Morshead Mansions Ltd v Mactra Properties Ltd [2013] EWHC 224 (Ch)

The dispute was simple: the lease required the landlord, Morshead Mansions Ltd, to provide, “as soon as practicable after the end of each Accounting Year … an account of the Expenses and the Service Charge payable for that Accounting Year”. The landlord failed to supply any form of account to the tenants between 2003 and 2007.

The tenant issued a claim for specific performance of the obligation. The landlord defended the claim on the ground that the manager appointed to run the block between 2000 and 2003 had been so poor at keeping proper accounts that recovering the situation was a monumental task: it was not yet practicable to provide the account for the years 2003 – 2007. It estimated that it would be able to publish fully audited service accounts for all years from 2000 to 2007 by the end of May 2008.

The tenant applied for summary judgment.

By the time of the hearing before HH Judge Bailey on 29 September 2011, there was still no sign of the accounts for which the estimated publication date had been May 2008.

The issue which really divided the parties was the form of the account required.

• The landlord contended that the lease required a proper set of accounts (“Full Accounts”), prepared by an accountant on an accruals basis and in accordance with normal accounting practice, whereas
• The tenant said that the lease required provision of something “less sophisticated”, namely a list of the expenses falling within the definition of Expenses in the lease (an “Expenses List”).

HHJ Bailey agreed with the tenant and granted summary judgment.

After the summary judgment hearing, the landlord produced accounts for 2003 to 2007 in Expenses List format. The account was prepared with regard to the ICAEW Technical Release 03/11 for Residential Service Charge Accounts.

The tenants were content with that format.

The landlord however, was not, and appealed HHJ Bailey’s order. It asked the court to find that it bore a more onerous accounting burden, which is why Warren J. described the appeal as “remarkable”.

Warren J.’s judgment on this appeal runs to some 35 pages. It is an exhaustive (and, some might say, exhausting) analysis of how the 4^th and 6^th Schedules to the lease impacted on the form of “account” to be supplied to the tenant.

This is my reading – in highly abbreviated form – of Warren J.’s reasoning:

1. The landlord has to provide an account to the tenants;
2. That account has to show the Expenses and the Service Charge payable;
3. The meaning of Expenses and the Service Charge must therefore be established;
4. Once that meaning is established, it will then be possible to ascertain the form of account envisaged by the lease.

The judgment does not meld the parties’ submissions into a whole: rather Warren J. sets out his own analysis, and then addresses any outstanding issues raised by the parties. I do not refer to those issues: this is a long post, and I would like to keep my readers with me for as long as I can.

Three Schedules to the lease were relevant to the appeal:

• The 4^th Schedule, containing the mechanics for calculation and payment of the service charge;
• The 5^th Schedule, containing the services which the landlord was to provide;
• The 6^th Schedule, which required the landlord to maintain a reserve fund.

Warren J. examined the 4^th and 6^th Schedules at length.

Paragraph 1(b) defined the “Expenses”. Warren J. considered three clauses in it, even if, in Morecambe and Wise style, not necessarily in the order in which they appeared in the lease. I highlight them here and will use them (in the order used by the judge) as headings later in this post:

“the Expenses” means in respect of each Accounting Year the cost to the Landlord of the items set out in the 5^th schedule and shall be deemed to include not only those expenses and outgoings which have actually been paid or incurred by the Landlord during the year in question but also such reasonable proportion of the expenses and outgoings of a periodically recurring nature (whether recurring regularly or irregularly) whenever paid or incurred (whether prior to the commencement of the lease period or otherwise) including a sum or sums by way of reasonable provision for anticipated expenditure as the Landlord or his accountants or managing agents (as the case may be) may in their discretion allocate to the year in question as being fair and reasonable in the circumstances.”

By paragraph 1(c), the “Service Charge” was defined as 0.96154% of the Expenses”.

Paragraph 4 required:

“As soon as practicable after the end of each Accounting Year the Landlord shall furnish to the Tenant an account of the Expenses and the Service Charge payable for that Accounting Year such account to be certified by the Landlord’s auditors and to contain a summary of the expenses incurred during the Accounting Year to which it relates and the relevant details and figures forming the basis of the Service Charge.”

Paragraph 7 provided that:

“Each service charge statement is to include a statement of the balance of the reserve fund and of the income and expenditure since the previous statement”.

Interpreting the lease

Warren J. set out his approach to interpreting the lease:

“The general principles of construction of documents are well known and I do not need to rehearse them. They can realistically be taken from the decisions (and in particular the speeches of Lord Hoffmann) in Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd [1997] AC 770 at [17] and Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896 at 912F-913G and, most recently, the decision (particularly the speech of Lord Clarke) in Rainy Sky SA v Kookmin Bank [2011] UKSC 50 at [14]), It is right to construe the Lease as a whole and not clause by clause or Schedule by Schedule. Thus the 4^th Schedule and the 6^th Schedule must be read consistently, if that is possible, and the meaning of one informs the meaning of the other. It is also right to construe the service charge provisions and the reserve fund provisions against the purpose of those provisions insofar as they can be ascertained from the four corners of the Lease and the admissible factual matrix”.

The 6^th Schedule: the reserve fund

Warren J. began his analysis with the 6^th Schedule, which dealt with payments into the reserve fund. Tenants paid contributions into the reserve fund in the same way as they did for services provided on an annual basis.

