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United Kingdom Upper Tribunal (Lands Chamber)
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Cite as:  UKUT 134 (LC)
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UPPER TRIBUNAL (LANDS CHAMBER)
UT Neutral citation number:  UKUT 134 (LC)
LT Case Number: LRX/16/2012
TRIBUNALS, COURTS AND ENFORCEMENT ACT 2007
LANDLORD AND TENANT – service charges – cost of employing full time resident caretaker – employment of such a caretaker not needed for the enjoyment of the building – however employment of such a caretaker needed to remedy breach of covenants in headlease – headlessee seeking to recover costs of employing such a caretaker (and notional loss of market rent of basement flat) through service charge – construction of lease – effect of sections 18 and 19 Landlord and Tenant Act 1985 as amended
IN THE MATTER OF AN APPEAL AGAINST A DECISION OF THE
LEASEHOLD VALUATION TRIBUNAL FOR THE
LONDON RENT ASSESSMENT PANEL
(1) LUDOVIC ADAM PAUL DE WALDEN Respondents
(2) CATHERINE CAMILLA DE WALDEN
Re: 3rd and 4th Floor Maisonette
15 Tite Street
London SW3 4JR
Before: His Honour Judge Nicholas Huskinson
Sitting at: 45 Bedford Square, London WC1B 3DN
on 5 March 2013
T C Dutton, instructed by Wilson Barca LLP, on behalf of the appellants
Helen Galley, instructed by the first named respondent, on behalf of the respondents
The following cases are referred to in this decision:
McHale v Cadogan Estate  EWCA Civ 14
Daejan Investments Limited v Benson  UKUT 233
Forcelux Limited v Sweetman  2 EGLR 173
Earl Cadogan v 27-28 Sloane Gardens Ltd  L & TR 18
1. This is an appeal from a decision of the Leasehold Valuation Tribunal for the London Rent Assessment Panel (“the LVT”) dated 7 December 2011 whereby the LVT decided certain points regarding the recoverability of sums claimed by the appellants from the respondents as interim on account service charges payable in respect of the third and fourth Floor Maisonette at 15 Tite Street (“the building”).
2. The building is a house on six floors comprising five units of habitation, namely a flat in the basement (which is central to the present case); flats upon each of the ground, first and second floors; and a maisonette on the third and fourth floor.
3. The appellants hold the building from Cadogan Holdings Limited (“Cadogan”) upon the terms of a headlease dated 23 March 1984 whereby the building was demised to the appellants’ predecessors in title for sixty years from 25 March 1983 at a rent of £1,250. per annum (subject to review). It is common ground between the parties that the nature of the building is not such as would lead one to expect the employment of a resident caretaker would now be needed. However the headlease contains covenants on the part of the headlessee not to use or permit the demised premises or any part thereof to be used otherwise than (so far as concerns the basement): a caretakers’ flat. Further, clause 2(11)(c) contains a covenant by the headlessee in the following terms:
“To provide for the demised premises throughout the said term a full-time Caretaker (who shall not be the Lessee or a Director or other officer of the Lessee if a company) who shall reside in the Caretaker’s flat rent-free as a licensee on a service basis and whose duties shall include (i) the cleaning of the entrances staircases halls passages and landings of the demised premises and the lift (if any) therein (ii) the daily emptying of the garbage bins of the tenants of the demised premises (iii) attending to and refuelling the communal boilers in the demised premises (iv) receiving and delivering to the several tenants of the demised premises all letters messages and parcels (v) reporting to the Lessee all defects in or to the common parts of the demised premises and (vi) the prevention of unauthorised persons from entering the demised premises.”
4. The respondents originally held the third and fourth floor maisonette on a lease dated 19 December 1984 expiring 22 March 2043. However the respondents exercised their rights under the Leasehold Reform, Housing and Urban Development Act 1993 to obtain an extended lease. This was granted on 7 November 2006 by Cadogan (the freeholder and competent landlord) and is for a term until 22 March 2133 at a yearly rent of a peppercorn (if demanded) and an insurance rent and also:
“THIRDLY by way of further rent the Service Charge payable in accordance with the Fourth Schedule hereto…”.
The lease was framed as being between Cadogan Holdings Limited (referred to in the Lease as the Company) and the respondents. Recital G made clear that until the expiration of the headlease the headlessee (namely the first appellant) would have the benefit of the rights and burdens and liabilities of the Company under the lease. The lease contained a covenant on the part of the Company (subject to payment of the insurance, rent and service charge and compliance with the various covenants in the lease) to use all reasonable endeavours to provide and maintain the services described in the Fourth Schedule of the lease.
5. The Fourth Schedule of the lease contained the following provisions:
(1) Paragraph 2 of Part 1 of the Schedule provided:
“The Lessees shall pay to the Company a Service Charge equal to a fair and proper proportion attributable to the Demised Premises of the cost of each of the services in relation to the Building and its appurtenances set out in this Schedule.”
(2) Paragraphs 9 and 10 of Part 1 of the Schedule were in the following terms:
“9. It is intended that all costs expenses and liabilities incurred by the Company in relation to the Building shall be fully reimbursed by way of the Insurance Rent and Service Charge payable under this lease and the leases that the Company has granted or intends to grant of the other parts of the Building.
