Reserve funds.

HL Deb 22 March 2001 vol 623 cc256-63GC

41A.—(1) Notwithstanding the specific terms of any lease of the whole or part of the building, where the tenants of two or more dwellings are required under the terms of their leases to contribute to the same costs by the payment of service charges, the person responsible for the exercise of the management of the premises under the lease shall establish one or more reserve funds to finance the repair and maintenance of the common parts and common services.

(2) Any demand for payment of service charges shall state the level of contribution within the total sum requested which will be paid into the reserve fund.

(3) The person responsible for the management of the premises may from time to time vary the level of contribution made to the reserve fund from the service charge contributions, but the level of contributions may not be nil.

(4) Regulations shall make provision for the preparation of a rolling management programme for repair and maintenance and for its presentation to the contributing tenants.

(5) In this section— service charge" means a service charge within the meaning of section 18(1) of the Landlord and Tenant Act 1985, other than one excluded from that section by section 27 of that Act (rent dwelling registered and not entered as variable); and the person responsible for the management of the premises" means either—

1. (a) the person who is the landlord under the lease,
2. (b) the Right to Manage company which has acquired the management functions under Part II of this Act, or
3. (c) a manager appointed under Part II of the 1987 Act to act in relation to the premises or any premises containing or contained in the premises".").

The noble Baroness said: The proposed amendment would amend the Landlord and Tenant Act 1987. It requires all buildings to establish one or more reserve funds. It is considered good management wherever possible to build up a reserve fund in order to cover the cost of planned major works or large renovation. However, many leases do not provide for a reserve fund. In those circumstances, some freeholders may look to borrow to fund the work and then charge the cost of borrowing back to the leaseholders through the service charge. Sometimes the leaseholders find themselves faced with a substantial service charge bill, and quite suddenly, to cover the cost of work which must be undertaken and paid for within that service charge year.

The amendment follows the format of Clause 38 which gives the commonhold association the power to establish reserve funds. Subsection (1) overrides the provisions of existing leases in order to establish a requirement to have a reserve fund. Subsection (2) requires the service charge demand to state how much of the money paid will be paid into the service charge fund.

Subsection (3) enables the manager to set the level of contribution, but insists that he cannot negate the purpose of setting up a reserve fund by setting the contribution as nil. The contribution level could still be set at a token figure—say, £1—which would allow those who wished not have a reserve fund to minimise the cost, but the counter argument to that would be that even a small sinking fund is preferable to none.

Subsection (4) empowers the Government to make regulations which can set out how the manager should establish a rolling programme of work, a budget of anticipated income and expenditure and the form in which this should be presented to the lessees.

The funds must be trust funds in accordance with Section 42 of the Landlord and Tenant Act 1987. The Committee will recall that the British Property Federation promoted an amendment to the provisions to establish reserve funds for commonhold units to ensure that they were trust funds. Leaseholders should also continue to enjoy all the relevant protection in relation to the reasonableness of service charges.

Under subsection (4), where the Government would be making regulations as to how to do it, it is very important that it should be well worked out because there is a need for an adequate amount to be in the reserve fund. However, as I have said in speaking to many earlier amendments, it is wrong that anyone should aim to set up an excessive reserve fund. That would be bad in two ways: first, that people would be asked to produce the money for such an excessive reserve fund; and, secondly, that there might be a tendency, particularly when management agents are involved, to do the work simply because the money is there. If the managing agent is on a commission of the work done, there is a double incentive for someone to propose unnecessary works. The issue needs to be thought through in that way and there needs to be some control over the amount in a reserve fund.

The noble Lord, Lord Whitty, said that he would consider houses in management schemes. That is a typical example in which someone must decide how much is required. Management schemes for houses that have been enfranchised and are now freehold are there to protect the environment and maintain the standard. However, no one wants to carry out excessively expensive schemes, particularly if the people who run those management schemes are the original freeholders and still retain a significant interest and it is in their interest to have the property maintained to a higher standard than is necessary.

Any credit built up in the reserve fund which relates to a leaseholder should be clearly identified as belonging to that property. If the person intends to sell the flat, or to move for any reason, that money will be taken into account when the property is sold. If, for example, there is £10,000 in the reserve fund to one's credit, one would expect the person who buys the flat to have the advantage of that money. Therefore, that would help to reduce the price of the flat and would be taken into consideration when determining that matter.

