The Royal Institution of Chartered Surveyors (RICS) has published an information paper on the need to improve the contractual regime for supply of service charge information from seller to buyer. This may result in changes to standard form contracts and enquiries before contract.
The Royal Institution of Chartered Surveyors (www.practicallaw.com/1-106-4420) (RICS) has published an information paper designed to encourage surveyors and lawyers to improve the contractual regime for supply of service charge information from seller to buyer, when a multilet property is sold. This may necessitate changes to standard form contracts and enquiries before contract. The information paper is complementary to the RICS code of practice on service charges in commercial property (www.practicallaw.com/7-505-9708), which requires the service charge information to be supplied promptly (and no later than four months after completion).Close speedread
When a property is sold subject to occupational leases which impose a service charge regime, it is important that the buyer (or its managing agent) understands how that regime works, and (unless there is good reason) continues to administer it in a consistent manner to the seller. Otherwise the occupational tenants may complain, perhaps that they are being asked to pay too much, or that surpluses from past years have not been rolled forward, that the sinking fund has not been applied in the way agreed, or that annual statements have been delayed.
Most of the information will come from the seller or its managing agent, rather than from the occupational leases. Whilst enquiries before contract may yield some of the essential information, often the replies are incomplete or unhelpful. Lawyers often assume that the managing agents for the two parties will be in direct contact, and that the missing information will be picked up through this (non-contractual) channel. There can be many reasons why this assumption is mistaken, for example:
The seller's managing agent is not aware that the property is on the market.
The buyer has not appointed a managing agent as yet.
The buyer is not willing to pay its normal managing agent to get up to speed on the service charge regime for a property for which the buyer has not yet exchanged contracts.
There is a confidentiality clause which prevents the parties disclosing the proposed sale to their agents, and the seller does not have the information itself to give to the buyer.
Sale contracts often contain little detail about the information that is to be supplied to the buyer or the time frame for doing so. Even where express obligations do appear in the sale contract, the sanctions for breach are not effective. For example, if the seller fails to send through the service charge reconciliation, or to account for the sinking fund balance quickly, or to explain the apportionments for void units, then at best the buyer has a right to pursue damages. The buyer's loss will often be difficult to assess, and the cost of pursuing damages may well outweigh the amount recoverable.
Instead, buyers or their agents have to make the best they can of the limited information they have received, and to keep chasing the seller's managing agent for the remainder. That agent will have little incentive to cooperate, as it is no longer managing the property, or (probably) being paid for assembling the service charge information for the buyer.
RICS has published an information paper RICS Information Paper on commercial property service charge handover procedures (March 2011) (www.practicallaw.com/5-505-9752) which, in the context of a sale of multilet property subject to occupational leases:
Sets out the full range of information that a buyer of multilet property will need about the service charge (see Range of information required).
Specifies time limits for production of that information or handover of any service charge funds (see Time limits).
Identifies who should be responsible for collecting in arrears of service charge payments from occupation tenants (see Arrears).
States what should be done about sinking funds and depreciation charges (see Sinking fund and depreciation charge information).
Indicates what to do if the seller has paid a security deposit for any energy supply contract in respect of the property (see Security deposits for utility supplies).
Suggests what should be done regarding the transfer, termination or novation of supplier contracts (see Supplier contracts).
Stresses that the sale contract should have reasonable enforcement action for failure by the seller to comply with these obligations. It particularly mentions the possibIlity of imposing liquidated damages (though there may be drawbacks to setting the amount for these). The RICS may well recommend, in a later edition of the information paper, that the buyer considers making a retention from the purchase price, to be released when all the information and payments have been received.
Provides a useful glossary and specimen, simple, service charge reconciliation statement.
The information paper covers the very similar issues which arise where there is a change of manager (but no sale of the property). This aspect is not covered in this update.
If the parties choose to implement the recommendations in the information paper, they will need to:
Review whether their sale contract covers the points and, if not, amend it. Standard sale conditions (such as the Second Edition of the SCPS (www.practicallaw.com/2-107-3787)) do not deal with the issues adequately. For a draft clause that reflects the information paper, see Standard clause, Alternative sale contract clauses compatible with RICS Information Paper on Commercial Property Service Charge Handover Procedures (www.practicallaw.com/1-506-9885)
Expand their enquiries before contract. If the buyer's conveyancer uses CPSE.1 and CPSE.2, these will cover some of the information and additional enquiries can be added using Form RQ (www.practicallaw.com/4-503-2485). For more details on the CPSEs, see Commercial Property Standard Enquiries (www.practicallaw.com/6-502-2923).
The information paper is intended to provide an explanation of the issues. It does not set out RICS advice on best practice, so surveyors are not bound to observe its recommendations. It is not binding on lawyers or their clients, though all those parties may choose to abide by its principles (and the RICS would encourage them to do so, in order to facilitate a smoother deal).
