When it comes to the recovery of legal costs as a service charge, what has changed since the Supreme Court ruling in Arnold v Britton? Howard Lederman reports.
The Supreme Court in Arnold v Britton  A.C. 1619 has ruled that there are no special rules of interpretation which apply to service charge clauses. The old “restrictive” approach to the interpretation of service charge clauses has been criticised. The recovery of a landlord’s legal costs as a service charge remains a troublesome area, where the impact of Arnold v Britton is still being worked out.
Recovery of landlord’s legal costs as a service charge – the traditional approach
Conventional wisdom has dictated that, in order for a landlord to recover its legal costs of suing a tenant as a service charge, there needed to be a clause which permitted recovery in “clear and unambiguous terms”. This was the view taken by Taylor LJ in Sella House v Mears  1 E.G.L.R. 65. In that case, the service charge clause permitted the landlord to: “employ at the Lessors’ discretion a firm of Managing Agents … to manage the Building and discharge all proper fees salaries charges and expenses payable to such agents or such other person who may be managing the Building including the cost of computing and collecting the rents and service charges. . .” The Court of Appeal held that this was not clear enough to embrace the legal costs of suing the defaulting lessees.
Similarly, a service charge provision permitting the landlord “to employ all such surveyors . . . architects engineers . . . accountants or other professional persons as may be necessary or desirable for the proper maintenance safety and administration of the Building” was held in Sella House to be directed to maintenance, not the legal costs of pursuing defaulting lessees. The absence of reference to legal costs (or lawyers) was thought to be critical. Support for this approach was found in the judgment of Rix LJ in McHale v Earl Cadogan  HLR 24, at , who concluded that: “it is the policy of the authorities not to bring within the general words of a service charge clause anything which does not clearly belong there. To put the matter another way, service charge provisions have been construed restrictively”.
This approach to legal costs was also adopted in other decisions, including Greening v Castlenau Mansions  UKUT 326, Twenty Two Clifton Gardens v Thayer Investments SA  UKUT 71 and St Mary’s Mansions Ltd v Limegate Investment Co Ltd  1 EGLR 41.
A new approach to the interpretation of service charge clauses – the start of the change
The Court of Appeal in Arnold v Britton  A.C. 1619 endorsed the first instance decision of Morgan J., who had indicated that:
“I do not see why a service charge clause in a lease should be subject to a special principle . . . what is required is that the court must examine the wording of the charging provision, in its context and against all the admissible background and in the light of the apparent commercial purpose of the clause, and then decide what the provision means and how it operates.”
In Francis v Phillips  1 WLR 741, at , Sir Terence Etherton considered that service charge clauses needed to make the subject of legal recovery clear:
“it is reasonable to expect that, if the parties to a lease intend that the lessor shall be entitled to receive payment from the tenant in addition to the rent, that obligation and its extent will be clearly spelled out in the lease: see, for example, Gilje v Charlgrove Securities Ltd  1 EGLR 41 , para 31, per Mummery LJ . . . the tenant will wish to be fully aware of any such additional obligation on which his or her continuing right to possess the land and to occupy it may depend . . . the lessor will wish to make such a continuing additional obligation clear because it arises under a lease which will subsist through successive ownerships of the reversion and the tenancy and because the lessor will not wish to be out of pocket in respect of services provided for the benefit of the tenant.”
The next stage – legal costs of proceedings against an adjoining owner – no “magic words” required
The Upper Tribunal decision in Assethold v Watts  UKUT 0537 was one of the first to consider the new approach to interpreting service charge clauses. The issue was whether legal costs incurred by a landlord in obtaining an injunction against an adjoining owner prohibiting works on a party wall structure were recoverable as a service charge. The clause permitted recovery of costs of: “. . . all matters as in the reasonable discretion of the landlord might be considered necessary or desirable for the proper maintenance, safety, amenity and administration of the property”. The Deputy President, Martin Rodger QC, held that the landlord’s costs of such legal proceedings were recoverable as a service charge under this clause and, at , he stated:
“It seems to me to be wrong in principle to start from the proposition that, with certain types of expenditure, including the cost of legal services, unless specific words are employed, no amount of general language will be sufficient to demonstrate an intention to include that expenditure within the scope of a service charge. Language may be clear, even though it is not specific.”