10. The Company may amend suspend or withdraw the provision of any of the services to be provided under the terms of this Schedule where in the reasonable opinion of the Company such services are obsolete or unnecessary or otherwise are not to the benefit of the Lessee and the other lessees of other parts of the Building.”
(3) Part 3 of the Schedule describes the various services which are relevant for the purposes of the lease. Paragraph 5 is in the following terms:
“5. Employing (whether by the Lessor or the Company or by any other individual firm or company) such staff as the Company may in its absolute discretion deem necessary to provide caretaking services for the Building and its appurtenances including all incidental expenditure in relation to such employment including but without prejudice to the generality of the above
5.1 Insurance pension and welfare contributions
5.2 The provision of uniforms and working clothing
5.3 The provision of tools appliances cleaning and other materials fixtures fittings and other equipment for the proper provision of such services and a store for housing the same and other costs reasonably incidental to the same
5.4 Where accommodation is provided for the use occupation or residence of such person a sum equivalent to the market rent of such accommodation together with the cost of maintaining servicing overhauling repairing and when necessary rebuilding renewing and reinstating such premises furnishing and equipment and of providing all normal utilities outgoings and services to such premises.”
6. It appears that until about 2008, despite the covenant in the headlease regarding the use of the basement flat, the basement was in fact let by the appellants or their predecessors so as to obtain a commercial rent for the basement. Accordingly there was no resident caretaker in the building. However in 2008 Cadogan decided that it should complain about this apparent breach of covenant. The LVT records in paragraph 16 of its decision how Cadogan’s solicitors Pemberton Greenish wrote to the appellants’ solicitors a letter dated 8 April 2008 stating that the covenants had been broken in that the basement flat had been used otherwise than as a caretaker’s flat and that there was no full-time resident caretaker. The letter threatened to apply to court for a declaration that the appellants were in breach of these covenants. Consequent upon this letter the appellants decided that they should employ a full-time resident caretaker (“FTRC”). The appellants entered into a contract of employment with Ms Dziadosz requiring her to act as FTRC and to live in the basement flat rent free.
7. Having employed Ms Dziadosz in this manner as FTRC the appellants’ position was as follows. As against Cadogan they contended that they had dutifully complied with the covenants in the headlease, such that no forfeiture or other proceedings alleging breach could be brought against them. As against the respondents (and other lessees in the building) the appellants contended that paragraph 5 of Part 3 the Fourth Schedule was now engaged in that they were now employing a caretaker and were entitled to recover through the service charge the costs of doing so and also a sum equivalent to the market rent of her accommodation in the basement flat. (This latter claim was only available against the respondents and another lessee in the building who had both taken extended leases and whose leases contained provision enabling recovery of the market rent of the caretaker’s flat in these circumstances). The result of this was to increase greatly the amount of the service charges claimed from the respondents. By way of example, of the total annual budget for the year ended 31 March 2010 of £30501.12 no less than £22,556.12 was accounted for by charges for the FTRC and on top of this there was a further £26,000 allowed for the notional loss of the market rent of the basement flat. Thus the total estimated service charge costs (a proportion of which the respondents were required to pay) had increased from about £8000 to about £56,500 because of the employment of the FTRC.
8. The respondents contended that they were not liable to pay through the service charges for the costs of employing Ms Dziadosz or for the market rent of the basement flat. The appellants issued proceedings in the West London County Court seeking a declaration that certain sums were due and payable by the respondents by way of service charge. The County Court ordered that the matter be transferred to the LVT “in order to determine the issue of the reasonableness of the service charges associated with the issue of the employment of a caretaker and accommodation charges related thereto” and also in respect of certain other matters not presently relevant.
Proceedings before the LVT and its decision
9. Before the LVT the respondents pointed out that the nature of the building was such that the services of a FTRC were not required – all that was required was a cleaner. Until the change in about 2008 all that ever had been provided was a cleaner and this was all that was needed and was perfectly satisfactory. The respondents then argued:
(1) The employment of Ms Dziadosz was a sham – i.e. it was argued she was not in substance employed as a caretaker at all.
(2) It was an unreasonable exercise of discretion within paragraph 5 of Part 3 of the Fourth Schedule to employ a FTRC.
(3) In any event Ms Dziadosz provided the services of a cleaner and not of a caretaker, such that a cleaner is what should be paid for.
(4) If anything was to be payable in respect of the notional loss of the market rent of the basement flat, this market rent should be calculated on the basis of the existence of the user restriction limiting the use of the basement flat to accommodation for a FTRC.
10. Before the LVT the appellants accepted that, given a free hand, they would not have thought it appropriate to employ a FTRC. However the appellants drew attention to the covenants in the headlease and to the threats of legal proceedings received from Cadogan. The appellants argued:
(1) The employment of Ms Dziadosz was not a sham. A contract of employment had been entered into. The appellants were actually paying her for her services.
(2) Under the terms of the lease the expenditure incurred by the appellants for payment of Ms Dziadosz’s wages etc was recoverable. Any complaints regarding the quality of the services would be a matter for the future once the final service charge accounts for the relevant years were put in – this was not a relevant matter when considering estimated on account service charges under section 19(2).
