UNIT 2, SECTION 4

SERVICE CHARGE RECOVERY

One of the elements of managing a leasehold property is the maintenance of cash flow
through the service charge account. Much can be achieved by intelligent budgeting and
efficient control of expenditure but the best regulated schemes are liable to be
undermined by leaseholders falling into arrears with their service charge contributions.

This section will look at measures which can be taken to keep debtors under control and
the procedures which can be followed to bring in debts through enforcement as a last
resort.

LEARNING OBJECTIVES

Having completed this section you will know and understand how to

• summarise basic steps to avoid debts accumulating

• describe the initial steps in pursuing debts
• explain the options for debt recovery action
• describe how fees and charges may be collected

4.1 Managing debtors

One of the essential ingredients in managing cash flow is the control of debtors.
Leasehold property managers are most likely to encounter debts in the context of
service charge arrears. The lease imposes an obligation on the leaseholder to pay the
proper service charge (with legislation inserting that it must be reasonable) and failure to
do so is a breach of the lease. In addition, the landlord or manager, as trustee of the
service charge account, has an obligation to collect the service charge contributions and
maximise the benefit to the trust fund (see Unit 2, Section 3.5).

It is important to have clear, sensitive procedures which are adhered to and regularly
reviewed. In seeking to minimise the impact of debt, procedures can be proactive as
well as reactive. They may include

• issuing demands in advance of due dates (but not excessively so)

• facilitating ease of payment (like direct debits or automatic bank transfers)
• it may be appropriate sometimes to offer concessions on payment terms.
If so, leaseholders should be reminded that such concessions are not to
be taken as binding in the future or creating any kind of precedent
• good communication with leaseholders to keep them informed and reduce
the scope for disputes (for example, through detailed budgets, explanatory
notes and meetings with leaseholders)
• remind leaseholders tactfully of the sanctions and costs they might incur if
service charges are not paid

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Managers need to understand that service charge arrears do not always build up
because leaseholders wish to be awkward but that they can spring from a huge range
of different reasons, including

• leaseholders in financial difficulties

• difficulties may be short term: for example, a leaseholder may have
inadequate savings to deal with a significantly increased service charge
for a one-off item like a lift renewal, especially if the leaseholder is on a
fixed income
• the problem may be long term, such as unemployment
• leaseholders may dispute the service charges on grounds of
reasonableness or legality or the validity of the demand
• leaseholders may not understand the demand or the service charge
• sometimes, leaseholders may not understand they have an obligation to
pay – this can arise especially where relatives are administering the estate
of a leaseholder who has died
• some leaseholders are persistent late payers
• incorrect payments
• accounting failures (for example, incoming payments may have been
posted to the wrong leaseholder’s account)
• demands have been incorrectly addressed
• the new leaseholders (or their solicitors) have failed to serve the notices
required by the lease when flats have changed hands

As you can see, arrears can build up because of a number of failings either on the part
of the leaseholder or your own organisation. Or the debt could simply be the result of a
misunderstanding. Most of these problems can be resolved by discussion between the
parties concerned or by correcting records. A good debtors’ management procedure will
allow for such issues to be identified and rectified swiftly and efficiently. In what should
be the minority of cases which cannot be solved it may be necessary to take firmer
action.

SELF CHECK QUESTION 1

The leaseholders of 27 Scallywag Court are two weeks late in paying the current interim
service charge. They have never been late before to the best of your knowledge except
on one occasion when they called before the due date to warn you there had been a
mix-up at their bank. Payment was received within 14 days after the due date. On this
occasion you have heard nothing. What steps might you take before instigating arrears
recovery procedures?

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4.2 Initial arrears procedures

It is important to appreciate from the outset that any action taken (or threatened) for
service charge debt must be carried out on behalf of the party legally entitled to receive
the service charge payment. This will be either the landlord or the management
company (depending on the terms of the lease) or, if the Right to Manage has been
exercised (see Unit 1, Section 3.10), the RTM company. Unless it is a party to the lease
concerned, the managing agent should not take action in its own name.

