On its face, this is a case about whether a landlord, here a company wholly owned by the lessees (generally known as an “RMC”), is entitled to put through the service charge:

• The costs of litigating and settling a claim for damages for disrepair from one of the lessees, and
• The damages paid to the lessee.

It is however also a case which allows Martin Rodger QC to stretch his wings so as to touch on a number of issues which tax landlords and tenants.

The stretching is equally geographical – our Deputy President travelled to North Shields in Tyne and Wear to hear the appeal.

I have never been to North Shields.

I have however been to South Shields several times, always for the same reason, always on foot and always with 35,000 odd companions. That is because South Shields is home to the thirteenth and final mile of the Great North Run. It is the longest mile in the country.

The block

Etal Court comprises 39 flats contained in three attached blocks, standing in landscaped grounds.

The blocks were constructed in about 1970, and 999 year leases appear to have been granted to all lessees.

Etal Court Maintenance Ltd, is an RMC: all of the lessees were shareholders in the company and vice versa.

Over the years, trees were planted and grew in the grounds.

For reasons which are not clear, in the five years between the turn of the millennium and 2005, several of those trees, which were by then quite sizeable, were felled.

The lease

The landlord’s obligations

The leases at Etal Court obliged the landlord to keep the retained parts of the building in “good and substantial repair and condition”.

The screed of the floor of Mrs Stevenson’s flat was demised to her, but the underlying floor structure was retained by the landlord.

The leases also contained a sweeping up clause of the kind that reverberates with the draftsman’s prayer that it will catch anything and everything that s/he may have otherwise omitted. The RMC was obliged:

“to do all other acts and thing for the proper management administration and maintenance of the blocks of flats as the Lessor in its sole discretion shall think fit”.

The accounting procedure

The RMC was also obliged to prepare accounts of the service charge expenditure. It had all the deceptive charm of the Sir Arthur Conan Doyle’s Grimpen Mire: straightforward on the surface, but pocked with boggy holes for the unwary.

The annual account was to be “prepared and audited by a competent chartered accountant who shall certify the total amount of the said costs charges and expenses (including the audit fee of the said account) for the period to which the account relates and the proportionate amount due from the Lessee to the Lessor …”

The account was to be served on the lessee within four months of the date to which the account was taken.

The lessee’s obligations

The lessee covenanted to pay for the landlord’s services, including those set out above, by way of a service charge. Two on account payments were required each year, followed by a balancing payment at the end of the year, if required.

The service charge was to be divided equally between all 39 lessees.

Cracking floors

In 2010, one of the lessees of the ground floor flats, Mrs Stevenson, noticed that her lounge, kitchen and hallway floors were cracked and damaged.

When she informed the RMC of the damage, the RMC responded that:

• It was not responsible for the maintenance and repair of her floors, and
• The insurance policy maintained by the RMC did not cover the damage of which she was complaining.

Mrs Stephenson’s claim

In March 2011, Mrs Stevenson sought independent legal advice. Her solicitors recommended that she obtain a survey.

The survey

In April 2011 therefore, Mrs Stevenson engaged a firm of chartered building surveyors to report on the damage. They came to the conclusion that the damage in her flat was “consistent with the incorporation of sulphate contaminated fill below the solid concrete ground floor at the time of construction” of the development.

They recommended breaking up the floor and replacing the contaminated material with an inert substitute.

The pre-action letter

Mrs Stevenson’s solicitors sent a pre-action letter, with a copy of the report, to the RMC, pointing out the RMC’s responsibility to keep the structural parts of the building, including the foundations, in repair.

The pre-action letter required the RMC to carry out repair works, and to meet the extra costs that Mrs Stevenson would incur as a result of having to move out of her flat whilst the works were completed.

The RMC’s admission

Having received the letter, the RMC instructed its own surveyor and solicitors and carried out its own investigation. In November 2011, it admitted that it was liable to carry out remedial work.

Its insurer refused to accept a claim because the policy expressly excluded damage caused by sulphate contamination.

The leases being long leases and the lessees being liable to pay for the remedial work through the service charge, the RMC was obliged to follow the requisite section 20 consultation procedure.

The claim is issued

Despite the RMC’s admission, in March 2012, Mrs Stevenson issued a claim in the North Shields county court for an injunction to oblige the landlord to carry out repair works, damages and costs.