(3) As regards the notional costs of the market rent of the basement flat, this was recoverable under the terms of the lease. In any event this notional rent was not a relevant cost within the meaning of section 18 of the Landlord and Tenant Act 1985 as amended and accordingly was not within the jurisdiction of the LVT to reduce or disallow under section 19 on the basis of reasonableness.
(4) As regards the amount of the market rent of the basement flat, this should be assessed on the basis that there was not in existence some restriction preventing the flat from being used for any purpose other than a FTRC. Reference was made to McHale v Cadogan Estate  EWCA Civ 14.
11. The LVT heard evidence, including evidence from Ms Dziadosz. The LVT dealt with the question of the “reasonableness or otherwise of the disputed estimated service charges” in the following terms in paragraph 67-75 of its decision:
“67. It is common ground between the parties that the Headlease imposes an obligation on the tenant thereunder to provide a full-time resident caretaker and not to use the basement flat otherwise than for a caretaker. The Applicants have given evidence that the freeholder was aware that they had previously been in breach of these covenants and that the freeholder was seeking to enforce these covenants, possibly with a view to trying to forfeit the Headlease. On the basis of the evidence presented, the Tribunal accepts that the freeholder has identified these breaches of covenant and that the Applicants have grounds for concern that the freeholder might indeed try to forfeit the Headlease. From the Applicants’ perspective, therefore, it seems to the Tribunal that it was prudent to do what they reasonably could to remedy the breaches of covenant.
68. Mr Dutton notes that the Applicants have the power under the Lease to provide caretaking services and to provide living accommodation for the caretaker and submits that this power together with their need to avoid being in breach of the Headlease made it reasonable to provide a full-time resident caretaker and to charge the cost to the leaseholders. Mrs Galley does not accept his analysis. Neither counsel brought any legal authority directly bearing on this point.
69. Having considered this issue at length the Tribunal is of the view that the disputed charges are of a greater amount than is reasonable. In their dealings with the freeholder the Applicants are obviously perfectly entitled to form a commercial view as to how to conduct their contractual relationship. It is also perfectly natural, on the basis of the evidence presented, that they should have come to the conclusion that it was prudent to employ a full-time resident caretaker in order to avoid being in breach of the Headlease, in other words to deal with their direct contractual relationship with the freeholder in a way that seemed to them best to serve their own commercial interests.
70. However, in the Tribunal’s view, it is a leap of logic to state that it is necessarily reasonable to impose on their own tenants the full cost of taking such a commercial decision if the cost is not otherwise a reasonable cost to incur. The Lease does indeed contain a power to charge for caretaking services and for a caretaker’s accommodation through the mechanism of notional rent but this is always subject to the statutory requirement of reasonableness, in this case pursuant to section 19(2) of the 1985 Act.
71. In this regard the Applicants’ own evidence is that the Building does not require a full-time resident caretaker, notwithstanding Mr Dutton’s comment that it can be an advantage to have someone available on call. The evidence shows that the Applicants did not choose to employ a full-time caretaker until pressured into doing so by the freeholder and the evidence suggests that they would not have done so at all if this pressure had not been exerted.
72. Therefore it seems to be common ground between the parties that the Building does not need a full-time resident caretaker and implicitly (or so it seems to the Tribunal) that only a cleaner is required. It is therefore hard to see how it can be reasonable to budget for and to impose on leaseholders interim charges for a resident full-time caretaker when all that was reasonably needed was a cleaner.
73. The Applicants may object that they simply had no choice in the matter and that it is unfair for them to have to risk a service charge shortfall. However, it is not uncommon for a landlord not to be able to recover all of its costs in full. Sometimes this will be because the lease in question very obviously fails to make provision for recovery of one or more heads of charge, but often the position is less obvious, for example a lease failing to make clear enough provision for the recovery of legal fees or managing agents’ fees. Whilst it is accepted that in this case the issue is largely the relationship between the Headlease and the Lease, in the Tribunal’s view the same principles apply.
74. It is an established principle that ambiguous service charge payment provisions are construed in favour of the paying party, and in the Tribunal’s view there would need to be an explicit link between the mandatory nature of the relevant tenant’s covenants in the Headlease and the obligation on the tenant under the Lease at all times and in all circumstances to bear a proportion of the cost of its landlord’s compliance with those Headlease covenants regardless of whether the service in question actually needed to be provided. The parties to the Lease had two separate opportunities – once when the Lease was originally granted and once when it was extended by way of surrender and regrant – to insert express provisions reflecting the absolute nature of the relevant tenant’s covenants contained in the Headlease and obliging the tenant under the Lease to contribute towards the cost of compliance whether or not a full-time resident caretaker was actually needed. But on each occasion the parties to the Lease chose not to do so.