A number of actions can be taken to recover a service charge debt, which may be
undertaken in conjunction with the collection of ground rent arrears. First, a clear
procedure for chasing arrears should be in place with dates set for each stage after the
due date for payment has passed. For example,

• reminder letter 14 days after due date

• final reminder 21 days after due date with a warning that legal action will
be instigated within seven days if payment is not made
• legal action instigated 28 days after due date

When setting the dates that the various stages of the procedure are put into effect,
consideration should be given to the circumstances of the leaseholder group. Subject to
that, action should be taken on the date notified. Indeed, it is generally preferable to
specify a date for the next step rather than saying “after seven days” or whatever may
meet the case.

Where there is more than one leaseholder to the flat concerned, it is recommended that
correspondence warning of legal action be addressed separately to each one.

If the leaseholder has a mortgage on the flat (which can be checked at the Land
Registry), it is often wise to notify the lender of the debt. When breaching the lease, the
leaseholder will also be breaching the mortgage agreement. Ultimately, lenders will want
to protect the security of their investment but they are unlikely to settle the debt (which
would then be added to the mortgage) unless their borrower (the leaseholder) agreed or
a court order or LVT determination was in place.

The rules governing the conduct of cases in the civil courts of England and Wales (the
Civil
Procedure Rules or CPR) require that letters warning of imminent legal proceedings
(“letters of claim”, traditionally known as “letters before action”) meet basic criteria under
the CPR’s pre-action protocol. The criteria are contained in the Practice Direction on
Protocols under the CPR. Essentially a letter of claim should

• give a clear and concise summary of the facts and what the claimant is
seeking
• refer to the availability of legal advice
• give a reasonable time for a reply
• inform the recipient that proceedings will be commenced without further
notice if no reply is received by a specified date
• if any information is requested, allow reasonable time for investigation and
reply

The more complicated the claim, the more the courts will require of the letter of claim.
However, in a relatively simple debt case the letter can be quite straightforward.
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Nonetheless, it should state clearly who is making the claim and for what and comply
with the fundamental requirements of the protocol. Failure to do so could lead to
subsequent penalties by the court, possibly including the striking out of the claim. If
your organisation conducts its own chasing procedures for arrears and you have a
role in that process you should take careful note of these criteria.

SELF CHECK QUESTION 2

The leaseholder of 14 Tenderfoot Mansions is Mr G Rumble. Mr Rumble owes one

instalment of ground rent of £50 and two instalments of interim service charge of £200
each.
You are managing the property on behalf of the freeholder, Tenderfoot Mansions
Management Limited. You are requested to instigate legal proceedings to recover the
arrears. Write a letter of claim to Mr Rumble.

4.3 Legal action

If arrears cannot be solved otherwise, it will be necessary to take legal proceedings

against leaseholders. Legal action can take the form of seeking a judgment for the debt
or forfeiture of the lease. Both require proceedings through the relevant court (nearly
always the county court) and, if necessary, enforcement measures are available. If
either type of case is defended then the matter will be heard by the court or referred to
the LVT. At all stages, you should try to ascertain whether or not the leaseholder
accepts the claim as this is likely to determine whether the matter will be dealt with by
the court or the LVT (which will carry implications in terms of recovery of the costs of the
proceedings).