This position contrasts with the position under the RICS code of practice on service charges in commercial property: RICS: Service charges in commercial property - RICS Code of practice (2nd edition) (May 2011) (www.practicallaw.com/7-505-9708)). That code does set out best practice for surveyors and observing it will be a relevant consideration for a managing agent who wishes to avoid being negligent. For more information, see Practice note, Second edition of RICS Code for service charges in commercial property (www.practicallaw.com/3-506-1001).
The information can be divided into several varieties. Some of these are covered in more than one place in the information paper.
The service charge accounting period.
The basis of apportionment including the contributions from the landlord (seller) for any void units.
The service charge budget.
Copies of the service charge accounts.
Copies of the latest on-account service charge demands.
Which expenses are billed to particular tenants alone, rather than through the service charge. The buyer needs to know how these expenses are calculated (including up-to-date meter readings, if appropriate) and will require a copy of the most recent demands for such expenses.
Other income credited to the service charge.
The credit balance (if any) in the service charge account and who is entitled to it, and interest earned on it.
This type of information is often supplied in response to enquiries before contract:
Tenant names, addresses, trading name and contact details.
A schedule of the current tenancies, including start dates and likely termination dates.
Details of any arrears (presumably of service charge payments, though in places the information paper seems to refer to all arrears) and disputes with occupational tenants about those arrears.
This will include a list of the expenditure for the current service charge year and copies of the invoices (so that the buyer will have the relevant information to produce to occupational tenants if they contest the service charge accounts for that year).
This type of information will include:
The final reconciliation of the service charge expenditure and income for all previous service charge years that have not been closed by the date of completion of the sale. The format of this reconciliation should comply with the occupational leases (which may require a certificate or an audited statement).
The final statement comparing the service charge expenditure incurred and service charge income received by the seller for that part of the current service charge year up to completion.
Notes on why expenditure differs from the budget.
The information paper proposes several time limits:
Most of the information is to be provided before completion, or within seven days after completion.
The information for that part of the current service charge year up to completion, and the final reconciliation for any previous service charge years, should be provided in a timely manner and certainly no later than four months after completion. This is consistent with Paragraph 4.6 of the RICS code of practice on service charges in commercial property: RICS: Service charges in commercial property - RICS Code of practice (2nd edition) (May 2011) (www.practicallaw.com/7-505-9708)).
Payments due (for example, any credit balance on the service charge account, or balancing payments when the final statement is produced) should be made within seven days of the issue of the reconciliation that showed the amount due.
The information paper is not consistent in benchmarking time periods to completion or to the completion date (which may well be different). This will, no doubt, be tidied up in later versions.
For previous service charge years that remain open at completion, the information paper states that the buyer should issue to the occupational tenants the eventual demands for any additional service charge contributions or credits for any overpayments on account. It also says that the seller is responsible for any arrears for those years (which may be intended to mean that, if the tenants do not pay the additional contributions, the seller has to bear the shortfall).
For the service charge year that is current at completion, the information paper requires the buyer to pay to the seller any shortfall between service charge expenditure and income. The buyer can then pursue the occupational tenants to recoup that shortfall.
There will not always be a sinking fund, reserve fund, or depreciation charges. However, where they do apply the seller should supply the following information before or within seven days after completion:
How much is in the sinking fund.
The tax liability due on the sinking fund and interest earned on it.
Details of any trust applicable to the sinking fund (for example, in favour of the current occupational tenants).
The assets covered by the sinking fund, how much is allocated to each, their life expectancy, and what has been spent already from their allocation.
The amount contributed by the landlord (seller) to the sinking fund and how this was calculated.
For depreciation charges, very similar information is required.
Utility companies may have required the seller to pay a security deposit, as a condition of supplying the service. The information paper reminds the parties to deal with this. Possible courses of action include:
Arrange for a refund of the security deposit by the utility company to the seller and for the buyer to provide its own deposit (which may be required to be a different amount).
Arrange for the utility company to hold the deposit for the buyer, following completion, and for an equivalent sum to be added to the purchase price to reimburse the seller.
Arrange for a refund to the seller, because the buyer is intending to make its own arrangements, with a different utility company, for continued supplies after completion.
The information paper explains how important it is for the buyer, or its agent, to know early on what supplier contracts there are, how they can be terminated validly and on what notice period, what work is done under the contract and how the payment arrangements work.
It seems to recommend that the contract imposes the following obligations (but in places the details do not quite fit together):
The seller should disclose all supplier contracts that cannot be novated to the buyer, or terminated on a period of one month or less. The buyer can then decide what it wants to do with those contracts. It is not clear why the seller should not disclose those which can be terminated on shorter notice, as the buyer is likely to want to be able to plan ahead for those too.
For other supplier contracts, the seller should secure their novation to the buyer within one month of completion, or give notice to terminate them by expiry of that month. It is not clear whether responsibility for payments due under contracts that are being terminated passes to the buyer from completion until termination.
Any supplier contract that is not disclosed will remain the responsibility of the seller (who must pay any sums due under it, and secure its eventual termination). The buyer will not inherit either the contract, or liabilities under it.
The RICS will amend and develop the information paper in response to comments and changes in the market.