The end of the line for overinflated service charges?

The news that Westfield, the shopping centre owner, has managed to cut the service charge at its London Shopping Centre following a campaign from retailers has been hailed a minor victory for disgruntled retailers unhappy at paying what they perceived as over the odds for their service charge.

The action taken by the retailers at Westfield is a tangible example of what retailers can do if a concerted effort is made by all the occupiers to make a landlord bow to commercial pressures.

The action by the tenants at Westfield may have been borne purely out of the current economic climate, but are tenants able to rely on the provisions of their leases to obtain the best value for services they are provided with?

The argument over how much a particular tenant should and should not pay for a particular service is not a new one. The classic example is the age old bugbear of ground floor tenants who state “I don’t use the lift so why should I pay for it”. Contract is king in the context of purely commercial properties, so landlords have historically drafted their leases as widely and as ambiguous as they can to claim for everything they want, using sweeper clauses as a fall back should a tenant expose a gap in the landlord’s charges.

Case law has chipped away at the ability of landlords to demand excessive service charges during the term of a lease. These cases have made landlords think more carefully, not only about the drafting of their leases but also the methodology of calculating the amounts charged to tenants.

Advances have been made with the British Property Foundation’s Code for Leasing Business Premises and the RICS 2006 Code of Practice on Service Charge in Commercial Premises, although the extent to which these have been adopted is questionable. It is hoped that one day, a landlord who is Lease Code compliant can advertise this and it will be seen as a kite mark for good landlords.

Driven by financial pressures, tenants are now more willing to take on landlords. The case of ‘Boots UK Ltd v Trafford Centre Ltd’ last year is a good example of tenants challenging the ability of a landlord to charge for items (in that case for the promotion of a centre) which they see as being outside what the landlord can properly charge for.

Should a dispute ever trigger legal proceedings, a court would look at the contract and the terms of a lease between the parties to govern their relationship. It may take a lot for a court to infer anything else. The Westfield case has shown that landlords do respond to commercial pressures imposed by the tenants who provide their income stream, and commercially why shouldn’t they? The difficulties occur when interpreting a lease and trying to unravel or amend an agreement which has already been struck.

Tenants who are looking at what they already have and what they may be able to negotiate should refer to the following points:

• Rent Will the landlord accept rent payable monthly in advance? Would this assist cash flow?
• Rent reviews There is some merit in moving towards fixed up lifts and treating the lease more like a bond rather than a traditional market reviewed rent. We may even see the introduction of downward reviews.
• Repairing obligations Tenants are now insisting on more reasonable repairing obligations. Generally a tenant should not sign up to renewal or rebuilding covenants and should only commit to more onerous repairing obligations if warranties or guarantees are available. Landlords should not expect, although some still do, a tenant in a second-hand space to sign up for a full repairing lease unless of course any potential dilapidations claim is rentalised or there is some other concession made for the state of the premises.
• Break clauses This gives the tenant greater flexibility but leaves the landlord with an uncertainty over their income stream. Again, this can be incentivised by rent free periods if tenants do not exercise breaks- or penalties if they do.
• Assignment This is a difficult balancing act for landlords. They want to exercise reasonable control over the assignment of the lease however, if the assignment provisions are too onerous this affects the ability to assign and thus the value of the lease.
• Sub-lettings A tenant will want the ability to sub-let at the market rent not the passing rent and be able to offer terms outside the lease. This ensures that surplus accommodation can be sub-let and at the moment, tenants are looking at the properties that they rent with a view to sub-letting and mitigating their exposure. Obviously they are not able to do that if the sub-letting provisions are particularly tight. From the landlords’ perspective, if the balancing act is done correctly then the tenant is encouraged to make better use of the space and is therefore more likely to stay and renew.
• Alterations The landlord should be prepared to take a more relaxed view on structural and external alterations depending on the configuration and nature of the building. It is obviously not unreasonable to insist on landlord’s consent for any structural alterations. An institutional landlord should not have any problem in any alteration so long as the obligation to reinstate at the end of the term exists is clear and specifically set out exactly what the alterations comprise so there is no argument over what the tenant should reinstate at the end of the term. Any licence to alter should include both before and after drawings to assist in the reinstatement and also, if applicable, this should assist in rent review negotiations.
• Rent review The lease needs to include clear hypothetical lease assumptions and disregards within the review clause and reflect the reality of the lease and the nature and peculiarities of the building.

After Westfield, landlords may be more willing to take a flexible approach on service charge items and the other substantive terms of the leases they grant.

Institutional landlords will have to get used to the prospect of shorter lease terms, realistic and accountable service charge provisions and the fact they will not be able to pass on all costs to prospective tenants. The property market will always adapt to changes in circumstances as it is very dynamic. What landlords need to do is look beyond the current leasing structure and focus more realistically on the re-letting prospect of the building once the current lease expires. In essence, does a landlord want an occupied building, albeit on slightly less favourable terms than they would like, or an empty building which they are going to be responsible for?

It may be that tenants ask for shorter lease terms, but given the current trend for consolidation both landlords and tenants may show more loyalty to the buildings they are in – which means we may find situations such as the one at Westfield more common.

For more information
Matthew Williamson, associate in Weightmans’ commercial property team. Please email at matthew.williamson@Weightmans.com