He concluded: “In my judgment, the 6^th Schedule is concerned principally with actual assets – the deposits representing monies actually paid together with any interest earned on and actually received in respect of the deposits – and with actual payments although there is, as indicated above, some uncertainty about the status of unpaid contributions.

“The 6^th Schedule is concerned with the actual payment of costs, not with the allocation from an accountancy perspective of costs (whether actually paid or only incurred) across different accounting periods. The reserve fund is not an accountancy construct: it is a fund of actual assets accumulated in advance to meet the expected costs of identified types of work”.

He drew support for this view from paragraph 7 of the 6^th Schedule, which obliged the landlord to provide a statement relating to payments into and out of the reserve fund.

The 4^th Schedule

This was the truly knotty Schedule. Whilst “Service Charge” was clearly defined in it, the meaning of “Expenses” was not, in Warren J.’s words, “a model of clarity”.

The purpose and structure of the Schedule established the amount of the actual payment which the tenant must make to the landlord so that the landlord was not “out of pocket for any serious length of time”.

Then, starting with the simple premise that “Expenses” were the “measure of the cost to the landlord of providing the services”, Warren J. worked his way through the definition of Expenses in paragraph 1(b) of the 4^th Schedule.

Paid or incurred

The first issue was to determine the accounting years to which costs were to be allocated. That, in his view, depended, to a certain extent, on what was meant by “actually paid or incurred … in the year in question”.

On the meaning of “incurred”, he concluded that a cost was incurred when the obligation to pay “actually arises”, resulting in the landlord being able to recover, as a service charge, an amount equal to that which it had had to expend in that year. “Therefore, an amount which has actually been paid or has become due for payment in an Accounting Year is an Expense of the year in question”.

“After all, the Service Charge obligation is to make an actual payment; it is not simply to accept an obligation to pay at some time in the future albeit that accounts drawn in accordance with proper accountancy practice might record matters in that way… Neither the Service Charge nor Interim Payments are accounting entries: they are actual obligations”.

A sum or sums by way of reasonable provision for anticipated expenditure

Warren J’s next port of call in examining the meaning of Expenses was the landlord’s entitlement to receive money on account of “periodically recurring” future outgoings.

He noted that there was a “measure of overlap” here with payments into the reserve fund in the 6^th Schedule. Both the 4^th and 6^th Schedules envisaged the lessees paying an amount to meet future expenditure which the landlord had, as yet, no contractual obligation to pay.

He concluded that these sums would fall within the meaning of Expenses in this sense if the reserve fund was insufficiently liquid to satisfy the full cost of those outgoings.

Also such reasonable proportion…

Although initially concerned that this clause may be otiose, Warren J. interpreted it so as to give it meaning: “The answer, I think, is to be found in the words “whenever paid or incurred (whether prior to the commencement of the lease period or otherwise)”. The effect of this is to enable [the landlord] or its accountants or managing agents to shift an item of expenditure from one year to another year” – but only in respect of periodically recurring expenditure”.

He added: “From an accountancy perspective, to allocate a cost to a later year may be appropriate but it does not follow from that that it is compulsory to determine the Expenses on an accruals basis so as to allow accountancy practice to dictate the result. The definition of the Expenses does not, after all, dictate an accruals basis… The result may … look very much like an accruals basis: but that result is not compelled by the wording of the definition”.

Warren J.’s conclusion was that Full Accounts were not required under the terms of the lease. That was not, in his view, to preclude the landlord from preparing Full Accounts, provided that those accounts complied with the lease. “To allow the form of the account … to dictate the determination of the Expenses and the calculation of the Service Charge would put matters the wrong way round”.

The ICAEW’s Tech 03/11 supported that proposition, making it clear that “where a lease sets out the way in which service charges are to be accounted for and who shall certify or approve the accounts, then the requirements of the lease must be followed”.

Warren J. rounded off his analysis by describing the landlord’s two accounting obligations for service charge expenditure:

• to provide the account of the Expenses,
• to provide what he called the “paragraph 7 statement”, ie, the statement required by paragraph 7 of the 6^th Schedule of the balance of, and income into and expenditure from the reserve fund.

An inability to provide the second did not, in his view, exonerate the landlord from supplying the first.

The landlord’s case that it had not yet been practicable, for various case-specific reasons, to prepare the account for the years 2003-2007 did not altogether curry favour with Warren J. He accepted the argument in relation to 2003, albeit observing that the defence appeared weak. As to 2007, he held that there was no evidence to show that it would have been practicable to prepare the account in the two month period between the 2007 year end (31/12/07) and the issue of the tenant’s claim on 27/02/08.

This is an eminently practical decision, which emphasises the importance of acting in accordance with the lease, this time in connection with preparation of accounts.

As a tenant however, I think that I would prefer to see proper service charge accounts showing accruals and debts, in addition to simple expenditure. It seems to me that if the landlord presents an Expenses List, it is difficult, if not impossible, to establish a full picture of the service charge in terms of unpaid demands.

It is interesting to note that, independent of any cited authority, Warren J. concluded that costs were incurred when the obligation to pay actually arises. In this his view coincides with the Lands Chamber’s decision in OM Property Management Ltd v Burr [2012] UKUT 2. The appeal in that decision is to be heard by the Court of Appeal on 10 April this year.