The “sweeper” clause in Assethold was found to be sufficiently clear to enable recovery of such legal costs, despite the express reference to the landlord’s legal costs in other parts of the lease.
The impact of Arnold v Britton – what has changed?
As is well known, the Supreme Court restated the approach to be adopted in the interpretation of contracts in the context of service charge clauses. Lord Neuberger concluded, at :
“When interpreting a written contract, the court is concerned to identify the intention of the parties by reference to ‘what a reasonable person having all the background knowledge which would have been available to the parties would have understood them to be using the language in the contract to mean’, to quote Lord Hoffmann in Chartbrook Limited v Persimmon Homes Limited  AC 1101, para. 14. It does so by focussing on the meaning of the relevant words . . . in their documentary, factual and commercial context. That meaning has to be assessed in the light of: (i) the natural and ordinary meaning of the clause, (ii) any other relevant provisions of the lease, (iii) the overall purpose of the clause and the lease, (iv) the facts and circumstances known or assumed by the parties at the time that the document was executed, and (v) commercial common sense, but (vi) disregarding subjective evidence of any party’s intentions.”
Lord Neuberger emphasised seven factors, three of which may be of particular relevance in the present context:
“17. First, the reliance placed in some cases on commercial common sense and surrounding circumstances (e.g., in Chartbrook  A.C. 1101, at paras. 16-26) should not be invoked to undervalue the importance of the language of the provision which is to be construed. The exercise of interpreting a provision involves identifying what the parties meant through the eyes of a reasonable reader, and, save perhaps in a very unusual case, that meaning is most obviously to be gleaned from the language of the provision . . .
18. Secondly, when it comes to considering the centrally relevant words to be interpreted, I accept that the less clear they are, or, to put it another way, the worse their drafting, the more ready the court can properly be to depart from their natural meaning. . .
23. Seventhly, reference was made in argument to service charge clauses being construed ‘restrictively’. I am unconvinced by the notion that service charge clauses are to be subject to any special rule of interpretation . . . The origin of the adverb was in the judgment of Rix LJ in McHale v Earl Cadogan . . . What he was saying, quite correctly, was that the court should not “bring within the general words of a service charge clause anything which does not clearly belong there.”
What has changed? It is suggested that, in practice, not very much has changed. What is required is a vigorous analysis of the terms of the lease. The issue continues to centre on what is the meaning of the relevant words in their documentary, factual and commercial context. The factual matrix behind many service charge clauses is that the tenant has had no involvement in the drafting of the lease. “Commercial common sense” will often take a back seat to the other principles of interpretation. This is illustrated by recent Upper Tribunal decisions upon the meaning of service charge clauses concerning legal costs. Although the context of these decisions is residential property, similar principles will apply to commercial leases.
The significance of other provisions in the lease concerning legal costs
In Union Pension Trustees v Slavin  UKUT 0103, the landlord sought to recover the legal costs of Tribunal proceedings brought in order to obtain approval of a service charge. The service charge clause relied upon by the landlord read as follows:
“… any other costs and expenses reasonably and properly incurred in connection with the landlord’s Property including without prejudice to the generality of the foregoing (a) the cost of employing Managing Agents and (b) the cost of any Accountant or Surveyor employed to determine the Total Expenditure and the amount payable by the Tenant hereunder.”