75. The Tribunal considers (and the Respondents accept) that it is reasonable to employ – and to budget for – a cleaner and that the reasonable estimated cost of employing a cleaner is properly chargeable as an estimated service charge item in each of the years in question. Allowing for a certain amount of leeway, given that the Applicants are not under an obligation to employ the cheapest cleaner available, the Tribunal considers that £10 an hour would be a reasonable rate for such a cleaner. Based on the evidence given, the Tribunal considers that 8 hours per week would be a reasonable number of hours for which to employ a cleaner at the Building. Therefore a reasonable cost would be £80 per week and therefore £4,160 per year. The Respondents share of this amount is 32.6% and therefore a reasonable amount for the Applicants to have charged to the Respondents as an estimate of the cost of employing a cleaner is £1,356.16 in each of the years 2009/2010 and 2010/2011.”
(The emphasis in bold type in paragraphs 70 and 73 is that of the LVT).
12. The following matters can be seen from these (and other) paragraphs in the LVT’s decision:
(1) The LVT proceeded on the basis that the service charge demands with which it was concerned were estimated on account service charges which fell to be dealt with under section 19(2) of the 1985 Act. After the end of the relevant period, once final service charge accounts have been prepared, it would be open to the respondents to challenge the final amounts charged under section 19(1) (save of course for a challenge on points of principle already decided in these proceedings). Thus on such a later challenge (and in the event that the appellants were in principle entitled to charge for the cost of a FTRC) the question of the reasonableness of the standard of caretaking services provided or of the wages etc paid to Ms Dziadosz or of the estimated market rent of the basement flat could be challenged.
(2) It was common ground between the parties (and the LVT must be taken as finding) that the building does not need a FTRC and that only a cleaner is required. This however is a finding that only a cleaner, rather than a FTRC, is required if one is considering the matter on the basis of what is required for the proper day-to-day running of the building rather than considering whether a FTRC is required for some other reason.
(3) The LVT concluded that Ms Dziadosz’s employment was not a sham. Mrs Galley on behalf of the respondents accepted that the LVT must be taken to have so found, and such a finding would seem clearly to follow from various passages in the LVT’s decision including in particular the last sentence in paragraph 71.
(4) The LVT accepted that Cadogan as freeholder had drawn attention to the absence of a FTRC and was seeking to enforce the relevant covenants in the headlease. The LVT accepted that the appellants had grounds for concern that Cadogan might try to forfeit the headlease. The LVT concluded that it was prudent (viewed from the appellants’ perspective) to employ a FTRC.
(5) However the LVT concluded that it was not necessarily reasonable, within section 19(2), to impose upon the respondents the full costs of taking this commercial decision to employ a FTRC.
(6) The LVT considered that the contra proferentem principle was of relevance and that it was significant that there was no express covenant in the lease obliging the respondents to reimburse the appellants through the service charge with the full costs of complying with the covenants in the headlease.
(7) The LVT concluded it was reasonable to employ – and therefore to budget for – a cleaner rather than a FTRC and that the reasonable estimated costs of employing a cleaner were properly to be included within the estimated on account service charges.
(8) Having reached these conclusions, the LVT decided that as the costs of employing a FTRC were not properly recoverable there could be no recovery of the notional amount of the market rent of the basement, such that it was not necessary to consider the question of whether this notional rent was capable of being challenged under section 19.
The nature of the appeal
13. The LVT granted permission to the appellants to appeal against the ruling that only the costs of a cleaner rather than a FTRC were recoverable through the service charge. The LVT refused permission also to argue the question of whether the notional rent of the basement was something outside the definition of “relevant costs” within section 18, but permission was granted by the Upper Tribunal also argue this point. It was ordered that the appeal would proceed by way of review.
14. As stated by the Senior President, Carnwath LJ (as he then was) in Daejan Investments Limited v Benson  UKUT 233 at paragraph 61:
“However, we remind ourselves that we are reviewing their decision, not substituting our own judgment. It is common ground that we can only interfere if the LVT has gone wrong in principle, or left material factors out of account, or its balancing of the material factors led it to a result which was clearly wrong”.
This case was appealed to the Court of Appeal and then to the Supreme Court, whose judgment has recently been given. However there is nothing in those judgments from those courts to cast doubt upon the general approach to be adopted upon an appeal by way of review.
The statutory provisions
15. Sections 18 and 19 of the Landlord and Tenant Act 1985 as amended are in the following terms:
“18 Meaning of ‘service charge’ and ‘relevant costs’
(1) In the following provisions of this Act ‘service charge’ means an amount payable by a tenant of a dwelling as part of or in addition to the rent –
(a) which is payable, directly or indirectly, for services, repairs, maintenance, improvement or insurance or the landlord’s costs of management, and
(b) the whole or part of which varies or may vary according to the relevant costs.
(2) The relevant costs are the costs or estimated costs incurred or to be incurred by or on behalf of the landlord, or a superior landlord, in connection with the matters for which the service charge is payable.
(3) For this purpose –
(a) ‘costs’ include overheads, and
(b) costs are relevant costs in relation to a service charge whether they are incurred, or to be incurred, in the period for which the service charge is payable or in an earlier or later period.”
“19 Limitation of service charges: reasonableness
(1) Relevant costs shall be taken into account in determining the amount of a service charge payable for a period –
(a) only to the extent that they are reasonably incurred, and
(b) where they are incurred on the provision of services or the carrying out of works, only if the services or works are of a reasonable standard;
and the amount payable shall be limited accordingly.