I received a letter from Mr Ernest H Shaw who said that he had replied to the government consultation document. He set out very extensively a method, which I can give to the Minister, to calculate the annual dilapidation cost paid in advance for variable service charges. There is a whole page of it here. I am very impressed that someone has put so much thought into it. I am slightly worried that it appears to involve a number of professional people and, therefore, a considerable amount of fees, which could impact upon the people who are asked to pay these service charges. I appreciate that this is a complex issue but it is an important matter to consider.

Mr Shaw, who is a lessee in an enfranchised establishment, writes: I am appalled at the lack of intent on the part of my fellow lessees to ensure that an adequate reserve fund sum is correctly estimated and appropriately collected. The standard response from lessees is that they will not be here then, so it is of no concern of theirs"".

We have to guard against the possibility that people who have been in those flats for a long time are not disadvantaged because of the reluctance of others to maintain the standard. I beg to move.

5 p.m.

Baroness Hanham

I should like to speak to Amendment No. 239B which is in this group. To continue with service charges, one area of concern on the part of leaseholders is the protection of service charge moneys. Since the accountancy profession accepts no responsibility for protecting leaseholders' money under Section 21 of the Landlord and Tenant Act 1985, the certification of accounts suggested by the Act seems to promise protection. That provision refers to the necessity for certification of the accounts by a qualified accountant. However, the Act does not give any guidelines, code of practice, or auditing or accounting procedures which the accountant must follow; it does not even make it a requirement that generally accepted accounting principles must be followed. The result is that the certification principle is completely ineffective and no reliance may he placed upon it.

This matter was recognised as one of many concerns in the consultation document in 1998. However, that concern was downgraded in the one that followed in August last year. The whole matter has retreated into obscurity in the Bill, in that it is not there at all. This amendment would restore the original concept by strengthening the 1985 Act.

Lord Richard

Amendment No. 239A stands in my name. It is an addition to the proposals in the earlier draft Bill and requires separate accounts for service charge moneys and greater accounting information for leaseholders. The issue has been raised on a number of occasions and is well known.

Lord Goodhart

Our Amendment No. 240 is in this group. We support all the other amendments in the group. The amendments seek—certainly Amendment No. 240 seeks—to bring back into the Bill one of the proposals in the consultation paper, which was mentioned by the noble Baroness, Lady Hanham.

The reforms are important for two reasons. First, they are important for the purpose of transparency, in order that all the tenants in a block subject to a single service charge will be able to find out what is in their fund.

[The Sitting was suspended for a Division in the House from 5.5 to 5.15 p.m.]

Lord Goodhart

I now return to the oration that I was about to deliver on this subject. This group of amendments concerns one of the proposals set out in the consultation paper published in August last year. Indeed, it goes back beyond that, as the noble Baroness, Lady Hanham, said. The proposals are important for two reasons. First, they are important for the sake of transparency, so that all tenants in a single unit that is subject to a single, collective service charge know, when they have paid services charges in advance, what is in the fund. For that reason, they will find it easier to notice whether anything has been wrongly taken from it. As the consultation paper pointed out, if funds from different blocks are put into a single account, neither group of leaseholders acting independently of each other would have any way of knowing what sum ought to be in the account. They would therefore be unable to realise whether any money had gone from it improperly. The safeguards for fraud are indeed inadequate. Although the consultation paper suggests that there might be some additional costs—and there possibly would be—such costs would be modest in comparison with the benefit of ensuring greater transparency. I doubt whether the costs are likely to be substantial because a large leaseholder with a number of accounts would very probably be able to negotiate a deal with the bank holding the accounts, under which all the money for the payment of interest was treated as a single, global account.

Secondly, the proposals give better protection from insolvency for the landlord or manager. Money in a client's account belongs to the client, not to the account holder. If the account holder is insolvent, then it cannot be used to pay the creditors. If it is part of a general fund, even if technically trust money, then normally it may well be accessible to the general creditors. In such a case, the tenants would be in a position of having to claim for their money back as unsecured creditors. Moreover, as unsecured creditors almost always are, they are unlikely to be able to get back any of their money.

