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Property Law Update

Raising the Stakes in Service Charge: Goodbye Code of Practice, Hello Professional Statement

The RICS recently launched a consultation on its draft ‘Professional Statement for Service Charges in Commercial Property’. 

The Professional Statement will be effective from 1 April 2018 and will supersede the current RICS ‘Code of Practice for Service Charges in Commercial Property’ which is now up to its third edition.  

So in a little over three months’ time, the current Code of Practice will replaced by a new Professional Statement. But as Shakespeare said, what’s in a name?

A step-up in regulatory importance

Professionals involved in the management of service charge accounts will no longer be guided by A ‘Code of Practice’ which merely sets an expectation or recommends best practice to follow in providing and operating a service charge. 

The new paper is a ‘Professional Statement’ and RICS members and regulated firms (who generally are the parties operating service charges) must comply with the eight mandatory core principles. RICS members and regulated firms will need to be aware of the legal and/or disciplinary consequences from departing from the Professional Statement. 

The eight mandatory core principles

The eight core principles are as follows:

Professionals involved in the management of service charge accounts MUST act in accordance with the following principles: 

1. Owners and managers MUST seek to recover no more than 100% of the proper and actual costs of the provision or supply of the services unless the lease of the property gives them the explicit right to do so. 

2. Owners and managers MUST ensure that service charge budgets, including appropriate explanatory commentary are issued annually to all tenants.

3. Owners and managers MUST ensure that a signed statement showing a true and accurate record of the actual expenditure constituting the service charge is provided annually to all tenants. 

4. Owners and managers MUST ensure that a service charge apportionment schedule for their property is provided annually to all tenants. 

5. All expenditure that the owner and manager seek to recover MUST be in accordance with the terms of the lease. 

6. Service charge monies (including reserve and sinking funds) MUST be held in one or more discrete (or virtual) bank accounts. 

7. All interest earned on service charge accounts – or where separate accounts per property are not operated, a proper and reasonable amount of interest calculates on normal commercial rates – MUST be credited to the service charge account after appropriate deductions have been made. This applies for instance to bank charges, tax etc. 

8. Where acting on behalf of a tenant, RICS members MUST advise their clients that if a dispute exists any service charge payment withheld by a tenant should reflect only the actual sums in dispute.

The best practice principles underpinning the core principles 

The mandatory core principles of the Professional Statement are underpinned by a number of best practice guidelines, illustrating how the mandatory core principles should be applied. 

The best practice principles which underpin the core principles are extensive but generally reflect the values contained in the current Code of Practice, but with some updating. Importantly there is no change to the timing of the provision of budgets and statements and which remain best practice rather than mandatory. The best practice principles can be read in more detail at: https://consultations.rics.org/consult.ti/servicechargescommercial

Stuck between and a rock and a hard place?

Although the new Professional Statement represents an increase in regulation for RICS members and regulated firms, the Professional Statement makes it clear that it cannot override the terms of a specific lease. 

So is there a risk that RICS accredited managing agents will be stuck between the mandatory requirements of its professional body and landlords wanting to abide by the terms of the lease? 

The mandatory core principles included in the Professional Statement have widely been accepted as standard service charge practice in recent years. It is likely, therefore, that the vast majority of modern service charge provisions contained in new leases granted by landlords who pride themselves on keeping up to date with modern leasing practice, will already be consistent with the mandatory principles and many of the best practice guidelines.

What may be more troublesome for managing agents are the outdated service charge provisions which have been in existence at buildings/estates for many years and have remained unchanged since the building/estate was built. In those situations, in some rare cases, managing agents may have a direct conflict between their professional body’s regulation and the longstanding approach of a particular landlord to a particular service charge regime. 

It remains to be seen if how difficult it will be for managing agents to drive through change to service charge provision on the back of the new regulation. It is standard practice for landlords to want to replicate the existing service charge provisions when granting new leases (and renewal leases) to ensure consistency across the estate/building and to ensure 100% service charge recoverability. The introduction of the Service Charge Code of Practice in 2008 did not (and does not) seem to have had a great impact on that approach. 

The Professional Statement makes it clear that maintaining consistency across service charge provisions should not act a barrier to updating service charge provisions to modern standards. It suggests that landlords should consider operating a dual service charge, with two service charge arrangements operating in tandem, one based on the older form of lease and the other based on the modern form. It even suggests an interim position, so that a new lease may reflect the ideal service charge regime going forward as well as maintaining the status quo for the time being, and when the tipping point is reached an owner can swap from the old service charge regime to the new. 

What is clear, however, is that there needs to be an understanding on the part of property owners, tenants and their solicitors as to the contents of the Professional Statement and the standards which are now compulsory for RICS accredited managing agents. 

Published: December 2017

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