service charges assignment

Leasehold assignment: who is liable for the service charge debt?

Leasehold properties regularly change hands without the knowledge of the managing agent and without the service charge arrears being settled., it can then be a challenge to know who – and how – to chase for these arrears: is it the old leaseholder or the new one and what debt recovery procedure should they follow, brady solicitors explain the legal position and gives some practical advice to both managing agents and leaseholders..

When one of your leaseholders sells their flat they should – in an ideal world – settle any outstanding service charge and ground rent arrears and, importantly, tell you, the managing agent, about the sale. In fact, this latter point is nearly always stipulated in the lease.

If there are outstanding arrears, these can be paid by the seller before completion or paid as part of the completion by the purchaser, and the purchase price adjusted accordingly. This allows the new leaseholder to start with a clean slate, without the worry of any pre-existing service charge debts.

The leasehold conveyancing position

Back to the real world and, unfortunately, leasehold purchasers often opt for the cheapest conveyancing quote and end up owning their new flat without getting proper advice on the associated liabilities.

There is no obligation on the seller’s solicitors to disclose information about any outstanding service charge arrears.

So, if there is an existing service charge debt, the buyer won’t know about it if their solicitor doesn’t make the appropriate enquiries.

Buyers can be reassured that, under The Landlord and Tenant (Covenants) Act 1995, the arrears remain the liability of the previous leaseholder and do not pass on to the new owner. However, if there is evidence of a breach of lease by the seller, forfeiture proceedings can be brought against the new owner of the flat – a rather unwelcome housewarming gift, most would agree! And, as we set out at the start of this article, selling a leasehold property without informing the managing agent can be a breach of lease in many situations .

How to recover service charge debts when a flat is sold

The first step is to pursue the seller for the arrears. If there has been no provision to transfer the arrears to the new owner, then the correct process is to issue proceedings (in either the county court or at the FTT) against the seller in order to obtain a judgment for their repayment.

We always recommend that you send a copy of these proceedings to the buyer.

Whilst the new owner is unlikely to be keen to pay the previous leaseholder’s bill, when they recognise there is a risk of forfeiture proceedings they may decide to settle up in order to avoid the ongoing hassle and costs.

Assuming you have secured the judgment at the first stage, you then need to decide whether to pursue the seller or the buyer for the arrears. Some former leaseholders will pay up immediately, not wanting to have a judgment against their name. Others will simply ignore it. We generally recommend that you seek to enforce the judgment against the current leaseholder – the buyer.

So the next step is to issue forfeiture proceedings against the buyer. Because the lease has been breached through non-payment of service charge arrears, albeit by the seller, you can issue proceedings against the buyer to forfeit. And, as the new owner of the property, they are likely to settle quickly. Additionally of course, by pursuing the buyer, you can rely on any cost clauses in the lease to ensure you can recover your legal costs.

If you are a leaseholder and find yourself in the unwelcome position of inheriting unknown service charge arrears or enforcement actions, you may have grounds for action against your conveyancing solicitor for potential negligence.

In the very unlikely situation that forfeiture proceedings fail, you can resort to personal enforcement proceedings against the seller. But be aware that this may involve bankruptcy proceedings and there is no guarantee you will be able to recover your legal costs.

So, in summary, where service charges remain unpaid, you should bring proceedings against the seller. However, by advising the purchaser that their property may be subject to forfeiture if the service charge arrears remain unpaid, you may be able to persuade them to settle the service charge to avoid this risk.

Take care to avoid waiving the right to forfeit

If you issue service charge demands – and collect monies – for periods after the leasehold assignment has taken place, you run a high risk of waiving the right to forfeit. It is very common for managing agents (and landlords) to end up in a situation where they have accidentally waived the right to forfeit the lease, simply because they have ‘carried on as normal’.

Without the right to forfeit you lose the ability to recover the service charge arrears from the buyer. And, whilst the buyer won’t want to pay the old owner’s debt, they arguably have more interest in settling it.

Brady Solicitors recommend that you put processes in place to make sure that service charge demands for the post-sale period are not issued to the new leaseholder.

What about balancing charges?

The situation becomes more complicated where the lease states that a separate balancing charge should be issued at the end of a service charge year to resolve any shortfall in the service charge amount.

Essentially, the balancing charge will be payable by whoever holds the lease at the time when the payment falls due. So, if the seller is up-to-date with their service charge payment but sells the flat before the balancing charge is due, then it is the purchaser who will be responsible for paying this charge.

Ensure you understand exactly when the balancing charge is due and when the lease assignment took place.

You can also save unwelcome surprises by making regular enquiries at your estates to check whether any flats have been put on the market.

Dealing with service charge debts when a lease is assigned can be tricky. but, there are clear routes open to you as the managing agent if you end up with a new leaseholder and old service charge arrears., contact the service charge specialists at brady solicitors..

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The importance of good housekeeping in service charge demands

What happens to service charge arrears when a property is sold?