The Deputy President, Martin Rodger QC, found such legal costs fell outside the clause. He placed weight upon the absence of any reference to lawyers or the costs of proceedings. The absence of a specific reference to legal expenses was not conclusive if there was other language apt to demonstrate a clear intention that such expenditure should be recovered. However, such an omission was significant when considering the meaning of the general words relied upon. In particular, there was a “very marked contrast” with an express covenant by the tenant to pay to the landlord all costs, including solicitors’, counsels’ and surveyors’ costs and fees, incurred in legal proceedings under ss.146 and 147 of the Law of Property Act 1925. The Deputy President emphasised that, at the date of the lease in 1981, before tribunals had jurisdiction to resolve service charge disputes, the parties would have anticipated that a dispute over the liability to contribute towards a service charge would be resolved in the County Court, and the successful party would recover its costs from the unsuccessful party. The idea that tenants should be collectively responsible through the service charge for litigation costs which had not been recovered from defaulting tenants would not have been obvious. The expectation was that the landlord’s costs would be recovered from the defaulting tenant, rather than through the service charge.
The latest ruling
In Geyfords Ltd v O’Sullivan  UKUT 683, another decision of Mr Martin Rodger QC, the landlord sought recovery of legal costs incurred by the landlord in County Court proceedings against lessees and of resisting Tribunal proceedings brought by lessees. The landlord relied on part of a schedule of service charge items which listed expenses to be incurred in maintaining and repairing the various parts of the building, cleaning and lighting the common parts, decorating and repairing the exterior of the development, discharging rates taxes and outgoings, and obtaining insurance against third party and public liability risks. The provision critical to the appeal was a “sweeper” clause enabling charge of: “All other expenses (if any) incurred by the Lessors or their managing agents in and about the maintenance and proper and convenient management and running of the Development”.
Other clauses in the lease were relevant to interpretation of the “sweeper” clause. Clause 3(i)(d) required the lessee to pay: “all costs, charges and expenses (including solicitors’ costs and surveyors’ fees)” incurred by the landlord incidental to the preparation and service of a notice under s.146 of the Law of Property Act 1925. Other clauses required the lessee to do everything in relation to the demised premises which might be required by any Act of Parliament or regulation, and to comply with the Town and Country Planning Acts. In each case, the lessee was required “at all times [to] keep the [landlord] indemnified from and against all actions proceedings costs expenses claims and demands in respect thereof.” The effect was that, if the landlord incurred costs as a result of the lessee’s breach of statutory requirement, the landlord would be reimbursed by the lessee.
Mr Martin Rodger QC held that “management” may sometimes include obtaining professional advice, including legal advice, and might involve litigation as in Reston Ltd v Hudson  2 EGLR 51, where the costs of proceedings to establish whether the repair of the windows in the building was the landlord’s responsibility fell within “the cost of management”. In so doing, he rejected the argument that the parties contemplated that the “sweeper” clause embraced the landlord’s costs of County Court and Tribunal litigation between the landlord and the lessees concerning enforcement and quantification of the lessees’ service charge liability. The Deputy President also referred to Sella House to illustrate the improbability that parties to a lease would regard general words as sufficient to express an intention that any shortfall in the landlord’s costs of litigation would be borne by the service charge fund. The Deputy President concluded that “clear and unambiguous terms” are required to impose what Taylor LJ in Sella House regarded as an onerous and unusual payment obligation. This was not the “heresy” of requiring “magic words” to impose liability for legal costs payable as service charge, but an orthodox interpretation of the lease.
So far as the statutory background to the lease was concerned, it was apparent that, in the late 1970’s, it was standard practice for payment of service charges to be enforced by proceedings seeking forfeiture of the lease in the County Court. Forfeiture would be avoided by the lessee (or the mortgagee) paying what was owed and the landlord’s legal costs on an indemnity basis. It would not have been expected that the landlord would incur costs in establishing the quantum of the service charge before a Tribunal operating in a no costs jurisdiction. The “sweeper” clause was interpreted on the basis that the landlord would have no need to recoup its legal costs through the service charge.
The law is stated as at 11 February, 2016.