(2) Where a service charge is payable before the relevant costs are incurred, no greater amount than is reasonable is so payable, and after the relevant costs have been incurred any necessary adjustment shall be made by repayment, reduction or subsequent charges or otherwise.
The parties’ submissions
16. On behalf of the appellants Mr Dutton advanced the following arguments:
(1) He reminded the Tribunal that what was being challenged were estimated on account service charges for the service charge years 2009/2010 and 2010/2011.
(2) Accordingly there were two relevant questions to be asked in respect of the inclusion within the estimated on account service charges of an amount for the wages etc of the FTRC and an amount for the market rent of the basement flat:
(a) Was the amount in question contractually recoverable as part of the service charge having regard to the proper construction of the lease?
(b) If so, did section 19(2) prevent the inclusion within the estimated on account service charges of an amount in respect of these two items on the basis that an on account service charge including an element for these two items would involve the charge of an amount greater than was reasonable?
(3) Mr Dutton submitted that the LVT held (and was correct in holding) that on the facts of the present case and the construction of the lease (i.e. leaving aside section 19 for the moment) the appellants were entitled to include within the estimated on account service charges a sum in respect of both the wages etc of the FTRC and in respect of the market rent of the basement. Mr Dutton submitted that the LVT must be taken to have so found because the ground upon which the LVT appears to have held against the appellants was not upon some point of construction of the lease but was instead under section 19(2) – see paragraph 70 of the decision.
(4) When testing within section 19(2) what is a reasonable sum to charge by way of an estimated on account service charge, the decision as to what is reasonable will be informed by whether as a matter of principle these items (i.e. caretaker’s wages etc and market rent) would be reasonably incurred if they were indeed incurred in the forthcoming service charge year. If it would be reasonable in principle to incur the costs of these items then an estimated on account service charge which included an element for these items would be reasonable within section 19(2). Mr Dutton pointed out that there is no challenge at this stage to the effect that the amount included within the estimated on account service charges for a caretaker’s wages etc and for market rent were unreasonable in amount – what is challenged is the point of principle as to whether it was reasonable to include these items at all when calculating the estimated on account service charge.
(5) Mr Dutton drew attention to the decision of the Lands Tribunal in Forcelux Limited v Sweetman  2 EGLR 173. He submitted that the test was not whether a reasonable person could have made a different decision from the one which was made by the appellants, but instead the question was whether a reasonable person in the appellants’ position might have considered it a reasonable thing to do to employ a FTRC. There was a margin of appreciation given to the appellants in the circumstances. The question is not might a reasonable landlord have acted differently, but might a reasonable landlord have acted in the way that the appellants did.
(6) In testing the question of reasonableness under section 19(2) it is relevant, so Mr Dutton submitted, that this is a building which is known to all parties to be such as would not normally require a FTRC, but notwithstanding this there is a provision in the respondent’s lease expressly contemplating that a FTRC might well be employed and charged for through the service charge provisions.
(7) The crucial question so far as concerns section 19(2) was whether the expenses of employing a FTRC were reasonably incurred. It was not relevant or permissible to seek to distinguish between (i) a decision that the employment of a FTRC was required to give proper amenity to the day to day enjoyment of the building and (ii) a decision that the employment of a FTRC was required in order to comply with the terms of the headlease.
17. As regards the recovery through the service charge of the notional loss of a market rent for the basement flat, Mr Dutton advanced the following arguments:
(1) He submitted that if it was reasonable to employ a FTRC, such that the wages etc of the FTRC were properly to be included within the service charge, then it was necessarily reasonable to make the basement flat available for the FTRC (indeed without this being done there would remain a breach of covenant and the caretaker would not be a resident caretaker). In these circumstances the appellants would be contractually entitled to include the market rent of the basement flat within the service charge and there could be no argument that it was unreasonable to do so within section 19(2), even if it were permissible (which Mr Dutton disputed) to treat the notional loss of this rent as a cost within the meaning of “relevant costs” in sections 18 and 19.
(2) However Mr Dutton advanced a separate argument in case the Tribunal concluded that the employment of a FTRC was not reasonable such that the wages etc of Ms Dziadosz could not properly be included within the service charge. He submitted that in these circumstances the appellants could nevertheless still recover the notional loss of the market rent of the basement for the following reasons.
(3) In these hypothetical circumstances the appellants would be contractually entitled to recover the wages etc of the FTRC and the loss of the notional market rent of the basement, but would be prevented from recovering the wages etc of the FTRC by the operation of section 19(2). In other words the wages etc would be contractually recoverable but would be disallowed because their inclusion was not reasonable within section 19(2) – the decision that they were not reasonable within section 19(2) being based upon a conclusion that in principle the wages of a FTRC would not be reasonably incurred within a section 19(1)(a).
(4) However the fact remains that in these hypothetical circumstances the appellants would be contractually entitled to recover through the service charge the notional loss of the market rent of the basement flat. Once again (as with the case regarding the recoverability of the wages etc of the FTRC) the only question would be whether section 19(2) operates to prevent this recovery.
