Consultation draft of second edition of RICS Code for service charges in commercial property

A draft revised version of the RICS Code of Practice for service charges in commercial property was released for consultation in December 2010. Comments had to be submitted by 21 January 2011. This practice note analyses the differences between that draft and the version of the Code which it was due to replace.

Following the consultation, the second edition of the Code was released on 4 May 2011.  For further details see Practice note, Overview of Second Edition of RICS Code of practice for service charges in commercial property.

Contents

New edition of the Code of Practice for service charges in commercial property

The RICS publishes a Code of Practice setting out best practice for operation of service charges in commercial property. A consultation draft of a proposed revised edition was issued on which comments were invited (see Consultation on changes to the 2006 Code for commercial property).

The 2006 Code for commercial property

The first version of this Code was issued in 2006. It was designed primarily for larger properties and was expressed in flexible language, to enable it to work with a wide variety of lease provisions. It was criticised for failing to provide adequate guidance on the accounting policies that should be followed, and for giving too much freedom on other issues. For more details about the 2006 edition, see:

The Residential Code

The RICS published (in 2008) a more detailed Code of Practice for service charges in residential property, compatible with the more robust legislative framework that governs residential service charges. For more details, see Legal update, RICS Code of Practice for Service Charge Management (residential properties) (www.practicallaw.com/6-385-7987).

Consultation on changes to the 2006 Code

The RICS issued a consultation draft of a revised version of the 2006 Code. Comments had to be submitted by 21 January 2011. For more details see Consultation on service charges in commercial property (code of practice) (December 2010) (www.practicallaw.com/3-504-4196).

Second edition of the Code

Following the consultation, the RICS published the second edition of the RICS Code of Practice for service charges in commercial property. This differed in some respects from the consultation draft.

For more details, see Practice note, Overview of Second Edition of RICS Code of practice for service charges in commercial property (www.practicallaw.com/6-505-4928).

Definitions used in this practice note

This practice note uses the following definitions and conventions:

  • 2006 Code: the 2006 version of the RICS Code of Practice for service charges in commercial property.

  • 2011 Code: the RICS consultation draft of the revised 2006 Code.

  • Residential Code: the 2008 RICS Code of Practice for service charges in residential property.

  • References to "Para [X]" are to paragraphs in the 2006 Code.

  • References to "paragraph [X]" are to paragraphs in the 2011 Code.

 

Who will be affected by the 2011 Code?

The 2011 Code will affect the following, all of whom may wish to submit comments in response to the consultation:

  • Managing agents:
    • in their day to day management activities;

    • in the way they keep accounts;

    • in the handover arrangements when properties are sold or the managing agent changes;

    • by embedding a requirement for better communication with tenants over service charges; and

    • by requiring transparency over the calculation of management fees.

  • Legal advisers:
    • in their drafting of leases; and

    • in their advice on whether or not items of expenditure are chargeable to the service charge.

  • Accountants.

    This is because the format of the service charge accounts and estimates is more prescriptive.

  • Landlords.

    This is because the 2011 Code makes it very clear that landlords:

    • are not intended to make a profit from the service charge;

    • should aim to achieve value for money; and

    • must contribute for void units and credit to the service charge account any interest earned on advance payments.

  • Tenants.

    This is because the 2011 Code may make it easier both to budget and to challenge items in the service charge accounts.

  • Contractors who provide services.

    This is because the requirements for regular benchmarking or re-tendering of service contracts are clearer.

 

What has not changed

Those familiar with the 2006 Code will be pleased to find that much of it survives. In particular:

  • It still promotes best practice (not a compulsory set of rules which must be implemented without change). In some circumstances, departures from the 2011 Code will be entirely appropriate. If so, this should be discussed with the other parties to the lease, and a record should be kept of why the 2011 Code was not followed. The 2011 Code does start by using the term "Best Practice", as if it were intended to be a defined concept. However, the glossary contains no such definition. This will need to be tidied up in the next draft of the 2011 Code.

  • It still applies only to commercial property, though there is a new section that discusses which code of practice applies to mixed use buildings, and reminds owners/managers that the more stringent requirements of the Residential Code may apply.

  • The stress remains on better communication between landlord and tenants about service charge expenditure. Whilst the references to this guiding principle have been redistributed throughout the 2011 Code, the basic message is unchanged.

  • The standard industry cost classifications (previously in Appendix E1) remain unchanged (though now appear as Appendix 1 to the 2011 Code, where the layout is rather muddled).

  • Most of the draft reports in the appendices to the 2006 Code appear (with only minor changes) in the 2011 Code. The changes are dealt with in Example reports (Appendix 2).

Some parts of the 2006 Code are omitted from the consultation draft. See Aspects of the 2006 Code omitted from the 2011 Code.

 

How to find your way round the 2011 Code

The format of the 2006 Code has been abandoned.

The 2006 Code

This was made up of:

  • Glossary (Section A).

  • Introduction: drawing together some of the main principles (Section B).

  • Best practice obligations: in numbered paragraphs, loosely grouped by subject heading (Section C).

  • Detailed technical notes: to flesh out some of the obligations (Section D).