Debt recovery

If proceedings to recover the debt are successful, the claimant (which will be the party
entitled to recover the arrears contractually under the lease – managing agents should
not sue in their own name) will be granted a judgment by the court (commonly known as
a “CCJ”) to cover the money owed and hopefully an award of interest on the arrears and
an amount towards the costs of the proceedings. The judgment debt incorporating these
figures may be settled by the leaseholder promptly or by instalments or the leaseholder’s
mortgage lender can be prevailed upon to discharge the sums owing on his behalf.
Failing payment by any of those methods, it will be necessary to enforce the judgment
through one or other of the measures available through the courts, including principally:
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 • Warrant of Execution – a visit from the county court bailiff which may
result, if necessary, in some of the leaseholder’s belongings being seized
and sold to satisfy the judgment debt
• Third Party Debt Order – a third party (often a bank or building society)
who owes money to the debtor can be ordered to pay to the claimant
instead (this can be especially useful if the leaseholder is deriving an
income from subletting)
• Attachment of Earnings Order – an employed debtor may have regular
payments deducted from his salary to satisfy the debt
• Charging Order – the debt can be secured against land or shares in which
the debtor has a beneficial interest (this can be followed up by an Order
for Sale of the property to satisfy the debt in extreme cases)

Whichever method the claimant selects should be determined by the individual

circumstances of the leaseholder owing the debt. If little is known about them, the court
can order the debtor to attend court to be questioned about his means.

Forfeiture

Alternatively, because non-payment of monies due under a lease represents a breach of

the leaseholder’s covenants in the lease, the landlord may threaten forfeiture. Forfeiture
means the early termination of the lease by the landlord taking possession of the
property, through court order or (very occasionally) physical re-entry, so that it reverts to
the landlord without any compensation to the leaseholder. If a lease is forfeited, the
landlord is notionally entitled to deal with the property as he sees fit (including, for
example, by granting a new lease).

As we have already seen (especially in Unit 1, Section 3.1 and Section 2.4 of this unit),
the landlord’s right of forfeiture has been very severely restricted by legislation and case
law, but it does still exist. Forfeiture is now a weapon of last resort but there are a few
circumstances in which it may still be necessary to deploy it. These would be in cases
where there are no realistic alternatives available which will result in the breach of
covenant concerned being remedied. These circumstances are rare but they include

• the property has been abandoned and there are no means of tracing the
leaseholder
• the leaseholder simply refuses to meet his obligations and none of the
usual enforcement measures work
• the leaseholder persistently gets into arrears and other recovery methods
have become uneconomic
• the arrears are a relatively minor issue compared to other breaches of
covenant which make it intolerable to continue with that leaseholder (or,
possibly, the leaseholder’s sub-tenants)

Remember, forfeiture cannot be commenced nor even threatened unless and until

• the leaseholder has admitted or agreed the existence of the breach of

covenant giving rise to the use of forfeiture, or
• the breach has been determined by a court, the LVT or by arbitration
under a post-dispute arbitration agreement, and
• at least 14 days have expired following the determination and any
appeals, and
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 • the breach remains unremedied

Although the LVT’s jurisdiction is not exclusive, most service charge determinations are
now carried out by the LVT. Among the advantages of applying to the LVT is the point
that a single LVT case can determine the service charge contributions of any number of
leaseholders in the same scheme – something which is not available through the courts.

Other alternatives

Depending on the individual circumstances of the case, a property manager may

consider the use of alternatives like debt collection agencies or bankruptcy petitions.
However, they tend to be little used in the residential leasehold context, both because of
their limited effectiveness and because of their unpopularity in principle.

The least active policy is to wait and see. Some leases state that the landlord’s consent
must be obtained prior to an assignment of the lease and this can also be the case in
respect of under-letting or an alteration of the property. In these circumstances, the
landlord may withhold consent until settlement of any outstanding arrears. Even if
consent is not required, it is often the case that arrears will be discharged on an
assignment, with payment being made from the proceeds of the sale.

SELF CHECK QUESTION 3

Refer back to the scenario on question 2. Tenderfoot Mansions Management Limited

now has a judgment against Mr Rumble for approximately £550 including interest and
costs. You know that Mr Rumble lives alone and that he has caused some annoyance to
his downstairs neighbour because of the volume of his luxurious home cinema system.
He is semi-retired but has a part-time security job to which he drives in his 10-year-old
Ford Fiesta. You know he has a bank account because when he pays monies due he
usually pays by cheque. However, you do not know how much is in his account. On file
is a Notice of Charge showing a mortgage over the flat but you do not know how much
equity is in the property. What enforcement methods would you recommend and why?