It appears that Mrs Stevenson felt compelled to issue the claim because:

• She believed that the RMC were trying to slow down the process;
• The RMC had given no firm promise to carry out repair work, and
• The RMC had not made any offer to pay damages to Mrs Stevenson.

The works were finally carried out in the summer of 2012. The total cost was £27,279.94.

Settlement

Mrs Stevenson settled her claim against the RMC in January 2013.

The RMC agreed to pay damages and Mrs Stevenson’s legal costs. Added to the legal costs that it had itself incurred, its total exposure was £25,534:

• £2,500 in damages;
• £13,358 for Mrs Stevenson’s legal costs, and
• £12,176 in legal costs of its own.

Martin Rodger QC observed that it was “a sum which was only a little less than the cost of the remedial work itself”.

Mrs Fairbairn becomes involved

The RMC put the £25,534.00 through the service charge, although it charged nothing to Mrs Stevenson.

It charged Mrs Stevenson’s share equally amongst her fellow lessees.

Mrs Fairbairn did not pay. The RMC issued a county court claim against her. The dispute found itself in the FTT.

The FTT’s decision

The FTT, faced with wide-ranging and not-always-relevant challenges by Mrs Fairbairn, applied the correct test. It determined that the costs were:

• Reasonably incurred and reasonable in amount. It was appropriate that the RMC should instruct solicitors to deal with Mrs Stevenson’s claim on behalf of all the lessees, and
• Recoverable under the sweeping up clause in the lease.

Permission to appeal

Permission to appeal was granted on two grounds:

• Whether the costs of unsuccessfully defending a claim for damages for breach of a landlord’s repairing covenant are recoverable under a clause which entitles the landlord to recover the costs of acts done for the proper management, maintenance and administration of a block of flats, and
• Whether the RMC had complied with the requirement to provide service charge certificates prepared by a chartered accountant.

The costs of litigation and settlement

Martin Rodger QC reminded himself of two points made by Lord Neuberger in Arnold v Britton [2015] UKSC 36 in relation to the interpretation of the wording of the lease:

• “The task is to identify what the language used by the parties means by reference to what a reasonable person having all the background knowledge which would have been available to the parties would have understood them to be using the language to mean… What the parties meant is most obviously to be gleaned from the language of the provision, over which the parties had control.”
• Service charge provisions are not to be interpreted any differently to any other contractual provision.

Turning to the facts of the case, Martin Rodger QC held that the RMC’s decision to take professional advice was reasonable, but that was the second stage of the interpretative process.

The first step was to determine whether the costs fell within any of the groups of expenditure which the RMC was entitled to put through the service charge.

The specific question was whether the expenditure was recoverable through a clause which entitled the landlord to recover the costs of actions done “for the proper management administration and maintenance of the blocks of flats”.

Impecunious companies

The RMC argued that it was relevant to consider its status as a lessee-owned company.

Martin Rodger QC accepted that the background information available at the date of the lease included the intention that ownership of the landlord should vest in the lessees.

That did not however “justify a radical departure from the natural meaning of fairly standard words”.

He continued, in a paragraph which will doubtless be cited repeatedly in future cases:

“[I do not] consider that it is of practical significance to the interpretation of the lease that the respondent is apparently a company without means other than those available to it directly from its members in that capacity, or through the service charge from the same people in their capacity as leaseholder. In particular it cannot be assumed that all expenditure by the respondent company must have been intended to be reimbursed through the service charge. If a liability is incurred which cannot be met through the service charge, it will be for members either to fund that liability voluntarily or face the risk of the respondent becoming insolvent. That is a characteristic of all leaseholder owned landlords or management companies”.

Sweeping up clauses

Martin Rodger QC introduced a new name for the sweeping up clause: the “general charging clause”. Such clauses were, in his opinion, capable of allowing recovery of legal costs. That much had been shown:

• By the Court of Appeal in Iperion Investment Corporation v Broadwalk House Residents’ Association [1995] 2 EGLR 47, where the costs of litigating against a tenant in breach of covenant were recoverable, and
• By the Upper Tribunal itself in Assethold Ltd v Watts [2014] UKUT 0537 (LC), where the costs of obtaining an injunction against a neighbour in connection with a party wall were recoverable because the costs had been “necessary or desirable for the proper maintenance safety amenity and administration of the development”.