  • Appendices: example reports (Section E).

The 2011 Code

This is divided differently from the 2006 Code:

  • Introduction: explains what a service charge does and where to find examples of Code-compliant clauses.

  • Aims and objectives of the 2011 Code and its core principles: Section 1. Both of these are new. The aims of the 2011 Code are consistent with the approach taken in the 2006 Code, so should not be contentious. The core principles are a useful summary of the intended best practice. For more detail of how they differ from the 2006 Code, see Core principles.

  • Detailed guidance on best practice: Section 2. This section includes methods to implement the core principles, grouped by subject heading. Many of these are based on similar paragraphs in Section C of the 2006 Code, but they have been grouped differently, more material has been added, and some sections are entirely new. The subject headings are very helpful signposts.

    The differences between each section of the 2011 Code and its former equivalent paragraphs from the 2006 Code are set out in Comparison of matching provisions of the 2006 and 2011 Codes.

  • Appendices: Section 3. These contain example reports, two of which are new, the rest being slightly amended versions of the old appendices.

  • Glossary: Section 4. This uses many of the old definitions and adds some new ones.

Owner/Manager

The 2006 Code referred to best practice obligations affecting owners, managing agents or occupiers as appropriate. The 2011 Code tries to make this simpler by defining the term manager as including the owner, manager, managing agent or management company, as the case may be. The idea is simple: it does not matter who, under the lease or in practice, has the job of managing the service charge expenditure and accounting, but they must do that job in accordance with the 2011 Code.

There is some tidying up to be done, however, as the 2011 Code still continues to refer to owner rather than manager in some places.

 

Core principles

The 2011 Code does not number these and it would be easier if it did so. In fact, cross-references later in the 2011 Code (for example in paragraph 1.3.3) suggest that the core principles were intended to be numbered. PLC Property imagines this will be resolved in the next draft.

Most of the core principles are derived from provisions that were in the 2006 Code, although they may have been grouped differently and some have been slightly amended. There are some new core principles.

New core principles

The new principles (with their relevant subject heading in Section 1, so that these are easier to find in the consultation paper) are:

  • Service costs.

    Services should now represent "appropriate" value for money. Appropriate is a new concept and is not defined.

    Owners should not profit from the supply of services. They should be limited to charging their management fee.

  • Certification.

    The 2011 Code introduces requirements that certified accounts must be true and accurate and high standards of care must be demonstrated (by those certifying the accounts) towards owners/occupiers who may rely on such accounts.

  • Communication.

    The 2011 Code requires the manager to consult occupiers on the services but clarifies that it is the owner who has the right to set the standard. There is also greater compulsion on the manager to comply with the principles of the 2011 Code. It now requires "manifest demonstration of compliance" and in the Proportionality section, directs all parties to seek to comply with the core principles at all times.

  • Financial competence.

    The first of these core principles requires much more extensive skills of the manager. None seem contentious, but compliance with this standard may require managers to use more senior or experienced staff, which will affect the cost of management.

    There is a new obligation on managers, when issuing accounts or certifying expenditure, to act in a non-partisan spirit.

    There is now an obligation to use the industry standard cost headings in the accounts and reports. This was advisory only in the 2006 Code (Para 51).

  • Dispute resolution.

    Both these principles are new. The first requires all leases to provide for use of ADR. The second encourages the parties to use ADR even where the lease does not so require.

  • Timeliness.

    Instead of producing certified accounts in a timely manner and by the latest within four months of the end of the service charge year (Para 49), this principle has been watered down to require, within four months, only production of detailed statements of actual expenditure, albeit along with accounting policies and other explanatory text. Oddly, in paragraph 4.8 of the 2011 Code the obligation is to produce "reconciled accounts" rather than detailed statements. This inconsistency should be sorted out in the next version.

  • Value for money.

    Service quality is to be appropriate to the location, use and character of the property. This corresponds to Para 31 (2006 Code) but not to Para 25 (2006 Code) which states that levels and standards of service depend on the nature, type and complexity of the property. There may be little difference in practice between these.

 

Comparison of matching provisions of the 2006 and 2011 Codes

For convenience and where possible, we have grouped these comparisons under the same headings as are used in the 2011 Code. This section does not paraphrase what the 2011 Code says on each issue. Instead it identifies where the 2011 Code differs from the matching provisions of the 2006 Code.

References to "Para [X]" are to the relevant provision in the 2006 Code whilst references to "paragraph [X]" are to the relevant provision of the 2011 Code.

Permitted departures from best practice

The 2011 Code has a new section (Proportionality), but the concepts behind it are apparent in various places in the 2006 Code. Owners and managers should seek to comply with the core principles at all times (this is similar to wording in bold on page 10 of the 2006 Code) but may depart from it where appropriate in the light of such issues as size, nature or type of property, the extent of the service charge costs or their apportionment between occupiers, or achieving best value.

Administration (paragraph 1)

This paragraph includes, but reorganises, most of the 2006 Code and is divided into the following topics:

Standard and quality of service provision (paragraph 1.1)

This embodies Paras 3, 4, 5, 10, 21, 23, 24, 25 without significant change. There is a new requirement for management policies and procedures to ensure that services are provided cost effectively and safely.

