Mixed use properties comprising commercial and residential elements are understandably an attractive prospect for investors. Typically the investor will acquire the freehold and then grant leases of the commercial units whilst disposing of the residential element. To avoid a direct contractual relationship with residential tenants, investors often distance themselves further by selling the residential space to a developer under one long lease with the developer in turn selling each residential dwelling by way of a long sublease.
The freehold investor however will remain responsible for providing the repair and maintenance services of the structure and common parts of the building. The freeholder will invoice the tenant in accordance with the service charge provisions of the lease and the tenant will invoice the residential subtenant under the provisions of the sublease. Whilst there is no issue in this downward recovery of service charge from the end-user residential subtenant, the mechanism by which a landlord may apportion service charge to the residential subtenant has in fact been the subject of recent scrutiny by the Upper Tribunal.
Tracking case law
In the case of Windermere Marina Village Ltd v Wild , a lease of a residential dwelling provided for a variable service charge to be paid by the tenant rather than a fixed proportion. The lease further provided for the landlord’s surveyor to determine the amount of service charge. The First Tier Tribunal held that this provision was void under section 27A(6) of the Landlord and Tenant Act 1954 which renders void any agreement in the lease of a dwelling that the apportionment of service charge will be determined in a “particular manner” (for example, by a third party whose decision shall be final and binding).
Although the Windermere service charge dispute case involved a cause of action being brought by tenants under a direct contractual relationship with the landlord, it was nevertheless applied by the Upper Tribunal in Gater v Wellington Real Estate Limited and LCP Commercial Limited  where no such direct contractual relationship existed between the tenants and the head landlord. In this case the freeholder, Wellington Real Estate Limited, sought to distance itself from the residential element of the development by adopting the structure discussed above. The lease between the freeholder and the intermediate landlord (LCP Commercial Limited) contained an obligation to pay a fair amount of service charge as determined by the freeholder’s surveyor. The sublease between the intermediate landlord and residential subtenants imposed an obligation to pay a fixed proportion of the service charge payable by the intermediate landlord to the freeholder.
Following an exponential increase in service charge demand, the residential subtenants sought an application of the First Tier Tribunal to determine a fixed apportionment of service charge allocated to the intermediate landlord under the head lease as opposed to a fair proportion. On appeal, the Upper Tribunal applying Windermere held that the existing service charge provision in the head lease was void whether in this case it was expressed to be final and binding or not. The subtenants were given leave to apply to the First Tier Tribunal for determination of the intermediate landlord’s service charge obligation under the head lease.
These cases highlight the need for investors of developments containing a residential element to be extra vigilant that any agreements with residential tenants provide appropriate mechanisms for applying fixed apportionment of service charge.