that the landlord’s determination of the proportion of the service charge costs and expenses payable by the tenant should be judged objectively (although the burden of proof would still lie on the tenant to show that the landlord’s determination was objectively “unfair”);
- fixing the percentage contribution payable by a tenant;
- capping the tenant’s annual service charge liability and excluding certain costs from the service charge calculation.
The case does possibly show a favouring towards the landlord, but also provides some input on how a tenant might challenge matters or might try and balance the position in any new lease being taken.
If you would like to discuss possible letting options then please contact Cathryn Pernstich.