Staffing and personnel (paragraph 1.2)

This embodies Paras 7, 21, 22, 26 and 27 but relates only to "on-site" staff, not outside contractors (the 2006 Code dealt with these together in Paras 21,22 and 27). The 2011 Code deals with outside contractors in paragraph 1.4. For more details, see Contract procurement (paragraph 1.4).

The changes are:

  • The language has been subtly altered to make certain targets aspirational rather than directive:

    • staff "should have" or "will need" the listed skills, rather than "will have" them (Para 7).

    • staff "should be required" (rather than "will be required") to comply with written standards.

    • it is "advisable" to review their performance regularly against the standards (rather than the obligation to regularly measure and review performance against standards as required in Para 22).

    These changes will comfort managers who cannot secure or, perhaps, afford, highly trained staff. Tenants should be more concerned about this apparent weakening of their protection.

  • The 2011 Code says training costs for such staff may be billed to the service charge, rather than should be (under the 2006 Code).

  • The definition of "total costs" for staff (Para 26) has been moved to paragraph 1.3.4.

  • The reference to incentive-based payment is expressed very differently, but the concept is the same as in the 2006 Code.

  • There is no requirement to regularly review the performance standards applicable to such staff. This used to be covered in Para 1.3, and has been applied to outside contractors (see Paragraph 1.4.1 (Service standards and provision)). It would be sensible to reinstate this.

Management charges (paragraph 1.3)

Paragraph 1.3.1 (Total cost of management)

This is similar to the two introductory paragraphs on Management Fees before Para 38 of the 2006 Code. However, the 2011 Code:

  • Breaks down the management charges into a minimum of two varieties:

    • the management fee charged by the owner/manager (fleshed out in paragraph 1.3.2); and

    • the cost of provision of on-site staff (dealt with in more detail in paragraph 1.3.4).

    No such distinction was made in the 2006 Code.

  • Introduces a new paragraph, which confirms that no two buildings are identical, and therefore the management charge and structure will vary to suit the particular property.

  • States that the management charge will relate not only to the work of managing the services but also to operating the services and administering the service charge.

Paragraph 1.3.2 (Management fees)

In the 2006 Code this was covered in Para 38, 39, part 40, Section D9 and the definition of management fees. The differences are:

  • The first paragraph is more explicit in recognising that the party providing the management service can include a profit element, but does limit it to a "reasonable" profit (this was not the case in the old definition).

  • The 2011 Code requires the service charge report to state that the management fees exclude costs of asset management and rent collection. It was (and remains) the case that such costs were excluded, but previously there was no requirement to confirm this in the report.

  • There is a completely new paragraph on service charge caps. The main message here seems to be that a contractual cap in the lease is a matter between the landlord and the tenant, and should not be used automatically to justify a reduction in the manager's management fee (so that the overall charge remains below the cap). It may also be suggesting that a service charge cap will not be a legitimate reason for providing a non-Code compliant service charge (perhaps in the standards of service).

  • The 2011 Code imposes a new requirement for the service charge report to include details of the terms of the management contract and whether it was competitively tendered. Para 38 merely required transparency, without details over what.

  • The 2011 Code no longer requires the management service to be regularly tendered or benchmarked (Para 39). Instead it requires the owner to be able to support the basis of the fee when benchmarked against other providers.

  • There is a new paragraph recommending that the costs of in-house specialist reports are billed separately from the management fees.

  • The 2011 Code refers to further guidance in a RICS information paper.

Paragraph 1.3.3 (Duties of the manager)

The first part of this tracks what was in Para 1 of the 2006 Code. There are some practical errors in it (references to numbered core principles that currently have no numbering system, and a distinction between duties of an owner and of a manager (when the definition of manager includes owner)).

The second part is new, but uncontentious, in that it says the manager may have other duties such as asset management or rent collection but repeats paragraph 1.3.2 in excluding such costs from the service charge management fees.

Paragraph 1.3.4 (Site management costs)

This is almost all new. The first paragraph is a slightly expanded version of Para 26 in describing what the total cost of staff may include. It then adds to site management costs:

  • the costs of providing offices and administrative support for the staff; and

  • HR and payroll costs.

or, in each case, a proportion of these where the staff serve more than one building.

The current draft of the 2011 Code does not set a basis for apportionment, merely requiring it to be fair. Some readers would prefer an explicit requirement to apportion cost by reference to time spent on each building.

The core principles of transparency and value for money are applied, with details of these costs, and the splits between buildings, to be given to occupiers.

There is a new paragraph clarifying when it is legitimate to charge the cost of a help desk service, as an alternative to providing on-site staff round the clock. This seems very sensible.

Paragraph 1.3.5 (Notional rent for management accommodation)

This was covered by early paragraphs in D2 of the 2006 Code. The new wording is very similar. The important change is that it now says it is "not advisable" to charge occupiers notional rent in certain situations. The 2006 Code merely stated that occupiers were likely to object if such a charge was made.

