DEFERMENT RATES & MANAGEMENT RISK

After Sportelli, two decisions of the Lands Chamber of the Upper Tribunal (UT), formerly the Lands Tribunal, held that there should be a further upwards adjustment to the deferment rate for flats, attributable to the greater management risk to landlords of blocks of flats resulting from The Service Charges (Consultation Requirements) (England) Regulations 2003 (the 2003 Regulations), which brought in amendments to service charge consultation procedures introduced by the Commonhold and Leasehold Reform Act 2002 (the 2002 Act).  The new procedures required a greater level of consultation on the part of landlords for the recovery of service charge expenditure with minimum cost thresholds above which consultation was required.  For instance, for proposed works the threshold was set at £250 per flat.

The first UT decision on this issue is known as Zuckerman, which related to a group appeal for lease extensions of various flats in a single block in Edgbaston.  It was published in November 2009 and held that the downside risk to landlords of the 2002 Act and the 2003 Regulations were not fully appreciated in the market at the time that the 2006 Sportelli appeals were heard.  It was only after the service charge case of LB Camden v The Leaseholders of 30-40 Grafton Way was determined by the LT in 2008, that it was appreciated that failure to comply with the regulations could leave landlords unable to recover a large proportion of the costs of repairs.  The UT held in Zuckerman that an additional ¼ percentage point (ie above the ¼% Sportelli uplift for flats) should be added to the deferment rate for flats attributable to these greater management risks, which together with other case specific risks relating to the growth rate and obsolescence took the deferment rate to 6%.

The second UT decision on management risk is known as Yeats and related to the lease extension of a flat in Horsham.  It was published in July 2012 and followed Zuckerman by re-confirming the ¼ percentage point uplift attributable to the additional management risks relating to the 2003 Regulations.  Further the decision referred to the 2009 UT decision in the service charge dispensation case of Daejan Investments Limited v Benson where the potential consequences of the landlord failing to adhere to the strict service charge consultation procedures were said to be “draconian on the one side and a windfall on the other”, in so far as the landlord was at risk of being unable to recover more than £250 per flat towards the costs of works, if it was held that he had breached the consultation rules. In Daejan v Benson, there were five long lease flats and, as the landlord was held to have breached the consultation regulations, he was limited to recovering not more than £1,250 of costs out of a total sum sought of circa £280,000.

Now move the clock forward to March 2013.  The Daejan v Benson case has progressed on appeal to the Supreme Court (SC), the Court of Appeal having earlier upheld the UT decision.   The SC issued its judgement on 6 March in favour of the landlord, in effect overturning the run of lower court judgments.  The SC held that the consultation regulations should be read such that where a landlord fails to consult properly and where the lessees have shown that they have been prejudiced, the lessees should be returned to the position that they would have been in if the correct procedures had been met by the landlord.  In other words, the lessees should expect to pay reasonable costs towards the works and not gain a windfall.  The Tribunal can grant the landlord dispensation on terms, eg paying towards the lessees’ litigation costs, but generally speaking, the result of the Daejan judgment is that landlords are no longer at risk of the draconian shortfalls in service charge recovery that the lower court judgments had ruled upon.

There remains much debate on the legal and practical implications of the Daejan judgment on block management and service charge recovery, but a knock on effect of the judgement in the enfranchisement sector has been the valuation implications in terms of the impact on the value of the landlord’s interest.  How should the Zuckerman and Yeats UT decisions on the addition to the deferment rate for management risk be treated in the light of the Daejan judgment?

The answer lies in the recent UT decision in the case of Voyvoda v Grosvenor West End Properties & another, for which the appeal was heard last June and the decision published on 25 July.  The case concerned the lease extension of a large flat with a Grosvenor Square address in prime central London (PCL).  There had been a number of issues before the Leasehold Valuation Tribunal (LVT), one of which was whether the Zuckerman addition for management risk applied to PCL flats.  The LVT had held that the addition has “no application whatsoever to a well-run block in prime central London”.   The lessee was granted leave to appeal that point to the UT.  In short, the UT held that the Daejan judgment has removed the risk to landlords of losing substantial service charge costs for failing to satisfy the regulations.   Accordingly, the potential effects of the legislation for the landlord of an efficiently managed block of flats are no longer “draconian”.  Further, the UT also held that “the risk profile which had formed the basis of the UT’s decisions in Zuckerman and Yeats has been changed to such an extent that although there is still an element of risk, the level of risk is adequately covered by the uplift of 0.25% in the deferment rate which was established in Sportelli”.  It appears that this included the issues raised by the recent service charge case heard in the High Court re Phillips v Francis concerning whether a series of works should be grouped together for consultation purposes.  As the UT had concluded that there is no longer any basis for making the Zuckerman addition, it was not necessary for the UT to decide whether or not the addition should apply to a well-run block in PCL.

Although not billed as a guideline decision of national relevance of the same status as the Sportelli decision, it is relevant that the Voyvoda appeal was heard and determined by the Senior President of Tribunals, Sir Jeremy Sullivan, sitting with Mr Norman Rose FRICS, who had heard and determined both the Zuckerman and Yeats appeals, the latter with Judge Huskinson.

It therefore seems that, as with the Sportelli appeals, the UT has again published a decision on important valuation issues that will influence the premiums payable for both lease extensions of flats and the collective enfranchisement of blocks of flats across the country, having heard evidence relating to an appeal concerning a property in prime central London.

Julian Clark is a Partner at Gerald Eve LLP.