Tips on issuing a service charge demand

MANAGING AGENT GUIDE TO SERVICE CHARGES

For more practical advice on how to make sure your service charge processes are working smoothly, download our free Managing Agent Guide to Service Charges. Click on the image to get your copy.

Get in touch with our experts

With hundreds of years’ worth of combined experience, our experts have dealt with nearly every leasehold property matter you can imagine. If you’re currently in need of legal support or advice, please get in touch.

Information Sheets
Glossary of Terms
Terms and Conditions
Service charge accounts

SERVICE CHARGE ACCOUNTS

What are service charge accounts.

Service charge accounts are the statement or statements typically prepared and issued annually to leaseholders by the landlord or manager to account for actual service charge income and expenditure. They are commonly referred to as accounts and legislation uses the term ‘summary of relevant costs’. The lease will usually set out how service charges should be accounted for, the costs that can be recovered and the period of time the accounts should cover.

What are relevant costs?

Leaseholders have the legal right to request and obtain a summary of relevant costs which are defined by Section 18 (2) of the Landlord and Tenant Act (LTA) 1985 as ‘the costs or estimated costs incurred or to be incurred by or on behalf of the landlord, or a superior landlord, in connection with the matters for which the service charges is payable’. Section 18(3) of the LTA also says that ‘(a) ‘costs’ includes overheads, and (b) ‘costs’ are relevant costs in relation to a service charge whether they are incurred, or to be incurred, in the period for which the service charge is payable or in an earlier or later period’.

What are interim charges?

Most leases allow the landlord or manager to make an interim charge based on estimated costs at the beginning of a service charge year so that funds are available throughout the year for expected day-to-day expenditure. This interim charge may also include an annual contribution to a reserve fund. Although it is not a legal obligation it is widely regarded as good practice for landlords and managers to produce a service charge budget and consult with leaseholders about the amount of interim service charge payments.

What is the service charge budget?

A service charge budget is a forecast of the anticipated expenditure for the coming year. The budgeting process usually takes place several months before each accounting year begins therefore the landlord will not have the certified accounts for the current year. This means that most budget forecasts will provide a comparison between the previous year’s budget and the previous year’s accounts showing actual expenditure and the proposed budget. Nevertheless a prudent manager should take the current year’s expenditure into account and make budget adjustments accordingly.

Is there a standard format for service charge accounts?

There is no recognised standard format or accounting framework for the service charge statement specified in any legislation. Although Section 21(5) of the LTA 1985 sets out the requirements for a summary of costs that need to be prepared in accordance with a request made by a leaseholder under Section 21(1) of the LTA, the requirements do not correspond with accruals based accounting and there is no requirement for any type of balance sheet.

This Institute of Chartered Accountants in England and Wales (ICAEW) guidance recommends that service charge accounts are prepared on an accruals basis and should include:

an income and expenditure account;
a balance sheet for the service charge funds; and
explanatory notes.

Although this may be good accounting practice it can create practical problems and misunderstandings, as most leases and relevant legislation seem to presume a cash basis of accounting.

Income, expenditure and surplus

As the name suggests the income and expenditure account shows money owing from service charges and monies owed for expenses. The surplus is the difference between the total income received or receivable and the total actual expenditure. The lease will often state what the manager should do in respect of a surplus or deficit.

It is unlikely that the income receivable and the total expenditure would ever be exactly the same although this can be achieved as an accounting procedure by retrospectively adjusting the amount that is transferred to the reserve fund if applicable. However, where a deficit arises, it is not always good practice to decrease the annual contribution to the reserve fund as it may result in a shortfall of funds available for cyclical maintenance.

Furthermore, it should be noted that when the figures in the income and expenditure account are presented on an accruals basis as opposed to a cash basis the account will show the total amount of service charges demanded, not the actual funds received. This corresponds to the estimated annual income that would have appeared in the budget prior to the accounting year. One anomaly with this system is that even though the income and expenditure account may show a ‘paper’ surplus, if there are service charge arrears it will result in a cash deficit and it is extremely rare for leases or codes of practice to explain how managers should deal with this real shortfall in funds when the accounts show a surplus.

The contents of the account will vary according to the services required by the lease and other factors such as an annual contribution to a reserve fund where applicable. The account will usually show expenditure in two columns of figures, one representing the current year and another representing the previous year for comparison. A third column showing the sums budgeted may also be included.

All items of expenditure will be shown inclusive of VAT, which cannot be recovered on residential expenditure although the VAT on utility supplies such as electricity should be subject to the lower rate of VAT for domestic supplies.

Right to Manage Companies and Resident Management Companies

Where a Right To Manage Company (RTMC) or Resident Management Company (RMC) has the responsibilities of a landlord, the service charges including any reserve funds are still subject to a statutory trust. As these funds do not belong to the RMC or RTMC they should be ring-fenced and not used for any other purpose or included as company assets in the accounts of the RMC or RTMC. The presentation of service charge accounts by an RMC or RTMC has been the subject of much debate among professionals and further guidance from the ICAEW is expected. The LA favours separate RMC or RTMC company accounts (which in most cases will be dormant) and the production of separate service charge accounts as this best protects the rights of individual leaseholders under landlord and tenant legislation.