Contract procurement (paragraph 1.4)

Paragraph 1.4.1 (Service standards and provision)

This covers Paras 1.3, 21 and 22 and deals with outside contractors and suppliers. It imposes similar (but not identical) obligations to those in paragraph 1.2 for on-site staff. The language is less prescriptive than the 2006 Code, in that it is merely "advisable to ensure" contractors perform according to standards. (Para 21 provided that they "will be required to perform".)

Interestingly, this paragraph retains the old requirement to regularly review the standards (Para 1.3). This requirement has not been inserted in paragraph 1.2 for on-site staff (see Staffing and personnel (paragraph 1.2)). There seems no good reason for this.

Paragraph 1.4.2 (Procurement of services)

This replaces the much simpler Para 36 (which permitted use of a procurement specialist to obtain services if this achieved greater value for money or cost effectiveness). The 2011 Code goes into far more detail. The new obligations include:

  • Transparency over the terms of the contract and cost of such a specialist.

  • Guidance on how to select contractors, including the checks to be done on financial standing, health and safety records and environmental credentials.

  • An express requirement to comply with TUPE (SI 2006/246).

  • How to manage a tender process, including making it accessible to tenants.

  • Encouragement to save cost by using a group or bulk contract.

The last sub-paragraph replicates Para 27 (permitting costs of terminating third party contracts to be billed to the service charge in certain circumstances). This is also applied to on-site staff contracts by paragraph 1.2.

Allocation and Apportionment (paragraph 1.5)

This draws together references from many places in the 2006 Code (the second paragraph on page 6, the introduction on page 12, Para 43 (first part), Para 44 and Sections D4 and D5), The language is often different, but the principles are very similar, in that the resulting apportionment of the service charge costs to occupiers should be fair, and should be communicated to them clearly. Moreover, it should be reviewed from time to time to make sure that it stays fair. None of it seems contentious.

The new sections are:

  • Heavier direction to use separate schedules to allocate costs in different proportions between occupiers who benefit from different services. Section D4 of the 2006 Code warned against this on grounds of expense.

  • A requirement to make the apportionment schedule available to all occupiers (the 2006 Code only recommended this).

  • The closing sub-paragraph is new, and highlights the need to draft leases in a way that allows future flexibility over the method of apportionment. There was only a gentle hint of this in the 2006 Code.

Direct recoveries (paragraph 1.6)

This is totally new. It deals with the cost of insurance and utility costs, which may be billed either through the service charge, or direct to the tenants.

Paragraph 1.6.1 (Insurance)

In many respects the new provisions track what is expected by the Lease Code  (www.practicallaw.com/1-219-3968) and will be relevant to the detailed drafting of insurance clauses in the lease itself (for example, selecting a fair policy, disclosing commission (though not necessarily crediting it against the premium), making the details of the policy available to tenants, and including waiver of subrogation and non-invalidation clauses). The paragraph refers to a RICS guidance note for further information.

Paragraph 1.6.2 (Utilities)

This new section encourages the charging for utilities by reference to meter readings, but also:

  • Suggests that the manager should also be able to charge a reasonable administrative charge.

  • Recommends copy invoices, unit costs and administrative charge are stated (presumably in the service charge account).

  • Exhorts occupiers to pay utilities bills quickly as owners may be subject to pressure from statutory undertakers. No similar pressure is applied to occupiers for payment of "normal" service charge bills, so this looks a little odd (though not unreasonable).

  • States that security deposits for utility supplies cannot normally be charged back through the service charge.

Communication and Consultation (paragraph 2)

This is broken down into three sections. The high level message, that better communication is the best way to avoid service charge disputes, is unchanged.

Communication (paragraph 2.1)

This covers paragraph 4 on page 6 of the 2006 Code and Paras 4 (in part), 9 (in part), 11 (first sentence), 12, 13 and 15.

There are only very slight differences:

  • Occupiers are only "encouraged" to be proactive in informing the manager of the key contact within the occupier who deals with service charges.

  • Managers are to inform occupiers of changes in plans for the property (as was the case in Para 6) but also changes in the asset strategy for the property (new) if either will have an impact on the service charge.

  • Managers are obliged to provide occupiers with a copy of the management policy (as in Para 4) but not of the management procedures (as was required by Para 5). This may be an error, as tenants will have a continuing need to see both.

Consultation (paragraph 2.2)

This is completely new. It points out the contrast between commercial properties (where there is no duty to consult unless the lease says so) and residential properties, where statute and the Residential Code require the manager to consult tenants before incurring certain types of expenditure, or run the risk of not being able to recoup the cost through the service charge. For more details, see Legal update, RICS Code of Practice for Service Charge Management (residential properties) (www.practicallaw.com/6-385-7987).

Paragraph 2.2 suggests that the manager of commercial premises should consult occupiers about the levels of service that are appropriate, even if the lease is silent.

Budgeting and cost review (paragraph 2.3)

This draws together the information at the top of page 6 of the 2006 Code, Para 16 and 17. The 2011 Code continues to insist that a manager quickly notifies the occupiers of any anticipated significant variance from the service charge budget. The differences from the 2006 Code are:

  • The language is less mandatory. It used to say the manager "will notify"; now it is only good practice to do so.

