Service Charges – who decides what is a fair proportion?

Criterion Buildings Ltd v McKinsey and Company Inc (UK) and another (2021) EWHC 216 (CH)

In this case the High Court was concerned with the meaning of ‘a fair proportion’ in the context of a tenant’s liability to pay service charges pursuant to its lease.

Facts

McKinsey & Company Inc (McKinsey), a management consultancy firm, occupied offices in part of the high-profile Criterion building in Piccadilly Circus from March 1993 until September 2018 pursuant to a lease.

Other tenants occupying the Criterion Building included a sportswear store, a theatre and a restaurant. Under the service charge provisions in the lease, McKinsey had covenanted to pay a ‘due proportion’ of the total cost of the services and expenses specified. Many issues were raised in this case in relation to service charge liability but the apportionment issue is of the most interest. Due proportion was defined in the lease as:

‘the due proportion’ shall mean a fair proportion to be determined from time to time by the Landlord or the Landlord’s Surveyors taking into account the use made of and the benefit received from the services and expenses and each of them and for the avoidance of doubt different proportions may be applied to different services or items of service charge expenditure (including if appropriate the attribution of the whole of the cost of any service or item of service charge expenditure to the Tenant) and the Landlord shall (having regard to the terms of this Lease and the principles of good estate management) adjust the due proportion to make fair allowances for differences in the services provided or supplied to or enjoyed by any Lettable Unit’.

Disputes arose between McKinsey and its landlord Criterion Buildings Ltd (‘Criterion’) over the proportion of the service charge allocated to it. McKinsey contended that it had been overcharged by Criterion in various respects and as such withheld payment of part of the sums which had been demanded.

By 2019, the arrears of service charge had reached £2.2 million plus interest. Criterion claimed that McKinsey had failed to pay service charges. These included charges for lifts and a ‘sinking fund’. Subsequently Criterion issued proceedings for the balance.

McKinsey objected to the claim and argued that no money was owed and raised the following two main issues:

Whether Criterion had apportioned the service charges due between the various tenants of the building in accordance with the provisions in the lease – McKinsey argued that the ‘due proportion’ of costs charged did not comply with the lease because it was not ‘fair’ when assessed on an objective standard. McKinsey considered that the way in which the service charges had been apportioned favoured another tenant (the Criterion Theatre and Criterion Restaurant) The treatment of the floor area in the theatre had provided the theatre with an element of discount at the McKinsey’s expense, which resulted in McKinsey paying too high a percentage.

Whether Criterion had properly operated the sinking / reserve fund provisions in the lease – McKinsey argued that some payments charged by the landlord as contributions to a sinking fund were not contractually due as they were being used to fund routine service charge costs. McKinsey further asserted that, since the goods lift was in working order, it did not require replacement and works to the lift would be unnecessary and premature.

The Decision

On the facts, the High Court found in favour of Criterion:

Apportionment

The court held that when apportioning service charge between tenants, the decision as to what constitutes a ‘fair proportion’ is one for the landlord to make rather than the court. It is for the tenant to establish (and not the landlord) that it has been charged more than a ‘due proportion’ of the service costs. It was also acceptable for the landlord to make a subjective decision in relation to apportioning the charges subject to the landlord acting rationally. In this case, McKinsey had not disputed the rationality of Criterion’s decision.

Sinking / reserve fund

The Court also found in favour of Criterion’s request for contributions to a sinking fund for the future refurbishment of the goods lift. The Court found that the wording in the lease allowed Criterion to require contributions to the sinking fund to replace the lift from the outset; building up a fund from a time when such replacement was not necessary. This is was what a sinking fund was for; to spread the costs over the term of the lease.

The lease gave Criterion the discretion to decide, notwithstanding that the lifts still operated day to day, that the lack of knowhow of current lift engineers and lack of parts to ensure uninterrupted service meant that it may be better to refurbish or replace the lifts. Whilst others may have a different view of the best course of action, ultimately, it was Criterion’s decision.

McKinsey had not shown that Criterion had made unreasonable decisions as the service charge contributions to sinking funds were to be spent during the following years. Further, it was not possible for any unspent advance payments to be returned, as the sinking fund was subject to a trust to be spent on certain types of expenditure.

Commentary /practical points

The decision is a helpful one for landlords as it confirms that, provided a landlord acts rationally, it has the ability to determine apportionments and it is for the tenant to prove otherwise.

On a practical point, it is advisable for landlords to keep evidence of how they calculate the apportionments of service charge in the event they are challenged at a later date.

For tenants it is a reminder that they should check the service charge clauses in their leases carefully so that they are aware of how the charge is apportioned and also ensure they understand the landlord’s methodology for calculating it. Unless the tenant can provide that its landlord’s decision is irrational, they will be bound by it and the courts will not interfere in this regard.

A tenant may consider providing in its lease that the landlord’s determination of the proportion of the service charge costs and expenses payable by the tenant should be judged objectively (although the burden of proof would still be on the tenant to demonstrate that the landlord’s determination was objectively ‘unfair’). Other options for the tenant to consider are:

• fixing the percentage contribution payable by a tenant;
• capping the tenant’s annual service charge liability; and
• excluding certain costs from the service charge calculation.