Reserve Funds

The term ‘Reserve Fund’ and ‘Reserves’ are often confused. A Reserve Fund is a specific fund of monies set aside for future expenditure, usually for major building repairs and maintenance. It should be represented in cash or in a form that can readily be converted into cash in an emergency. Reserves on the other hand, represents the total assets of the estate, which usually includes monies owned in the form of debtors and is not immediately available as cash. Landlords and managers should provide a separate annual account showing the movement of monies in and out of the Reserve Fund and the Reserve Fund balance.

As a matter of good practice the annual accounts should show the following:

The balance in the Reserve Fund at the start of the accounting year;
the amount that was transferred to the Reserve Fund from the annual service charge or if the lease allows it, sums collected at the time of re-sale;
any sums that were withdrawn from the Reserve Fund to meet the costs of major works;
any additional sums such as supervision fees withdrawn from the Reserve Fund;
any interest that has accrued in that annual accounting period; and
the balance in the Reserve Fund at the end of the accounting year.

Please see the LA information sheet 101 Glossary for a precise explanation of the terms used in this information sheet. Although service charge accounting is a complex process there is a great deal of good practice guidance in addition to the protection leaseholders are given by legislation and the terms of their lease. The government approved codes of practice such as those produced by The Royal Institution of Chartered Surveyors (RICS) and the Association of Retirement Housing Managers (ARHM) include good practice guidance on accounting that goes further than what is required by legislation. There is also comprehensive advice and guidance, primarily for managers, provided by the ICAEW which leaseholders may wish to refer to at www.icaew.com

Disclaimer: This is a very general explanation of the subject. Where issues are not governed by statute the information is our opinion or best practice. You are advised to seek professional advice before acting on the guidance contained herein. Whereas The Leaseholder Association endeavours to ensure that published information is correct, it does not warrant its completeness or accuracy. The Leaseholder Association assumes no responsibility or liability for any injury, loss or damage incurred as a result of any use or reliance upon the information and material contained herein.

Info Sheet: 123/4/15 ©Copyright

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Home > Finance > Service Charge Definition, Types, And Why It’s Not A Tip

Service Charge Definition, Types, And Why It’s Not A Tip

Published: January 27, 2024

Learn the definition and types of service charges in finance, and discover why they're not considered tips. Uncover the ins and outs of service charges in this comprehensive guide.

Definition starting with S

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Understanding Service Charges in the Finance World

When it comes to managing our finances, understanding the various fees and charges we may encounter is essential. One such charge that often causes confusion is the service charge. In this article, we will delve into the definition of service charges, explore the different types, and shed light on why they are not the same as tips. So, let’s get started!

Key Takeaways:

Service charges are fees levied by businesses to cover the cost of providing a service.
Unlike tips, service charges are mandatory and non-negotiable.

Defining Service Charges

In the finance world, a service charge refers to a fee imposed by a business or service provider for delivering a specific service. This charge is typically separate from the product or service’s cost and is often outlined in the terms and conditions or contract.

Service charges can vary depending on the industry and the nature of the services provided. Common examples include fees for account maintenance, processing transactions, or accessing certain features or benefits. In restaurants or establishments that offer food and beverages, service charges may be added to the total bill to cover the wages and overhead costs associated with providing attentive service.

Types of Service Charges

Service charges come in various forms, depending on the industry and business practices. Here are some common types:

Monthly or Annual Fees: Many financial institutions charge a monthly or annual fee to maintain an account or access certain banking services.
Service Fees: These fees are imposed for specific services, such as wire transfers, account statements, or overdraft protection.
Processing Fees: Businesses may charge a processing fee for handling paperwork or facilitating transactions.
Convenience Fees: When making payments online or via phone, some companies add a convenience fee to cover the cost of processing the transaction.
Resort Fees: In the hospitality industry, resorts often charge a daily fee for amenities, such as pool access, fitness centers, or Wi-Fi, even if you don’t use them.

Service Charges vs. Tips: Debunking the Confusion

One common misconception is that service charges and tips are interchangeable. However, they serve different purposes and have distinct characteristics:

Mandatory vs. Discretionary: Service charges are mandatory and non-negotiable, while tips are discretionary and given at the customer’s discretion.
Allocation of Funds: Service charges are usually pooled and distributed to employees as part of their wages, while tips are meant as a direct reward for excellent service and go directly to the server.
Taxation and Legal Implications: Service charges are subject to applicable taxes and often have legal regulations, while tips may be subject to different tax and legal considerations.

Understanding the distinction between service charges and tips is crucial for both consumers and businesses. It helps consumers make informed financial decisions and prevents misunderstandings between customers and service providers.

In Conclusion

Service charges are a common aspect of the finance world, and understanding their definition, types, and differences from tips is paramount. By knowing how service charges work, consumers can manage their finances better and businesses can provide transparency. So, the next time you come across a service charge, you’ll be equipped with the knowledge to make informed decisions.