Landlord’s breach of covenant

In both Iperion and Assethold, the landlord was the injured party. In Mrs Fairbairn’s case, as observed by Martin Rodger QC, the landlord was the offending party:

“It was because the proper management and administration of the building had been neglected, although possibly only for a relatively short time, that proceedings were commenced by Mrs Stevenson”.

He turned to the history of the disrepair.

Notice requirements

The RMC was obliged to keep “in good and substantial repair and condition” the retained parts of the building, which included the foundations and structure.

That meant that, as soon as there was any disrepair to those retained parts, the RMC was technically in breach of covenant. Authority for that proposition was to be found in:

• Woodfall, Landlord and Tenant, paragraph 13.066, and
• British Telecom v Sun Life Assurance Society [1996] Ch 69 (CA).

Technical considerations aside however, proper management of the building dictated that the RMC should have arranged to carry out reasonable investigations in 2010 when it was first given notice of the disrepair.

Instead, it had denied liability. It was only when it received Mrs Stevenson’s letter before action, accompanied by a surveyor’s report, that it instructed a surveyor to inspect the floor.

Costs of investigating v costs of litigating

There is an important distinction to be drawn between these two sets of costs.

In this case, Martin Rodger QC was unable, from the “uninformative invoices which have been produced … to identify how much, if any, of the professional fees were for advice relating to what the respondent was obliged by its covenant to do, rather than in dealing with the consequences of a failure of compliance”.

In the absence of evidence to the contrary, he determined that all of the costs at issue were litigation costs.

Costs “saved”

Martin Rodger QC was not persuaded that the “proper management” clause of the lease allowed the RMC to recover the costs of limiting its exposure to Mrs Stevenson any more than any of the other litigation costs.

“Mrs Stevenson’s claim was for enforcement of the [RMC’s] obligation and for damages for breach of covenant. It seems to have been a valid claim in principle … although its true value may have been very modest. All of the costs were referable to that claim”, he said, making the following points:

• “A sum paid in satisfaction of a successful claim for damages for beach of covenant does not readily fall within the scope of expenditure on proper management and administration of the buildings;
• “It seems to me just as inappropriate to classify the reasonable legal costs incurred in minimising such an award of damages, or payable as a condition of a settlement of a valid claim, as having been incurred in proper management and administration of the buildings;
• “Each element of the payment was either part of, or a consequence of, a valid personal claim by the leaseholder against the defaulting landlord;
• “Such payments have nothing to do with the management and administration of the building, they are cost incurred by the landlord in protecting itself from the consequences of its own previous omissions;
• The costs in this case could quite appropriately be described as having been incurred in the management and administration of the respondent company, but that is not enough to make them recoverable through the service charge”.

The appeal on the interpretation of the lease was therefore allowed.

Certification

The RMC not being entitled to put its costs through the service charge, the question of certification took rather a back seat. Martin Rodger QC did however deal with it.

It transpired that the RMC had never complied with the certification procedure set out in the lease. The RMC prepared its own company accounts, but nothing more. No real distinction had been drawn between:

• On the one hand, the rights and liabilities of the shareholders in the RMC, and
• On the other, the rights and obligations of the same people in their capacity as leaseholders.

The failure to comply with the lease was, in Martin Rodger QC’s view, understandable and – ahem – appropriate in a case where the landlord and the lessees were the same people.

Nonetheless, he noted, if the parties fell out, there was always a risk that a lessee might demand that the landlord comply with the lease. That was what Mrs Fairbairn had done, and the RMC had not contended that she had waived that right.

Martin Rodger QC had the following words for the RMC:

“I would suggest for the future, that the terms … concerning certification of expenditure be complied with, unless the [RMC] can obtain from every leaseholder an explicit waiver of the need for a certificate prepared and audited by a competent chartered accountant”.

Observations

To my mind, the substantive decision is not as interesting as the heap of good stuff that accompanies it.

Yes, this decision is salutary reminder to landlords to ensure that they fulfil their repairing obligations.

Yes – again – the lesson is that everyone must comply with what one managing agent giving evidence for my client once rather worryingly described to the FTT as “the small print”, by which he meant the actual terms of the lease.

But the more interesting points are these.

Notice requirements

Long leases almost invariably impose repairing obligations on a landlord.

