Owain Rhys James pines for an autumn break by reviewing the latest case about service charges in chalets on the Gower.....
Earlier this year, we featured Arnold v Britton  EWHC 3451 (Ch), heard before Morgan J at the Cardiff District Registry, on the Civitas Law Blog. The Court of Appeal upheld that judgment over the summer: a decision which may have far reaching consequences for lessees obliged to pay service charges.
The case required the Court to decide whether or not a lease relating to holiday chalets in Oxwich Park in the Gower contained “service charges” as defined in Section 18 of the Landlord and Tenant Act 1985 (“the Act”). There were 91 chalets on the holiday park in relation to which the leases had been periodically varied. There were five forms of the relevant service charge clause contained in the various leases for the Court to consideration. The lessees concentrated on the wording of version 3 during the appeal, that being the most favourable to their case, as if they could not succeed on the basis of the wording of that version they would not succeed on the other version.
The specific question which the Court of Appeal was required to decide was whether or not the clauses created a charge which “is payable, directly or indirectly, for services, repairs, maintenance, improvements or insurance or the landlord's costs of management” and “the whole or part of which varies or may vary according to the relevant costs.”
The provision for service charges
The leases were initially granted with ground rent of £10 per annum; to be increased by £5 every 21 years. The provision relating to service charges was set at a fixed rate of £90 per annum; to be increased by 10% every year or, in case of some of the leases, every three years. That charge was payable irrespective of the actual cost of the services used. That amount now stood at £3,000. By 2020 the amount would stand at nearly £6,000 and by 2050 the annual charge would be over £100,000. The service charge for the final year of the current lease would amount to £1,025,004. An eye watering amount for what the Court described as a “modest holiday chalet” the use of which was limited to half a year.
The approach to interpretation at first instance
The Court’s first hurdle was to determine the correct approach to take in interpreting service charge clauses. It was a particular string of the lessees’ argument was that service charges should be interpreted narrowly. In particular, that in the absence of clear words to the contrary a service charge clause should not be interpreted so as to enable a landlord to a profit over and above his actual expenditure on the services provided.
In his judgment, Morgan J stated that the usual rules of construction apply so that there is no special rule of interpretation applicable to service charge. His explicit rejection of the need for express words allowing a profit to be made was endorsed by the Court of Appeal: that being contrary to the position set out in the current edition of Woodfall on Landlord and Tenant. There is, of course, an issue of interpretation where service charges fall within the Act as an amount which is indexed to the cost of the services could not be construed so as to include a profit and so the passage in Woodfall would appear to apply correctly to all service charges which fall within Section 18 of the Act.
The review by the Court of Appeal
The Court of Appeal upheld Morgan J’s judgment and directed itself to interpret the clause on the basis of the ordinary meaning of the language, set in context of the commercial objective of the agreement. A service charge was not a special clause and would not attract a particular manner of interpretation: to that extent it was not open to the Court to improve upon the interpretation which, in its judgment, was clear from the lease.
The substance of the lessees' case was that the service charge provisions were in fact a variable service charge within the definition of the Act. The lessor averred that on a true construction of the clause there was a fixed service charge and so fell outside of the relevant provisions of the Act. At first instance HHJ Jarman QC held that all five forms of the clause appearing in the various leases satisfied the test under Section 18(1) that the “whole or part of [the charge] varies or may vary according to the relevant cost” so that they were service charges within the meaning of the Act. On appeal, Morgan J disagreed finding that none of the clauses were variable charges where the increase was attributable to the actual expense. Rather they were fixed sums which were to increase in a specified manner and by a specified amount at specified times. It was that compound interest formula which lead to the costs increasing so dramatically.
The Court found that the clause created a fixed formula for the increase of a charge where the outlay (the cost to the landlord) had no correlation to the receipts obliged under the lease (the service charge payable by the lessee). It is of note that the Court expressly noted that the reasoning set out in Morgan J’s judgment was correct. The Court of Appeal noted that it is inevitable that where parties elect for the certainty of a fixed increase it is almost inevitable that, particularly as time goes on, the actual expenditure is likely to bear little or no resemblance to the actual expense incurred as time passes. The advantage for the parties, however, was certainty. The lessees' arguments that that result was adventitious or arbitrary was not persuasive because, ultimately, that was the bargain that the parties had struck: certainty of payments over a correlation with actual expenditure.
In the leading judgment, Davis LJ indicated that "an initial gut reaction is that the lessees' argument, in terms of result, ought to be right. But, on reflection, I do not think that that is the proper outcome for this case. It seems to me that to reach such a conclusion would involve subverting the proper process of construction of the language actually used and would in truth involve the court rewriting the bargain the parties have made". The judgment held that compound interest at 10% was the clear agreement of the parties and that that was the only plausible interpretation of the clause, the fact that that resulted in an annual payment of £3,000 for this year and is set to increase, as set out above, was irrelevant to the meaning of the words in the lease.
Some commentators have viewed the decision as allowing landlords to enforce agreements which amount to an unconscionable bargain or fraud. It is fair to say that the Court of Appeal's judgment relies on a strict interpretation of the clauses, and given the above decision not to treat service charge clauses differently from others, that would appear to be correct as a matter of contractual interpretation. An argument that doing so to the disadvantage of lessees who had not contemplated the true meaning or consequence of a service charge clause may find some public support; however it is difficult to see how any criticism of the Court of Appeal's interpretation could be sustained without that underlying public policy concern. Ultimately, however, the certainty of the clause enabled the lessees to know on day 1 of their lease what the service charge for the final year would be. It is of note that the Court rejected an argument that the 10% be calculated as simple interest, as opposed to compound interest, in an attempt to mitigate the ever increasing sums of money payable by the lessees as the clause simply could not accommodated such an interpretation.
At its simplest, and the broad impact that it is likely to have, is that the judgment confirms that a fixed percentage increase in a service charge where the sum is not linked to the actual expenditure means that such a clause falls outside the ambit of Section 18 of the Act; that being the case notwithstanding the difference between the actual cost of the service and the income from the service charges. The more general point would be to ensure that you understand the nature and effect of each clause in your lease before signing it. We shall have to wait and see whether the case is appealed to the Supreme Court, potentially on the basis that such a clause is void as contrary to public policy. That would make it the second high profile service charge case to come before the Supreme Court Justices in 12 months (following Daejan Investments Ltd v Benson [UKSC] 14.)
27 September 2013