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Do commercial leases provide tenants with rights to inspect the source documents that form the basis for annual service charge costs?

16 Nov 2017

Reviewing the source documents for annual service charge costs: what rights do tenants have within UK commercial leases? 

Dr Andrew Holt, Professor of Accounting at MSU Denver (formerly of Kingston University) has, in conjunction with Property Solutions, undertaken a research project that investigates the content and provisions within the commercial leases for 90 multi-let office premises.

This important research has been undertaken to obtain factual information about the level of detail and clarity within typical lease provisions, in support of proposals to strengthen the impact of the RICS Code by upgrading its status to a professional statement for RICS members.

An initial discussion paper about the findings and implications from this research was published by PSL in August 2017, and the final paper from this research piece of academic research will be released in early 2018. Over the next few months we will be releasing select findings from the research to highlight the current state of commercial lease provisions for service charges.

This present article addresses the following question:   

Do commercial leases provide tenants with rights to inspect the source documents that form the basis for annual service charge costs?

 

The 3rd edition of the RICS Code states, in Core Principles numbers 3 and 25, that:

All costs are to be transparent so that all parties, owners, occupiers and managers, are aware of how the costs are made up. 

Transparency is essential to achieving good communication. By being transparent in the accounts, the explanatory notes, policies and day-to-day management, the manager will help prevent

disputes.

(RICS, 2014)

While these best practice statements about the importance of accounting transparency are helpful, it must also be noted that as monies received on the service charge account should be held in trust for the tenants and are not assets of the landlord, lease provisions should establish a process whereby occupiers can access the vouchers or accounting documents that support the charges within the periodic service charge accounts. In practice, only 49% of the leases examined provided such a provision.

An example of a lease provision that embodies the recommendations of the RICS Code in this area is as follows:

“… the tenant shall be entitled at all reasonable times upon reasonable written notice to inspect all books of account (or the electronic equivalent thereof) and all vouchers receipts invoices and other documentation relevant to the calculation of the Service Charge Proportion of the Building Services and to be provided with copies thereof …”

Of the 90 leases analysed, only 49% (44 leases) included a provision of this type, with the remaining 51% (46 leases) containing no guidance about a tenant’s right to inspect this source information.

In terms of the 44 leases that included provisions allowing tenants to inspect the supporting accounting documents, this direction varied in three key ways, which will now be discussed in turn.

 

1) Tenants are required to carry out the inspection.

19 of the 44 leases stipulated that the document inspection be conducted by the tenant and shall occur at the landlord’s or their agent’s offices or a place that they designate. Most clauses stipulated that the inspection must take place during working hours, and none allowed the tenant to receive the accounting information electronically in digital form.

 

2) Time period allowed for inspection lasts for from the date of issuance of the year-end service charge certificate.

Of the 44 leases that included an “inspection” clause, 25 stipulated a time period within which the review should be conducted and completed. This period normally commenced from the issuance of the service charge year-end certificate to the tenant, and ranged from 28 days to 12 months, with a median time period of 2 months.

Many of these clauses stipulated how much notice the tenant shall give the landlord should they wish to inspect the information, which is reasonable since the landlord or their agent would need to allocate resources to accommodate this request.

 

3) Who must incur the inspection costs?

Less than half (17 out of 44) of clauses stipulated that the expenses resulting from the document inspection (i.e. making photocopies of documents or the cost of staff time) were to be covered by the tenant. These costs ranged from the costs of “making copies” through to “payment of a reasonable inspection fee”.

The Model Commercial Lease project, commissioned by the British Property Federation (BPF), provides the following clause relevant to this topic:

 “The tenant will be entitled upon prior appointment to inspect evidence of the Service Charge Costs at the Landlord’s head office or any other location the Landlord specifies. The Tenant must ask to inspect the evidence not later than four months after receipt of the Service Charge Statement”

(Model Commercial Lease Project, BPF 2017)              

The lease clause appears fair and equitable, since it allows the tenant to carry out the inspection, but gives the landlord the reassurance that the inspection will only take place upon prior appointment at their offices. However, a surprising omission is that it fails to provide for remote electronic inspection of the information via cost-effective digital or electronic media.

 

In summary, the research identified that only 49% of the leases examined granted tenants with any formal right to review the accounting source documents.

In theory, as service charge monies are held in trust for the provision of services, the managing parties completing such a task should be willing to provide tenants with open and unrestricted access to accounting source documents. However, since many leases fail to provide guidance in this area, tenants may be hindered in their quest to access this type of information. Where leases lack such a provision, it falls on the RICS Code to determine best practice in this area. While the 2014 Code does not specifically address the tenants right to inspect the accounting source documents, it does note than when an occupier requests an “audit”, the manager should agree and the costs involved should be charged to the occupier (see p. 21 of RICS, 2014).

With the forthcoming 2018 version of the Code being issued as a Professional Statement, will those leases that are currently silent about a tenant’s rights to inspect the supporting documentation automatically be afforded this right?