(5) Mr Dutton submitted that a notional rent is not in fact a cost incurred at all by the appellants – it is entirely notional. Accordingly the notional loss of the market rent does not fall within the expression “relevant costs” within sections 18 and 19 and therefore is outside the limitation imposed by those sections upon the recoverability of relevant costs. Mr Dutton referred to an obiter observation of His Honour Judge Michael Rich QC in Earl Cadogan v 27-28 Sloane Gardens Ltd  L & TR 18 at paragraph 26 expressing doubt as to whether a notional cost could fall within the definition of “relevant costs”.
(6) During the course of argument I drew attention to the fact that, having regard to the wording of paragraph 2 of Part 1 of the Fourth Schedule, an item could only be included within the service charge calculation at all if it represented “costs”. I enquired whether there was an inconsistency in an argument which required the notional loss of the market rent of the basement flat to be treated as a cost for the contractual purposes of the lease but to be treated as something other than a cost for the purposes of sections 18 and 19. Mr Dutton argued that the meaning of the word cost in this particular lease was not the same as the meaning of cost under section 18.
18. On behalf if the respondents Mrs Galley advanced the following arguments:
(1) She accepted that Ms Dziadosz had been employed as a FTRC and that this contract of employment was not a sham. However she contended that although this was a genuine employment of a FTRC this employment had only been entered into for appearances sake so as to appease Cadogan rather than because the building actually required the services of a FTRC.
(2) She did not suggest that the appellants should have defied Cadogan and refused to employ a FTRC. She accepted that the position was accurately represented by the final sentence in paragraph 67 of the LVT’s decision when it stated:
“From the Applicants prospective therefore, it seems to the Tribunal that it was prudent to do what they reasonably could to remedy the breaches of covenant”.
(3) She submitted that if there had been an express covenant in the lease to the effect that the appellants could charge through the service charge for the full costs of complying with all the covenants in the headlease, then the appellants would be entitled to include in the service charges the amounts which they seek to include and the present dispute would not have arisen. However she pointed out that there was no such express covenant in the lease. Instead there was a mismatch between the headlease and the lease because the headlease says that there must be a FTRC whereas the lease (in paragraph 5 of Part 3 of the Fourth Schedule) only contemplates the recovery of the costs of a FTRC if the employment of a FTRC is deemed “necessary to provide caretaking services”.
(4) She submitted that paragraph 5 of Part 3 of the Fourth Schedule should be construed as only entitling the recovery of expenditure on the employment of a FTRC if such expenditure was necessary to provide caretaking services to the building for the proper day-to-day enjoyment of the building rather than necessary for the purpose of complying with covenants in the headlease.
(5) In considering the reasonableness of the charges for the purposes of section 19(2) it is wrong to look at the matter only on the basis of the appellants’ position as lessee under the headlease – instead the position of the appellants as lessor under the lease should be considered.
(6) She submitted that the costs of a FTRC would not be reasonably incurred (within section 19(1)) and accordingly could not reasonably be included in the estimated on account service charge (for the purposes of section 19(2)) because it was common ground that a FTRC was not needed save only for the purpose of avoiding breach of covenants in the headlease. Thus the costs of a FTRC were only reasonably incurred from the point of view of the appellants as lessee under the headlease (so as to avoid breach and possible forfeiture) rather than from the point of view of the appellants as lessor under the underlease (so as to provide services of actual practical use to the occupants).
(7) She submitted that paragraph 10 of Part I of the Fourth Schedule shows that it is the interests of the lessees under the underlease which are to be considered when providing services.
(8) As regards paragraph 9 of Part I of the Fourth Schedule she submitted that this is not to be treated as the equivalent to a covenant to pay, through the service charge, the full costs of the appellants in performing the terms of the headlease. In any event even if paragraph 9 did have this effect as a matter of contract, there still remained the crucial question of reasonableness under section 19(2).
19. As regards the inclusion within the estimated on account services of a sum in respect of the notional loss of the market rent of the basement flat, Mrs Galley accepted that if the appellants are entitled both as a matter of contract under the lease and as a matter of reasonableness under section 19(2) to include within the estimated on account service charges a sum in respect of the wages etc of a FTRC then the appellants are also entitled to include a sum in respect of the market rent of the flat. She further accepted on the basis of the McHale decision that this was a rent which was not to be assessed on the basis that user would be restricted to occupation by a resident caretaker.
20. As regards Mr Dutton’s alternative argument that the appellants were entitled to include a sum in respect of the notional loss of the market rent of the basement flat even if the costs of the wages etc of a FTRC would be costs which were not reasonably incurred, Mrs Galley advanced the following argument. She said that if the notional loss of the market rent of the basement flat is not a cost then the appellants cannot include it at all (see paragraph 2 of Part 1 of the Fourth Schedule), whereas if it is a cost then it is subject to the restriction on costs in sections 18 and 19.
21. I have decided that the appellants’ appeal must be allowed. My reasons for so concluding are substantially those advanced by Mr Dutton in argument. I express my reasons in my own words as follows.