  • The manager must keep expenditure under constant review (rather than to do so every quarter or half year).

  • There is no longer a benchmark of what is significant (this used to be more than 2% above RPI). Instead there is a new explanation of what may be significant depending on a variety of issues.

New leases and lease renewals (paragraph 3)

The 2011 Code covers this both in a section under "Limitations of this Code" and in paragraph 3. Both are discussed here. Similar issues were covered in Section B of the 2006 Code. There are the following differences:

Requirement for new or renewal leases to comply with the 2011 Code (Limitations of the Code and paragraph 3.2)

The 2011 Code is less insistent than the 2006 Code on new and renewal leases being Code-compliant, though it still strongly recommends this.

Section B of the 2006 Code has several references to new leases implementing the 2006 Code, owners and occupiers ensuring that their advisers have brought renewal leases up to the standards set out in the Code, and it benefiting all users of property if those who draft lease documentation follow the 2006 Code.

The 2011 Code does this differently by:

  • identifying a new or renewal lease as an "ideal opportunity" to include Code-compliant service charge clauses;

  • reminding readers not to sign such a lease without considering the 2011 Code; and

  • recommending that owners, occupiers and solicitors ensure the lease reflects the 2011 Code.

Existing lease provisions must be looked at first (paragraph 3.1)

The 2011 Code contains new wording reminding the parties that they may avoid unnecessary service charge disputes if they read their lease carefully so that they know what their service charge obligations are, or take professional advice where the lease is not clear. This is not contentious.

Sweeper clauses (paragraph 3.2)

This is completely new. It advocates caution in the use of sweeper clauses (which is not contentious). However, as currently worded (which may be an error) it suggests that a sweeper clause may not work in a short lease, unless it is crystal clear.

Financial controls and competencies (paragraph 4)

There is considerably more detail in the 2011 Code on the way in which service charge accounts and audits should be carried out. This is to bring the position for commercial property service charges closer to that for residential property. For more details on the Residential Code, see Legal update, RICS Code of Practice for Service Charge Management (residential properties) (www.practicallaw.com/6-385-7987).

The opening sub-paragraphs cover the same ground as Paras 18 and 19 of the 2006 Code. The difference is a greater stress on the principle that owners should not profit from the supply of services, and a statement that it is advisable that service charge advance payments should be kept in a separate account, with interest accruing to that account. There was no such recommendation in the 2006 Code. Interestingly, the matching core principle in the 2011 Code obliges the manager to keep such a separate account (rather than saying it is advisable to do so). This inconsistency will, no doubt, be cured as part of the consultation.

Accounting principles (paragraph 4.1)

The 2011 Code requires service charge statements to include a list of the accounting policies that have been used and sets out a suggested (non-exhaustive) list. Para 62 used to require the same details to be given of credits and debits to the sinking fund account and interest earned or tax paid on that account, but the other suggested policies are all new.

Audit and certification of service charges (paragraph 4.2)

The 2006 Code dealt only briefly with this. Para 54 allowed the occupier to request (and pay for) an independent audit, whilst Paras 53 and 55 set out limited (and potentially conflicting) regimes for certification of the service charge accounts, the cost of which was billed to the service charge. The 2011 Code is far more detailed.

Paragraph 4.2.1 (Certification)

This sets out the purpose of certification (to provide occupiers with certainty that the accounts are accurate) and the standards of professionalism to be observed by the person providing the certificate. It also expressly requires the service charge statements to be issued in a non-partisan spirit, and in strict accordance with any procedures in the lease.

Paragraph 4.2.2 (Auditing of the service charge accounts)

This is new. It sets out the auditing standards to be observed and the requirement to use an auditing professional. However, it also points out that, where the lease requires a lower standard of review, such that a fully compliant audit would not provide best value for money, then it may be more appropriate to ask an independent accountant (who need not be a registered auditor) to provide a review of the accounts. There is a new table setting out the general sequence of steps to be carried out in a service charge accounts audit.

The 2011 Code has retained the parts of Paras 53 and 54 that prohibit managers from using an external audit (or independent accountant's report) just to give credibility to the service charge expenditure, and which allow the occupier to ask for an independent audit or report at their own expense.

Benchmarking and cost code analysis (paragraphs 4.3 and 4.9)

These replace section D7 of the 2006 Code and are expressed far more clearly. In essence they recommend that service charge expenditure is grouped (in the accounts) by reference to industry standard cost codes, to make it easier to compare costs between buildings, and indeed between different periods for the same building.

Rightly, the 2011 Code warns that standard codes will not suit every property and that exceeding the industry benchmark does not necessarily mean that the services in that building are meeting the tests of service efficiency or value for money.

The cost codes are set out in Appendix 1 and are the same as those used in Appendix E1 of the 2006 Code, though there are some layout problems in the current draft.

More detail about how to use cost codes appears in paragraph 4.9, where it explains the different degrees of sophistication that are built into the cost code matrix, and when it is appropriate to use each of these. The language of this section is rather confusing for a novice, so this could be improved in the next version.

