Budget Setting, Apportionment and Reserve/Sinking Funds
It is the lease that is the first point of reference when the service charge budget is set as it may have express provisions (clearly stated) that must be adhered to. Service charges are either a fixed or variable percentage with clearly stated contribution clauses but others will have very general and brief/restrictive contribution clauses such as ‘to pay a fair proportion of the cost of maintaining and repairing party walls and structures, shared pipes and wires and other things used in common’.
This somewhat woolly description means that agreement on how to interpret this can be very difficult and so leaseholders often compare the cost of their service charge contributions to those paid by others in the same block especially if they have similar leases, However working out the cost on different sized flats is a percentage cost based on a number of factors. So the apportionment should generally reflect the following:
- The number of rooms (usually bedrooms) in each flat especially if the block has more or less identically written leases;
- The size of the flats calculated by floor area and which is usually considered the most fair and is the most commonly used because a larger flat will have cleaning and decorating/maintenance liabilities than those of smaller flats;
- What facilities are provided and which flat uses them, (such as lifts or main front doors);
- The rateable value in largely pre-1990 leases (council tax banding).
- Other considerations can include the location and the view.
The methods used for applying apportionment will be one of the following 3 ways:
- A simple fraction, where a building with 20 flats with each flat owner paying one-twentieth of the service charge expenditure;
- A simple percentage, so one twentieth would be 5%;
- A variable percentage, where some flat owners may pay more because of size or overall number of rooms. For example if 10 flats have one bedroom and the other 10 have two, then the first 10 may pay 4% and the other 10 pay 6%.
Knowledge of the block, a site plan (or both) can also help to ensure the costs are divided fairly but the apportion payable per flat always needs to total 100%.
If there is no apportionment then leaseholders and freeholders can apply to the First Tier Tribunal to get them to determine what is payable under s27a of the Landlord and Tenant Act 1985. The FTT not only has the jurisdiction to determine whether the charges are reasonable but also to establish:
- Who is liable to pay;
- To whom the amount is payable to;
- The amount to be paid;
- The date and manner under which it is payable.
The FTT can also vary a defective lease as long as certain criteria is met.
RESERVE AND SINKING FUNDS
Most leases will usually allow the building up of funds to provide a safety net for both planned and unplanned long term expenditure. One is known as a reserve fund and the other is known as a sinking fund.
A buildings surveyor can put together a capital expenditure (CAPEX) report which will highlight how much is required to place in these funds each year.
Although the terms are used interchangeably, they both work in completely different ways.
A reserve fund is used to put aside money for work that is required on a regular basis, such as redecoration of the common areas. It can be drawn upon should the service charge account be empty and works need doing as a matter of urgency. It is also easy to gain access to it. If the lease doesn’t make provision for a reserve fund, if one is established then it’s not usually challenged because most leaseholders recognise it as being of benefit. On the other hand occasionally it will be challenged because the lease makes no provision for it.
A sinking fund on the other hand is set aside for larger, less frequent repairs, such as replacing a roof, windows or lifts as a building ages. The lease should set out what the sinking fund is to be used for and it is usually paid on the same percentage charge as the service charge contribution. How much should be paid is usually determined by a cyclical maintenance report carried out by a qualified surveyor. This report will identify the parts of the building that will need replacing over time and the prospective cost which in turn is divided by the number of years expected to pass before the work is required.
Holding the sinking fund in trust (with a Trust Deed) will avoid the consequences of an insolvent freeholder where the liquidator may try to seize the fund if it is not clearly designated as a sinking fund. The account should also provide a good rate of interest (just like the service charges) but care should be taken of any limitations set down in the Memorandum and Articles of Association (or other documents).
The only time the sinking fund can be drawn on for any other purpose is when the lease permits it to be used temporarily to finance the cost of routine services.
Unless the lease states otherwise, both funds are not refundable when a flat is sold and even at the end of the lease term, the leaseholder is still not entitled to repayment of the contributions made during the time of ownership.
DIVIDING THE BUDGET
The budget should be divided into clearly marked categories and subcategories and could look something like this:
- Accountant: Fees paid to an accountant to Audit or Certify the year end service charge reconciliation.
- Bank: Fees charged by the bank in relation to the developments bank account.
- Company and Secretarial Services (if applicable).
- Consultancy Fees and other costs in providing and reviewing all legally required risk assessments and audits.
- Managing Agent: Fees paid to the managing agent to include salaries and employment costs. In the case of RMCo’ s these fees are agreed between the agent and the company directors.
- Solicitors: Fees for the collection of service charge arrears as after a certain amount of time, they are often handed over to a debt collection company.
Health and Safety
- Health and safety audit of the common areas;
- Fire risk assessment;
- Maintenance of the fire control panels, air/smoke vents systems, lightening conductor systems;
- Water risk assessment;
- Five-year periodic electrical inspection;
- Maintenance of emergency lighting.
- All Risk buildings insurance costs where recoverable through service charges;
- Liability Cover for directors and officers;
- Insurance Revaluation to ensure adequate cover is in place (about every three to five years).
A good practice guide to service charge budget setting can be read here.