22. The LVT was concerned, and this Tribunal is concerned, with estimated on account service charges for the two service charge years in question. The Tribunal is not concerned with the quality of the services actually provided, nor whether the entire amount actually paid to Ms Dziadosz for wages etc was all reasonably incurred nor with the question of what is the proper assessment of the market rent of the basement flat. For instance regarding wages etc there may possibly be an argument available that sufficient services from a FTRC (i.e. sufficient to comply with the covenant in the headlease so as to satisfy Cadogan) could be obtained at a cost lower than that incurred, having regard amongst other matters to the fact that the caretaker would be enjoying the occupation of a rent free flat in Tite Street. At this stage the Tribunal is not concerned with such matters. Instead the Tribunal is concerned with the principle of whether, when deciding whether the amounts estimated for the on account service charge payments for the forthcoming years were reasonable, it was proper to include an estimate for the wages etc of a FTRC and an estimate for the notional loss of the market rent of the basement flat. If having regard to the proper construction of the lease and to section 19 the appellants were in principle entitled to charge through the service charge provisions the wages etc of a FTRC, then it was reasonable to include in these estimated on account service charge demands an estimated amount in respect of the wages of the FTRC and for the notional loss of the market rent of the basement flat.
23. I agree with Mr Dutton that it is appropriate to conduct a two-stage approach, namely to ask first whether the appellants are entitled under the terms of the lease to seek to recover through the service charge provisions sums in respect of the wages etc of a FTRC and in respect of notional loss of the market rent of the basement flat; secondly to consider whether, if the appellants are entitled under the terms of the lease to seek to recover such sums, the operation of section 19(2) renders unreasonable the inclusion in these estimated on account service charges of estimated sums in respect of the wages etc of a FTRC and in respect of the notional loss of the market rent of the basement flat.
24. I begin by leaving aside for the moment the question of the notional loss of the market rent of the basement flat. I first consider whether under the terms of the lease the appellants are entitled in principle to recover through the service charge provisions the wages etc of a FTRC.
25. Turning to the wording of paragraph 5 of Part 3 of Fourth Schedule, I accept that the appellants did not deem (and could not reasonably have deemed) that it was necessary to employ a FTRC if one limits one’s consideration regarding what is necessary to a consideration of what services were needed for the purpose of the proper day-to-day running of the building by the appellants or the proper day-to-day enjoyment of the building by the respondents and the other lessees. It is common ground that the building simply did not need a FTRC for such purposes.
26. However, subject to relief from forfeiture, no one can enjoy the building at all, neither the appellants nor the respondents nor any other of the lessees, if the headlease is forfeited for breach of covenant.
27. The LVT accepted in paragraph 67 of its decision that Cadogan had identified breaches of covenant by the appellants regarding the failure to employ a FTRC. The LVT found that the appellants had grounds for concern that Cadogan might try to forfeit the headlease. The LVT concluded that from the appellants’ prospective it was prudent to do what they reasonably could to remedy the breaches of covenant. The LVT thus found that it was prudent and reasonable for the appellant to employ a FTRC. The LVT was plainly right so to conclude. It has not been suggested on behalf of the respondents that the appellants could and should reasonably have defied Cadogan and refused to employ a FTRC.
28. I turn to paragraph 5 of Part 3 of the Fourth Schedule. The appellants are entitled to charge through the service charge the costs of employing such staff as they “may in [their] absolute discretion deem necessary to provide caretaking services for the Building and its appurtenances….” There is no qualification in this provision to stipulate that the provision only operates if the reason for deeming it necessary to employ someone to provide caretaking services arises from a perception that such caretaking services are needed for the purpose of the day to day enjoyment of the building as opposed to being needed to avoid forfeiture of the headlease.
29. The respondents’ lease must be construed against the factual matrix in which it was executed, which includes (a) that it was an underlease where the immediately superior title (after the deemed surrender and regrant recorded in paragraph F of the recitals) was a headlease which contained express covenants by the headlessee to employ a FTRC and (b) it was an underlease of a unit in a building which, looked at solely as regards physical extent and nature of amenity, was a building where a FTRC would not be needed for the day-to-day enjoyment of the building.
30. It would therefore be contrary to the language and purpose of paragraph 5 to construe paragraph 5 as limited to the costs of employing a caretaker if such caretaking services were needed for the purpose of the day-to-day enjoyment of the building (which circumstances were most unlikely to arise having regard to the physical characteristics of the building) and to construe the provision as not applying where the need to employ a caretaker arose from the enforcement of covenants in the headlease (which circumstances might well happen at any time).
31. Paragraph 9 of Part 1 of the Fourth Schedule was only slightly relied upon by Mr Dutton. I find that this paragraph supports the conclusion I have reached. If the appellants deem it necessary to employ a FTRC to avoid risk of forfeiture of the headlease, then the cost of doing so in my view falls within the expression “all costs expenses and liabilities” incurred by the appellants in relation to the building. The express intention in paragraph 9 is that such expenses shall be fully reimbursed through the service charge.
32. Accordingly I conclude that upon the proper construction of the lease the appellants as a matter of principle are contractually entitled to include within the service charge the costs of the wages etc of Ms Dziadosz pursuant to her employment as FTRC. The LVT appears also to have reached this conclusion because the only basis upon which the LVT ruled against the appellants was upon the question of reasonableness under section 19(2).