Budgets and actual expenditure accounting (paragraph 4.4)

This used to be covered by Paras 48, 49, 50 and 51. There are a few changes:

  • An introductory section that explains that no one system of accounting will suit all properties.

  • It requires only "detailed statements of actual expenditure" to be provided within four months of the end of the service charge year (Para 49 required certified accounts to be produced in a timely manner, and at the latest, by expiry of the same 4 month period).

  • Para 51(h) (relating to the treatment of non-standard income in the service charge accounts) has been moved to a different section, devoted wholly to this topic (paragraph 10.2).

There is an odd repetition (at the end of paragraph 4.4) of information that is set out in paragraph 4.9. It may be worth asking for it to be deleted here.

Right to challenge (paragraph 4.5)

This repeats Para 52 with a new introductory sentence that says the provisions of the 2011 Code cannot override any other legal right that the occupier may have to challenge inappropriate service charges. This is not contentious. It is also possible that a slight change in wording has reduced the obligation to allow occupiers a four month window in which to challenge the accounts, to merely a recommendation that the manager should follow such a procedure.

Change of owner or manager (paragraph 4.6)

This is similar to Paras 56 and 57, but extends from a change of owner on sale of the property (which was covered by the 2006 Code) to include also a change of manager or managing agent. Also this:

  • Stresses that a definitive timescale must be agreed for closing and handing over the service charge accounts on such a change.

  • Waters down (from an obligation to it being "helpful" if they chose to do this) the requirement that the new owner or manager issues service charge accounts in a format that is consistent with those issued by their predecessor or converts the historic data from past years into a consistent format (to enable easy comparison by the occupiers from year to year).

  • Refers the user to another RICS information paper for further details of best practice handover procedures. This may pick up what used to be in Para 63, which required the prompt transfer of sinking fund balances. Para 63 is not replicated in the 2011 Code.

Interest on service charge accounts (paragraph 4.7)

This replaces Paras 64, 66 (first and second sentences only), 73 and part of 76. The language is unchanged.

Timeliness (paragraph 4.8)

This draws together many existing aspects of the 2006 Code and is not contentious. Inspiration for it comes from the fourth paragraph on page 6 of the 2006 Code, Paras 12, 48 and 49 and the introductory words to the apportionment section on page 12 of the 2006 Code.

The 2011 Code requires the manager to provide a budget one month before the start of the service charge year and "reconciled accounts" (rather than certified accounts under the 2006 Code) within 4 months of the end of the year. The reference to reconciled accounts may well be a mistake, as the related core principle on timeliness and paragraph 4.4 both refer to production of detailed statements.

Value for money (paragraph 4.10)

This important principle used to be dealt with in Paras 24, 32, 33 and 34. There is still a requirement to achieve value for money and effective services rather than just going for the lowest price. There are a few changes:

  • The obligation to "ensure" value for money has been watered down to one of "at all times endeavouring to achieve" value for money.

  • There is a new definition of value for money, which does not at present seem to make grammatical sense. It states that value for money is "paying no more for no less than is required".

  • The circumstances where three yearly competitive re-tendering by contractors and suppliers is not needed have been extended. In the 2006 Code re-tendering could be avoided if the owner and occupiers were happy with the existing service standards. The 2011 Code also permits re-tendering to be avoided where it would not be cost effective. Where re-tendering is not to take place, benchmarking must be done instead (as in the 2006 Code).

Dispute Resolution (paragraph 5)

This appeared as Section D8 of the 2006 Code and has been completely rewritten. There is now a very good introduction on why alternative dispute resolution methods  (www.practicallaw.com/0-107-6391)(ADR) are a sensible way to settle service charge disputes. It recommends that all leases permit ADR or that the parties choose to use it, even if the lease does not require them to do so.

There are then clear explanations of four relevant types of ADR and the advantages of each:

  • Early neutral evaluation (ENE).

  • Mediation (of two varieties).

  • Independent expert determination.

  • Arbitration.

There is no reference in the 2011 Code to Professional Arbitration on Court Terms (PACT) and less information about the RICS Dispute Resolution Service.

Mixed use schemes (paragraph 6)

This is completely new. It reminds commercial property owners that, where there is a residential component to the property, the Residential Code may apply. For more details about the Residential Code, see Legal update, RICS Code of Practice for Service Charge Management (residential properties) (www.practicallaw.com/6-385-7987).

The paragraph includes a link to two RICS Information papers on managing and service charges for mixed use developments.

Provision for anticipated future expenditure (sinking funds) (paragraph 7)

This draws together wording from the top of page 15 and Section D6 of the 2006 Code. However, it omits Paras 58-61 and 63, which contained more detail on sinking funds, and the more extensive explanations in D6. This may be because further information and guidance on sinking funds is in the RICS Information paper to which this paragraph refers. The paragraph contains a new explanation of a depreciation charge which, oddly, is also defined in the glossary. This duplication may be resolved in the next draft. It also refers to planned preventative maintenance as a new term of art.