4.4 Penalties for late payment

Managing leasehold property is hard work at the best of times but when the task of
managing debtors is added, property managers’ workloads increase significantly.
Chasing arrears and going through court and LVT proceedings are very time-consuming
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and expensive. This section will take a brief look at how managers can recover some
recompense from defaulting leaseholders rather than necessarily from the service
charge (as passing on costs to the service charge can be perceived as unjustly
penalising the majority of leaseholders who make payments on time).

Interest charges

Some leases allow for penalty interest to be charged in respect of outstanding arrears at
a specified rate. Penalty interest is particularly useful in the case of persistent late
payers.

However, interest can only be charged if it is specified in the lease or if it is awarded by

the court as part of a judgment.

It is possible to apply to the LVT for a variation of a lease to include provision for interest
on late payments. Such applications are made under Section 35 of the Landlord and
Tenant Act 1987 (see Unit 1, Section 3.6). On the other hand, the LVT also has the
power to prevent landlords from relying on penalty clauses which it regards as
unreasonable and high rates of interest could fall into this category.

Late payment fees

Many leases provide for the payment of some form of penalty or compensation to
landlords or managers when leaseholders allow breaches of their covenants to occur.
There is a great variety of descriptions and definitions but their purpose is the same.
They can provide some comfort to landlords and managers, especially perhaps to
residents’ management companies which have no other resources to fund arrears
recovery measures. However, certain fundamental points must be borne in mind.

• As with all other charges on leaseholders, it is only permissible to claim

what is expressly allowed by the lease. For example, a clause which
provides that the leaseholder must pay the landlord’s costs “of and
incidental to the preparation of a Section 146 Notice” (a common form of
words) will not entitle the landlord to recover the costs of debt proceedings
which have nothing to do with Section 146.
• If the lease is silent on the question of late payment fees or penalty
charges then they cannot be charged.
• However they may be described, these charges are administration
charges and they come under the statutory regime for administration
charges introduced by the Commonhold and Leasehold Reform Act 2002.
• They are not payable unless any demand for them is accompanied by a
summary of the leaseholder’s rights and obligations.

Costs of court proceedings

Most proceedings to recover arrears will either result in a judgment obtained in default of
defence (an uncontested action with no need for a hearing) or, if defended, a hearing
before the District Judge on the “small claims track” in the county court. Generally, all
claims for £5,000 or less are dealt with as small claims.

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Apart from reimbursement of the fees paid to the court, only solicitors’ costs are
recoverable on default judgments. In small claims, apart from exceptional cases of
flagrantly unreasonable conduct by the other side, only fixed solicitors’ costs and limited
compensation for loss of income and out of pocket expenses are awarded.

Even in higher value cases heard in the “fast track” or “multi-track” the costs which can
be awarded to representatives other than lawyers are very strictly limited.

Costs of LVT proceedings

The LVT has power to award costs but it is also very limited. It may award
reimbursement of fees paid to the tribunal and it may allow up to £500 against opposing
parties but only if that party has acted “frivolously, vexatiously, abusively, disruptively or
otherwise unreasonably in connection with the proceedings”.

Meanwhile, under Section 20C of the Landlord and Tenant Act 1985, the LVT may
prevent a landlord or manager from adding the costs of proceedings to a service charge
(as opposed to an individual leaseholder’s account – that would be an administration
charge).

SELF CHECK QUESTION 4

You are still engaged on attempting to recover the arrears of Mr Rumble of 14

Tenderfoot Mansions. In the meantime, he has failed to pay a further instalment of
service charge of
£200 and your accounts department has added that and a late payment fee to his
account. Could these sums be added to the enforcement action for the existing
judgment? If not, how might they be recovered?

4.5 Management fees and commission

Managing agents get the bulk of their income from the management fees they charge.
Those fees may be fixed by agreement between the agent and the client or a
percentage of the total service charge costs for the accounting year. In addition, the
manager may be able to recover some specific costs if these are clearly identified in the
lease.