33. The question therefore arises as to whether section 19(2) operates so as to make unreasonable an estimated on account service charge which includes an estimate for the costs of these wages etc of employing a FTRC. Paragraph 5 of Part 3 of the Fourth Schedule lays down the contractual entitlement and provides that the appellants may recover the costs of employing such staff as the appellants may in their absolute discretion deem necessary to provide caretaking services. However section 19(2) must operate as to limit this absolute discretion. I conclude that this limitation is to the effect that the appellants are only entitled to include within the service charge the costs of employing such staff as the appellants reasonably deem necessary to provide caretaking services for the building. If the appellants’ decision that the employment of a FTRC is necessary is an unreasonable decision then, while the strict terms of the lease might nonetheless entitle recovery of such costs through the service charge, section 19 would have the effect of preventing the appellants including within the service charge an amount in respect of costs of employing a FTRC, because in these circumstances the costs would not be reasonably incurred.
34. With respect to the LVT, I find that it was in error in reaching the conclusions it did (see in particular paragraph 72) to the effect that it was not reasonable to include within the estimated on account service charges the cost of a FTRC. The reason given by the LVT for this conclusion was that all that was reasonably needed was a cleaner. The LVT appears to have approached the question of what was reasonable under section 19(2) on the basis that what it is necessary to consider is what is reasonably needed for the day-to-day running of the building (namely a cleaner) rather than having regard to its own findings that employment of a FTRC was prudent and reasonable for the purpose of avoiding potential forfeiture proceedings. I conclude that this disregard by the LVT, when considering section 19(2) matters, of the reasonableness (and indeed necessity) of employing a FTRC to avoid potential forfeiture proceedings involved the LVT going wrong in principle, and leaving a material factor out of account, so as to entitle this Tribunal to interfere with the LVT’s decision.
35. It was reasonable for the appellants to employ a FTRC in order to remedy a breach of covenant in the headlease. Accordingly, despite the fact that a FTRC was not needed for the proper day-to-day enjoyment of the building, the costs of employing the FTRC would be costs which were reasonably incurred within section 19(1)(a). Therefore an estimated amount for the on account service charges which included an amount for the costs of employing a FTRC would be in principle a reasonable amount. The appellants were not limited to including in the estimated on account service charges only an amount in respect of the costs of employing a cleaner. They were entitled to include the estimated costs of employing a FTRC because such costs would be reasonably incurred because employment of a FTRC was necessary to remedy breaches of covenants in the headlease and to avoid the risk of forfeiture proceedings.
36. The considerations in paragraphs 28-30 above confirm me in my conclusion that, in the circumstances of this case, it was in principle reasonable to employ a FTRC such that the costs of employing a FTRC would be reasonably incurred within section 19(1)(a) (when the final accounts are prepared) and such that an estimated on account service charge which included an element for the costs of employing a FTRC would be reasonable.
37. Mrs Galley has (correctly) accepted that if the LVT’s decision was wrong, such that the costs of employing a FTRC can reasonably (i.e. within section 19(2)) be included in an estimated on account service charge, then so also can there be included a sum in respect of the notional loss of the market rent of the basement flat.
38. In these circumstances it is not necessary to consider Mr Dutton’s argument in the alternative which was to the effect that, even if it was not reasonable within section 19(2) to include in the service charge the costs of employing a FTRC, it was still proper to include an amount for the notional loss of the market rent on the basis that this notional loss of rent was not a cost within the expression “relevant costs” and was therefore outside section 19. Upon this argument I would merely observe that on the wording of this particular lease the appellants can only recover sums through the service charge if the sums they are claiming represent “costs”, see paragraph 2 of Part 1 of the Fourth Schedule. It seems to me that paragraph 5(4) of Part 3 of the Fourth Schedule is in effect providing that for the purposes of the service charge provisions the lessor shall be deemed to have incurred as a cost a sum equal to the market rent of the basement flat. In these circumstances I can see an unfortunate inconsistency for the appellants in embracing this treatment of the notional loss of the market rent as a cost incurred by the appellants (for the purpose of being entitled to recover it at all) but then simultaneously rejecting its treatment as a cost incurred by the appellants when it comes to consideration of section 19.
39. For the reasons set out above I allow the appellants’ appeal. The appropriate proportion of the estimated costs of employing the FTRC and for the notional loss of the market rent of the basement flat is payable by the respondents as part of the estimated on account service charges for the two service charge years 2009/2010 and 2010/2011.
40. No argument was addressed to me upon the question of whether I was invited to consider making an order under section 20C of the 1985 Act in respect of the costs or any of the costs incurred by the appellants in connection with these proceedings before the Upper Tribunal. I note the way in which the matter was dealt with by the LVT in paragraphs 78 and 79 of its decision. If the respondents wish to make an application for some order under section 20C they should do so in writing (with copies to the appellants’ solicitors) within 28 days of the date of this decision. If any such application is made by the respondents, the appellants are to reply in writing (if so advised) within 28 days of the respondents’ submissions (with copies to the respondents). I will then give a separate ruling in writing upon this section 20C application.
Dated: 14 March 2013
His Honour Judge Nicholas Huskinson