Repairs, replacement and improvement of fabric, plant and equipment (paragraph 8)

This new paragraph replaces Paras 28, 29 and 30 and part of Section D2. The rest of Section D2 has been omitted from the 2011 Code. It tries to explain, under various subheadings, which types of capital expenditure can legitimately be billed to the service charge. The 2006 Code illustrated the differences by hypothetical scenarios (in Section D2). The 2011 Code does not use examples like this.

The wording of the 2011 Code on this issue is somewhat confused. In the "Introduction to the Service Charge Arrangement" it reproduces the same list as in the 2006 Code of items that would not be eligible to be charged to the service charge. Neither redevelopment costs, nor improvement costs above normal maintenance, repair and replacement would be eligible for recovery. Some limited enhancement work might be permissible where this is justified on a cost-benefit basis. This accords with normal expectations.

Paragraph 8 distinguishes between:

  • Maintenance and repair: it tracks Paras 28 and 29 (a)-(f) of the 2006 Code on this issue.

  • Like for like replacement work: it seems as if this may be intended to cover replacement and renewal where this is sensible from a cost-benefit perspective when viewed over the length of the lease. There is a rather odd reference to improvement or enhancement works, which does not fit with the rest of the sub-paragraph.

  • Replacement with enhancement work: this is similar to some parts of page 21 in the 2006 Code, but overlays a similar cost-benefit test to determine whether this type of work can be charged to the service charge. It explains why enhancement may be permissible where it comes as a result of replacing something with an item of more modern standards, provided these are not unnecessarily enhanced.

The 2011 Code no longer deals with innovation and refurbishment (as did Section D2 of the 2006 Code), presumably because these involve extensive works that would rarely be covered by a service charge regime.

Sustainability (paragraph 9)

This is completely new. The first part alerts users to the new types of clause (in leases or accompanying memoranda of understanding) that deal with sustainability issues, and the need for cooperating and sharing data for this purpose. The real intention of this paragraph is to:

  • Advocate that sustainability and improved environmental performance should be taken into account when carrying out any cost-benefit analysis of improvement costs above the normal cost of repair.

  • Require a fair and reasonable approach to apportioning the cost of works that improve the environmental performance of the building or its sustainability.

  • Permit restrictions on work that adversely affects environmental performance of the building. This could restrict the services provided or repairs done, but would equally apply to alterations that the occupier proposed to do (which really lies outside the scope of the 2011 Code).

It is odd that the paragraph does not, in its current form, require sustainability and environmental performance standards to be taken into account when assessing whether a particular service or provider offers value for money. This would be worth adding and would be consistent with paragraph 4.1, which does mention environmental credentials as something to consider when selecting a contractor.

Additional best practice guidance for shopping centres (paragraph 10)

Marketing and promotions (paragraph 10.1)

This covers Paras 78-81 and is in almost identical form to those. The new features are:

  • Costs of specialist marketing staff and office accommodation for them should be included in the shared marketing expenditure.

  • The obligation to prepare and present the marketing plans to occupiers has been watered down from mandatory to recommended.

  • There is a new sub-paragraph stressing how important it is for occupiers proactively to make known their views on marketing strategy.

  • Christmas and other seasonal decorations are disallowed as marketing costs. Instead they should be charged under another service charge head (of general amenities). This may be because the ratio in which marketing costs are split is often different from that applicable to normal service charge costs (for example, the tenants of the anchor stores in a shopping centre might be willing to pay more towards a joint advertising campaign because they stand to gain more business as a result).

Commercialisation (non-core income) (paragraph 10.2)

This replaces Paras 83-86 and Section D3 and deals with which income (and related expenses) should be put through the service charge in relation to small areas of the property that generate additional revenue (for example, kiosks, barrows, photocopying services from the management centre, selling recyclable waste). There is no change to the substance (though reference to BT payphones has been omitted).

Example reports (Appendix 2)

These repeat (with small changes) the sample reports in the 2006 Code. In the 2011 Code there are some distracting layout issues, which will doubtless be resolved in the next draft (for example, in the Service Charge Reconciliation and Expenditure Report, repetition of the introductory headings and inability to distinguish between main and subcategories of expenditure heading). The following table indicates which of the old and new template reports match up and which are new.

2011 Code

2006 Code

Differences

Service Charge Reconciliation and Expenditure report.

No equivalent.

This has the new paragraphs required to be included in the Report, and also has the certification clause that used to be in Appendix E2.

Summary Expenditure report.

Service Charge Certificate - Appendix E2.

Figures are slightly different due to a different entry under "forward funding".

There is no certification clause as this is now in the first report.

Detailed Expenditure report.

Detailed Expenditure Report - Appendix E3.

Figures are slightly different due to a different entry under "forward funding".

Expenditure variance report.

Expenditure variance report - Appendix E4.

No change.

Property apportionment schedule.

No equivalent.

 

Best practice compliance checklist.

No equivalent.

 

 

Aspects of the 2006 Code omitted from the 2011 Code

It can be difficult to track where parts of the 2006 Code appear in the 2011 Code, because the layout is very different. We have done a detailed comparison to produce a summary of the points that no longer appear. This should assist those who might wish to respond to the consultation to request that these aspects are re-inserted.