It is a common conception that no liability attaches to a landlord in any circumstances until s/he is notified of disrepair and has failed to remedy that disrepair within a reasonable time.

The conception applies where the disrepair arises inside property which is demised to a lessee, and which the landlord is obliged to keep in repair.

It does not however apply where the disrepair occurs in or to property which is not demised, that is, property which is retained by the landlord.

This is why.

By virtue of section 11 of the Landlord and Tenant Act 1985, it is an implied term of all short tenancies that the landlord will keep in repair:

• “The installations in the dwelling-house for the supply of water, gas and electricity and for sanitation (including basins, sinks, baths and sanitary conveniences, but not other fixtures, fittings and appliances for making use of the supply of water, gas or electricity), and
• “The installations in the dwelling-house for space heating and heating water”.

These items are necessarily located inside the demised property: the giveaway is the word “in” in both provisions.

A landlord is not entitled to wander into demised property at will. Therefore s/he cannot keep an eye on the state of repair of items for which s/he is responsible.

The law therefore allows the landlord some leeway – without knowledge of the disrepair and a reasonable opportunity to remedy it, a landlord is not fixed with liability for that disrepair.

It is however rarely the case that a landlord under a long lease covenants to keep in repair anything inside the demised property.

Generally, the lessee is required to keep in repair the demised property and anything which only services it, such as water pipes.

Conversely, the landlord generally covenants to keep the retained parts in repair.

As those parts remain his/hers, s/he is entitled to inspect and enter them at any time. There is therefore no need for the lessee to give the landlord notice of disrepair. For example, if a crack develops in an outside wall, the onus is on the landlord to notice it and to take remedial action.

Investigation v litigation costs

Martin Rodger QC rather left the reader in the dark on the distinction between these two sets of costs. This is my understanding of the position:

• The costs of obtaining advice and surveys in relation to the condition of a building are likely be recoverable through the service charge as part of the package of services which the landlord covenants to carry out under his repairing and/or maintenance covenants under the lease. In other words, they are incurred in the course of the landlord complying with his/her covenants, but
• The costs of litigating a disrepair claim, as this case shows, are far less likely to be recoverable that way because the landlord does not incur them them in the course of complying with his/her covenants.

Impecunious, assetless companies

Cash and/or asset poverty is an affliction that plagues many RMCs and other companies which exist solely for the purpose of owning or managing a freehold.

In principle, as soon as the Tribunal disallows a given item of service charge expenditure, a typical RMC is insolvent. Very few companies have a clause along the lines of article 16 of Morshead Mansions Ltd, which entitles them to require shareholders to pay what would otherwise be a service charge within the meaning of section 18 of the 1985 Act.

The gap must however be plugged, because the long term prospects for company are otherwise bleak. More often than not, it falls to the shareholders who are most committed to the preservation of the company to put in the requisite funds.

Whilst I agree with Martin Rodger QC that an RMC’s impecuniosity should not constitute a blank cheque for the recoverability of all and any expenditure in which the company wishes to indulge, I have to say that I disagree with him on the (ir)relevance of an RMC to the interpretation of a lease.

To my mind, some weight should be given to an intention, obvious from the words of the lease, that the freehold should ultimately vest in an RMC.

Costs incurred by a landlord’s breach of covenant

In this case, the landlord was unable to recover the costs incurred as a result of its breach of covenant.

Many are the cases where a landlord makes a section 27A application to the FTT, and where the FTT reduces the amount claimed by the landlord to the amount that it determines to be reasonable within the meaning of section 19.

It is uncontroversial that the reduction represents the amount by which the landlord has effectively overcharged a tenant.

Can it therefore be said that, by analogy with this case, any costs incurred in connection with the amount by which the service charge is reduced are – as a matter of principle – not payable? Section 19 does not constitute an implied term of a lease, but it strikes me that a direct comparison can be drawn between a breach of covenant and a failure to comply with section 19.

Company accounts v service charge accounts

I looked – briefly – at the difference between company accounts and service charge accounts on day 7 of the Law and Lease advent calendar.

I indulged in a rather more detailed review of service charge accounting in my observations on the Elysian Fields case.

The key point to take from both/either posts is that there is a difference between the set of accounts that a company is

• Required to file at companies house because it is a company incorporated in England and Wales, and
• The accounting procedure and lessee notifications that are required by a lease.

My soapbox is wearing out. I will put it away.

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