Service Charges in Commercial Leases: A Guide

Service charges in commercial property are a common area of dispute between landlords and commercial tenants. Whilst the RICS Code provides a widely recognised industry standard for commercial lease service charges, it is the lease itself which will take precedence.

For commercial tenants, understanding how commercial leases dictate service charges, how they are calculated and when they can be challenged is essential before signing a commercial lease in England and Wales.

What are service charges in commercial property?

A service charge is an extra sum that tenants or leaseholders pay to cover the landlord’s costs of running, maintaining, and managing shared parts of a building or an estate.

Disputes regarding service charges are common amongst landlords and tenants. A good lease will clearly set out:

• The services which a landlord is obliged to provide
• How a tenant’s contribution towards those costs is to be calculated
• The dates and manner in which the tenant should pay the costs
• What happens in the event of a breach or dispute

What is included in a commercial property service charge?

This will very much differ depending on the type of property or estate.

For example, in a shared building such as an office block, a landlord may be obliged to cover:

• Insuring, cleaning, repairing and maintaining the structure, exterior and ‘common parts’ (for example lifts and shared toilet facilities)
• The cost of lighting and heating any shared parts
• Security equipment
• Employing security or reception staff

Alternatively, where the whole of a building is let to the tenant, the landlord may be responsible for:

• Keeping any private estate roads in repair
• Providing lighting to the estate
• Arranging security services

How much is a tenant obliged to pay?

A lease should specify how the tenant’s proportion of the landlord’s costs are calculated.

Fixed service charges

In some leases, the amount of service charge that a tenant will pay is fixed or capped. Whilst a fixed service charge provides certainty and clarity to a tenant, to balance the risk to the landlord, it is common to find that the ‘fixed’ amount is higher than a variable service charge.

Variable service charges

More commonly a tenant will pay a variable service charge. The sum payable will differ year on year depending on the landlord’s actual expenditure. The lease will usually set out the parameters of the type of charges the landlord is entitled to charge for, including not only day to day maintenance and running costs but also potential items of significant expenditure (for example, replacement of a roof) and also how the tenant’s proportion of those costs should be determined. This latter aspect is known as a ‘fair proportion clause’.

How are commercial lease service charges calculated?

The manner in which a tenant’s proportion is calculated can vary greatly. Some leases simply say that a landlord shall charge a tenant a ‘fair proportion’ which leaves the method of calculation up for dispute. Some tenants are charged based on the size of their individual property compared to the size of other tenant’s property and/or by reference to the level of services a particular tenant benefits from. 

It is common that tenants are required to make payments on account of service charge expenditure (commonly around the same time as rent is payable), so that a landlord can manage cash flow. Where the service charge is variable, a landlord usually needs to estimate likely expenditure in advance of a financial year, and then at the end of the same financial year, to run a ‘balancing exercise’ based on actual expenditure.

Some times landlords are entitled to claim an amount from its tenants to hold towards items of significant or unexpected expenditure. This is known as a ‘reserve fund’ or a ‘sinking fund’.

What happens if the parties dispute the service charge?

Regardless of how a dispute is to be determined, the starting point is to carefully examine the wording of the lease in light of the situation ‘on the ground’.

In some cases, the lease will include an agreement between the landlord and the tenant to use a specific dispute resolution procedure to resolve disputes which may involve the appointment of a independent expert or arbitrator.

Alternatively, if the parties cannot reach agreement then a Court or Tribunal may be asked to make a determination.

Can a Tenant refuse to pay a service charge whilst it is disputed?

This is rarely advisable. It is quite common for a lease to contain a right for the Landlord to terminate it if a tenant is in breach and in some cases, it is possible for a landlord to terminate a Lease for non-payment of service charges without first giving any notice to a tenant.

In order to avoid any suggestion that by paying a service charge, a tenant has accepted responsibility to pay it, a tenant could make the payment on a protective basis, but at the same time, or shortly before payment, to write to a landlord make it clear that the service charge is disputed. This is commonly known as ‘paying under protest’.

Tenant rights and responsibilities

Although commercial service charges are contractual, tenants still have important protections through lease wording and industry standards.

Commercial tenants should:

• Review service charge clauses carefully before signing
• Check for caps, exclusions or restrictions
• Request previous service charge statements
• Query unexplained increases promptly
• Seek legal advice where drafting is unclear

Transparent accounting and clear communication can reduce disputes and financial risk.

How a commercial property solicitor can support

Service charge disputes can often be complex. It is important that Landlords and Tenants get early advice to understand their legal position and options, to attempt to reach an amicable solution and maintain a good working relationship between them. Jennifer Rogers is a specialist commercial property litigation solicitor with a wealth of experience advising Landlords and Tenants and would be delighted to assist.

Get in touch today via our form to get acquainted.

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