In this section, references in the subheadings are to the provision in the 2006 Code which has been omitted from the 2011 Code. Where possible, we have suggested a reason for the omission.

Definitions

"Services" are no longer defined. Interpretation of this word will now depend on the lease wording and case law.

Several of the old definitions to do with marketing and promotion services are omitted ("rebranding", "relaunching" and the reference to the Good Practice Guide - Shopping Centre Marketing and Promotions). The relevant paragraph of the 2011 Code (paragraph 10.4) does use some of these phrases.

The definition of OSCAR is much shorter (and the references to it which appeared on page 9 of the 2006 Code are also missing).

Methods of apportionment (Section D4)

The 2011 Code contains no description of the various approved methods of apportionment of service charges (other than weighted floor area which is covered in paragraph 10.3 in much the same terms as before but with a different worked example). Nor does the 2011 Code oblige managers to use any particular method of apportionment. It merely requires the method used to be demonstrably fair and reasonable.

Mezzanine Floors (Introduction, Page 7)

The 2011 Code no longer discusses potential complications as a result of insertion of mezzanine floors. Presumably this is because market practice has now been established on how these should impact on service charge apportionment.

Occupiers' obligation to maintain records (Para 8)

Occupiers are no longer required to keep records up to date and advise the owner or manager of organisational changes.

Providing occupiers with details about service contracts (Para 20)

There is no equivalent requirement in the 2011 Code to share with the occupiers, details of all service contracts. However, the general duty of transparency mentioned in Para 20 is replicated in the 2011 Code, so the same concept may be implied.

Benchmarking performance related contracts to market rates (Para 37)

This is omitted, perhaps because it is considered sufficient to rely on the general obligation (in paragraph 4.10 of the 2011 Code) to either re-tender or benchmark all contracts on a regular basis.

Calculation of the Management Fee (Para 40, second sentence)

The 2011 Code does not state that expenditure and income receipts will be shown separately in the service charge accounts, nor that the management fee is to be calculated before crediting any income to the service charge account.

Service Charge deductions (Para 45)

There is no equivalent paragraph in the 2011 Code, dealing with when (and if) service charge expenditure (attributable to income yielding facilities) should be billed to the service charge. The general obligation for the service charge to be fair may cover this point, as may the spirit of paragraph 10.2 of the 2011 Code.

Expectation of full recovery (Para 47)

This concept is not spelt out expressly in the 2011 Code. The nearest equivalent is the first sentence of the Introduction section, entitled "The Service Charge Arrangement".

Sinking fund administration (Paras 58-61 and 63)

There is far less detail (in paragraph 4.1 of the 2011 Code) on how to manage the sinking fund. This may be because the guidance on best practice for service charge statements, certificates and audits has been considerably improved.

Balancing service charge items (Para 65)

The purpose of Para 65 is not clear. It may have been intended to encourage the manager to even out expenditure over the year. It is not in the 2011 Code.

Charging interest on borrowed money (Para 66)

The second part of Para 66 is not replicated in paragraph 4.7 of the 2011 Code (unlike the first part). There is therefore no confirmation that it is best practice to bill to the service charge both interest charged on borrowing to fund services and interest earned on the service charge account.

Other service charge procedures (Paras 71, 74 and 75)

The 2011 Code does not:

  • Require credit to the service charge, net of tax, of any interest paid by occupiers for late payment of service charge contributions.

  • Explain the tax treatment of on-account payments.

  • Permit costs of separate bank account operation to be billed to the service charge.

Marketing costs (Para 77)

The second and third sentences do not appear in the 2011 Code (discussing the potential marketing cost sharing ratios for landlord and tenant in the lease). This seems sensible as the 2011 Code is not intended to prescribe what should be drafted into the lease (although it may well influence this).

Service Level Agreements (Section D1)

There is nothing on these in the 2011 Code.

Costs of the site management office (Section D2)

Whilst the 2011 Code does deal with the notional rent attributable to an on-site management office, it no longer discusses which costs of fitting out and equipping such an office should be billed to the service charge. This does not mean such costs cannot be charged, merely that doing so must be capable of being justified as fair and reasonable.

Explanation of sinking and reserve funds (Section D6)

The definitions are carried forward into the 2011 Code, but the explanations are not. Instead the 2011 Code refers to the RICS information paper on such funds.

 
{ "siteName" : "PLC", "objType" : "PLC_Doc_C", "objID" : "1247429531245", "objName" : "Consultation draft of second edition of RICS Code", "userID" : "2", "objUrl" : "http://us.practicallaw.com/cs/Satellite/us/resource/9-504-3957?q=&qp=&qo=&qe=", "pageType" : "Resource", "academicUserID" : "", "contentAccessed" : "true", "analyticsPermCookie" : "21083ca1b:149daed151e:-6ca8", "analyticsSessionCookie" : "21083ca1b:149daed151e:-6ca7", "statisticSensorPath" : "http://analytics.practicallaw.com/sensor/statistic" }