Rational or Reasonable? A Recent Case Highlights Clarifies the Meaning of Contractual Reasonableness.

Introduction

JB Leitch has recently acted in an Appeal case in the Upper Tribunal which, amongst its many considerations, raises a notable point on the definition of what is “reasonable” in the context of lease interpretation.

This is an appeal from a decision of the First-tier Tribunal (“the FTT”) in its jurisdiction under section 27A of the Landlord and Tenant Act 1985 to determine whether variable service charges were payable by leaseholders in a mixed-use block of flats.

The appellant leaseholders applied to the FTT for a determination that service charges, in relation to an onsite gym, paid, or to be paid, by them were not payable. The FTT found that the charges were reasonable and payable and the appellants were later given permission to appeal by the Upper Tribunal.

Background

The subject property was constructed in the 1930s as an office block and converted to mixed use by 2006. Thereafter, it comprised 168 flats, four commercial units and a gym. Long leases of the residential flats were granted, and the commercial units were all fully let.

The gym had not been let initially, having been in the proprietorship of the then freeholder and open for the exclusive use of the leaseholders within the building. However, since 23 October 2013 the gym had been let to a third party, the gym owner, who was permitted to make the gym available to others outside the building, provided that residential leaseholders were not prevented from using the gym. An annual rent was payable by the gym owner for the gym, but the lease contained no service charge payment provisions. The respondent acquired the freehold in 2017.

The gym lease grants the lessees: “The Right for the Tenant and Guests to use the Gym Equipment from time to time in the Unit in conjunction with the Occupiers provided that the Tenant shall not allow such number of Guests to use the Gym Equipment that the Occupiers are routinely prevented from the [sic] using a reasonable proportion of Gym

Equipment (with the intent that there should always be Gym Equipment available for use by a reasonable number of Occupiers (the residential leaseholders).”

The residential leases were deemed materially identical in form, containing provision for the tenants to pay a service charge. The leases define the landlord’s expenditure as Residential Service Charge Items or Building Service Charge Items.  The former are payable in whole or in part by the residential lessees, and the latter in whole or in part by both the residential and commercial lessees. The landlord’s obligations included the obligations to maintain the building, facilities and common parts.

In 2014, an agreement was reached between the then landlord and the leaseholders to the effect that the landlord would use the rental income from the gym as a contribution towards the costs of maintaining the gym and its equipment, reducing the leaseholders’ apportionments.

In November 2021, the respondent landlord sent to all the residential leaseholders a notice of its intention to carry out major works to the gym, to be paid for through their service charge. That notice was the first step in the process of consultation required by section 20 of the Landlord and Tenant Act 1985 when a programme of works is going to cost each leaseholder more than £250. The notice stated that the work was being done in order to comply with the landlord’s obligations both under the gym lease and under the residential leases. A notice of estimates, served later in the process, indicated that the work would cost over £218,000.

The Challenge

In December 2022 the appellant leaseholders made an application to the FTT for a determination as to whether the service charges demanded relating to the gym in the years 2013 to 2021, and to be demanded in 2022 and 2023 and constituting 100% of the gym maintenance costs, were fair and reasonable.

Further, the tenants sought a determination as to “what would be a fair and reasonable apportionment of the Gym costs to the residential Leaseholders in light of the grant of the Gym Lease on 25 October 2013”. The tenants alleged that since 2013, use of the gym had not been exclusive to the leaseholders.

The tenants’ application set out the argument that a reasonable apportionment would be that the residential leaseholders would pay no more than 50% of “the Gym costs” incurred in 2013 to 2020 and 0% thereafter because their access to the gym had been restricted after July 2020.

The leaseholders said that the landlord was not entitled by the lease to designate the gym costs as payable by them in full. The challenge therefore was based not on the level of a cost or the standard of work done, but on a decision taken by the landlord.

The Legal Focus

Section 27A of the Landlord and Tenant Act 1985 enables the FTT to decide whether service charges are payable by leaseholders:

“(1) An application may be made to [the FTT] for a determination whether a

service charge is payable and, if it is, as to—

(a) the person by whom it is payable,

(b) the person to whom it is payable,

(c) the amount which is payable,

(d) the date at or by which it is payable, and

(e) the manner in which it is payable.”

The FTT’s decision

The FTT found that leaseholders had paid the service charges without any challenge or objection for seven years, from 2013-2020. As a result, they had accepted that the service charge was payable and in the apportionments paid.

With regards to the service charges relating to years after 2020, the FTT held that the landlord had reached its decision rationally and was entitled to recover 100% of the gym maintenance costs from the leaseholders, stating in its judgment that the decision by the landlord “was not a decision of the type where it could be said that no reasonable landlord in a similar position could ever have made it.”

The leaseholders appealed to the Upper Tribunal (“the UT”).

Conclusion & Comment

The UT dismissed the appeal on the first point, agreeing with the FTT that the leaseholders had accepted the service charges demanded and paid during the years 2013-2020 without raising any challenge or dispute.

However, the UT upheld the tenants’ appeal in respect of the charges for 2021-2023. According to the UT, the landlord’s decision as to how it apportioned costs between leaseholders and the gym tenant must be “objectively reasonable”.  The UT concluded that “It is manifestly unfair, and therefore not objectively reasonable, for the residential leaseholders to pay the whole of the gym costs after 2020 when they no longer have exclusive use of the gym.”

The key points raised by this decision are:

1. The decision, in respect of whether a contractual obligation to act reasonably means objective reasonableness, conflicts with the approach taken by the Deputy President in the case of Braganza v The Riverside Group Ltd [2024]. In this case, the UT concluded that, although the landlord may have followed a rational process, it did not reach a reasonable and fair conclusion;
2. The decision finds that a contractual obligation to act reasonably must mean to act reasonably in an objective sense, as opposed to rationally (meaning not to act in a way that is capricious i.e. making a decision that no other reasonable landlord would make);
3. This, we say, brings into question the jurisdiction of the FTT as it appears to widen the FTT’s jurisdiction on the basis that it must now consider what would be in the interest of each party to the contract and whether the outcome of the decision would be fair.

This decision has sought to clarify, following the Supreme Court’s decision in Aviva Ground Rent Investors GP Ltd v Williams [2023], the law on contractual reasonableness. In doing so, the decision has the effect of making the administration of service charges much more difficult for landlords.