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The lease will sometimes specify the basis on which any management fees are to be
calculated. As with other service charge items, management fees must be reasonable
having regard to the services provided. If a new management agreement is proposed for
more than 12 months and any one leaseholder will have to pay more than £100 per
year, the landlord must consult leaseholders about it under Section 20 of the Landlord
and Tenant Act 1985 (see Section 2.2 of this unit). Part of that process is to invite
leaseholders to nominate other potential managers.

In a new lease – or when an existing lease leaves it open – it is generally accepted that
fees should be set per accommodation unit rather than as a percentage of outgoings or
income. The RICS service charge code states that “this is considered to be preferable
so that leaseholders can budget their annual expenditure”. The ARHM code is more
prescriptive, stating: “You should not use any other method of calculating management
fees (for example, charging a percentage of outgoings or income) unless a lease
entered into before this Code specifically provides for another method of collection or
unless it can be shown that such an arrangement does not operate to the potential
disadvantage of leaseholders”.

Although management fees may be set per dwelling in a property this does not mean
that leaseholders will inevitably pay the same fee. Total management fees (number of
units multiplied by the unit fee) are apportioned between leaseholders in the same way
as all other service charges. Therefore, if some leaseholders pay a higher proportion
than others then they will pay a higher management fee as well.

There is no fixed definition of what the management fee should pay for – or, therefore,
what other services should be billed separately. Indeed, the balance between the two
can change over time without leaseholders always being made aware of this. Managers
should provide a list of the duties which are included in the basic management fee and
itemise and price those which are charged separately. Leaseholders should be advised
of any changes before they are implemented.

Management fees of social landlords

Retirement schemes with dwellings first sold before April 2001, which receive a public
subsidy (housing association or social housing grant) and are managed by registered
social landlords, are subject to statutory limits. The limits are computed on a flat rate, per
unit basis taking no account of property sizes or the type of scheme.

No one leaseholder on such a scheme should be required to pay more than the
prescribed limit. The limits are reviewed annually by the Government and published by
the Housing Corporation.

Fees for registrations, approvals and conveyancing

As discussed earlier in Section 1.7 of this unit, many leases provide for the landlord or
manager to be paid fees for providing occasional, ancillary services such as

• registering notices of assignments, mortgages and sub-lettings

• approving licences to assign or carry out alterations

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 • considering grants of consent to a wide variety of matters from keeping
pets to erecting aerials

Moreover, managers can derive an income from matters outside leases like responding
to conveyancing enquiries from leaseholders’ solicitors.

However, managers should always be conscious that administration charges (as some
of these items are) are only payable to the extent that they are reasonable (see Section
4.4 above).

Commission

Management fees are not the only source of potential income for managers. They may
also receive commission from companies which provide services on a development,
such as insurance. RICS, ARMA and ARHM adopt essentially similar positions on the
issue of declaring commissions, which is that if commissions are received there should
be complete transparency and openness with clients and leaseholders about the sums
involved.

RICS – “Insurance commissions and all other sources of income to the managing agent
arising out of the management should be declared to the client and on written request to
leaseholders.”

ARMA – “If an agent receives commission directly or such commission is paid to any
other member of the same group of companies as a result of undertaking the
management, then ARMA requires that it is declared to the client, whether an investor
landlord or a residents management company. If a lessee or residents association
makes a written request then an agent should declare any insurance commission
receivable.”

ARHM – “You should declare to leaseholders on request any commissions (eg,

insurance commissions) and all other sources of income arising out of the provision of
services to your schemes, and be able to demonstrate that any service involving receipt
of commission represents good value for leaseholders’ money”.

SELF CHECK QUESTION 5

Locate a copy of the RICS Service Charge Code or the ARHM Code of Practice (or
both if you can) and look at their lists of services normally covered by the
management fee and of extra services attracting additional charges. Make a note of
where they are to be found as well as considering their contents.

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