Tenant contributions to a freeholder’s sinking fund

The background

The upper residential floors of the subject property formed the demise under a head lease between freeholder and head landlord, and subsequently a residential lease to the tenant from the head landlord.

The head landlord was obliged under the head lease to contribute to the freeholder’s sinking fund, and in turn recharged this and other sums owed to the freeholder, in addition to its own service charge, by way of a ‘Landlord Estate Charge’ to the residential tenant under the underlease.

The tenant initially paid this sum without objection as it was relatively minor. However, the sum rose from 2011 and the tenant argued that it was not obliged to pay into a sinking fund.

The law

Under the underlease, the tenant’s proportion of the service charge was payable in respect of ‘Total Expenditure’, defined as:

‘…the total expenditure incurred or payable by the Landlord in any Accounting Period in carrying out its obligations under this Underlease including…all costs and expenses payable to the Superior Landlord under the Head Lease in respect of insurance and services relating to the Building and any other costs and expenses reasonably and properly incurred…’

Services towards which the tenant was required to contribute included maintenance of the main structure of the building, external and some internal decoration, together with the reservation of a sinking fund sum:

‘…such sums of money as the Landlord shall reasonably require to meet such future costs as the Landlord shall reasonably expect to incur in replacing maintaining and renewing those items…(such sums set aside to form a sinking fund)…’

The decision

The Upper Tribunal held that the tenant could in principle be charged in respect of funds reserved to a sinking fund and, on interpretation of the ‘Total Expenditure’ provision, the lease terms were wide enough to accommodate this.

The issue of ‘reasonableness’ was addressed by the Upper Tribunal, however, pursuant to s.19 (2) of the Landlord and Tenant Act 1985 which requires any service charge sums payable by a tenant before they are incurred to be subject to reasonableness.

The landlord was obliged to ensure that any sums it was charging to the tenant were reasonable; in this case the sinking fund sum was held to be excessive. The landlord had paid over such sum to the freeholder and recharged it to the tenant without querying or challenging the amount owed.

The Upper Tribunal therefore held that, whilst the tenant must contribute towards the sinking fund in accordance with the terms of the underlease, it was required only to contribute a proportion of £25,000 rather than a proportion of the £44,000 initially demanded.

JB Leitch’s Phil Parkinson comments:

“This case serves as a warning to landlords that, simply because they have paid a sum to a freeholder, this sum cannot be recharged to a tenant without the landlord first assessing and, if necessary challenging, its reasonableness. Tenants should be aware that where a freeholder operates a sinking fund, they can expect to contribute towards this.”