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Chalet tenants could be paying service charge of over £550,000 by 2072

Service charge clauses are often lengthy and complex. One way to avoid such complexities is to agree a fixed charge, which is increased by reference to an agreed index (such as the Retail Price Index or Consumer Prices Index). Alternatively, the fixed sum may increase by a set percentage each year. The problem with such a formula is that it can have unintended results. The rents or service charges may rise to a level never contemplated by the parties at the outset.

This is what was agreed in Arnold v Britton. The case concerned leases of chalets in a holiday park in Wales granted in the 1970s for terms of 99 years. There were various versions of the service charge clauses but the important point was that they provided for an initial service charge of £90 to increase at a compound rate of 10% in each succeeding year.

The tenants argued that the 10% increase in each year was a cap on the service charge. Their view was that the sum was not a fixed sum, but was a service charge within the meaning of section 18(1) of the Landlord and Tenant Act 1985, ie a variable sum according to the expenditure of the landlord on the services.

The landlord's view was that the sum was a fixed sum, and did not fall within the meaning of service charge under section 18(1).

In the County Court the tenants were successful. The judge held that the services offered by the landlord were limited and that a landlord should not be making a profit from a service charge.

Both the High Court and Court of Appeal held that this decision was wrong. Whilst the remorseless compounded increase in the payment for services was not at all attractive this was the bargain that had been made between the parties. Yesterday the Supreme Court confirmed the decisions of the High Court and Court of Appeal - that service charge clauses are not subject to any special rules of interpretation.

The wording of the clauses, although unfavourable to the tenants, is clear. At the time that many of the leases were granted, inflation was over 10%. Therefore, whilst a tenant may not have been wise in entering into such clauses in 99 year leases, at the time of the grant, the landlord would have obtained a greater sum if the increase had been linked to inflation. The Supreme Court made it clear that it is not willing to depart from the natural meaning of a clause even if that means that one party is unfairly prejudiced.

The Supreme Court did, however, express its dissatisfaction with the result for the tenants, commenting that it was unfortunate that none of the statutory provisions which protect tenants against unreasonable service charges applied in this case. Lord Hodge stated that the "conclusion that the court does not have power to remedy these long term contracts so as to preserve the essential nature of the service charge in changed economic circumstances does not mean that the lessees' predicament is acceptable. If the parties cannot agree an amendment of the leases on a fair basis, the lessees will have to seek parliamentary intervention." So this may not be the end of the matter.

Both landlords and tenants granting new leases must be aware of the dangers of providing for increases in rent or service charges in a compound way. It is essential to run some figures through any formula and consider the end result.

Contributors: Alexandra Holsgrove Jones and Laura Ford

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at June 2015. Specific advice should be sought for specific cases; we cannot be held responsible for any action (or decision not to take action) made in reliance upon the content of this publication.

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