For both those reasons, it is good practice to require advance service charges to be paid into a client account. We believe that that obligation should be made compulsory.

Lord Selsdon

As I said previously, the Bill is about money. One of the most difficult areas we are about to confront is the letting loose on the property world of thousands of amateur managers. With that goes the problem of liquidity and lack of funds. The possibility of a building failing to have proper lift insurance, failing to observe health and safety regulations and all the standard matters that professional managers know about is a real worry.

Finance and adequate resources can help. It is often the case that one tenant in a building will fail to pay the service charges but the manager does not notify the others. No penalties can be charged against someone who fails to pay and the other tenants have to cover the costs.

Without a sink fund or an adequate reserve, there is a serious possibility of management organisations becoming completely liquid. Service charges in general are calculated with a budget in advance by a professional manager to show the expenditure that will be required during the coming 12 months for regular maintenance of the building, but not the exceptional maintenance that is often required for external or roof repairs that may take place under certain leases every four or five years, or internal redecoration of common parts. Depending on where the buildings are—for example, listed buildings in London— such charges can be extremely high and often place a severe burden on the poorer residents of a building. The richer ones will say "I would rather pay as and when the bill comes up". Other people would like to have the opportunity to save something on account for the future.

It is difficult to legislate for that and it is difficult, too, to get banks to adopt these smaller kinds of account. But in general it is reasonable to point out that between 15 and 20 per cent of an annual service charge should be set aside for a reserve fund. The point has been made by my noble friend that if the reserve fund becomes too large, people try to spend it and then in come the professional charges. "Of course, my dear chap, you must have a surveyor to survey it. You must have an engineer as well". They then send a four-page letter with all the standard scales and before you realise it, 25 per cent of the expenditure has gone out of the window. They must, of course, obtain three or four quotations and there is a duty on them to take the lowest one, though often the lowest one is not the best. It is a worrying area, but I do not see how it can be legislated for. There should be an obligation on people to put aside a percentage of each annual service charge, which should be budgeted in advance.

This is fairly easy to do, because most of the buildings that we are talking about will have been in existence for a long time and there will be a record of what the expenditure has been. Many will be in default under their leases when they try to extend the refurbishment outside for a further two years because it may have been done properly before. They try to make short cuts from time to time to save money. It is all about money. If the management companies do not have an adequate reserve, they are bound to fail.

Lord Whitty

We have some understanding of the concerns which lie behind this group of amendments. The lead amendment, Amendment No. 238ZA, seeks to protect leaseholders' interests by, among other things, requiring managers to set up separate reserve funds. Amendment No. 240, standing in the name of the noble Lord, Lord Goodhart, would also require managers to use separate accounts and, moreover, would provide that leaseholders could not be held liable for charges unless they were paid into such accounts. Amendments Nos. 239A, tabled by my noble friend Lord Richard, and Amendment No. 239B, tabled by the noble Baroness, Lady Hanham, are intended to improve the existing arrangements for accounting for leaseholders' money.

This is a delicate area and the use of property money by people unused to managing it, as the noble Lord, Lord Selsdon, said, will be a new phenomenon. In our consultation paper last August, we put forward proposals to improve the accounting regime. It is only considerations of time and space that have prevented their inclusion in the Bill. We therefore have general sympathy with much of what has been said today. While I cannot make any firm commitments, we will consider carefully the views that have been put forward and perhaps return to them at a later stage. That is not an unqualified view. There are parts of some of the amendments that we would not, in any circumstances, be prepared to introduce in quite the way proposed.

The lead amendment tabled by the noble Baroness, Lady Gardner, would put landlords under an active obligation to set up reserve funds, to plan ahead and to demand regular advance payments from leaseholders. That is all very good practice, but requiring managers to prepare and present plans is quite a limited use, unless there is some means of controlling the quality of the plans, which is necessarily very complicated, and indeed of enforcing their implementation, which is even more complicated. Nor would it necessarily achieve much to insist that managers demand advance payments, if one cannot ensure that those payments are set at the right level and at the right frequency and that they are used to fund repairs in a timely and appropriate fashion. The amendment would probably go too far from anything that we would look on favourably. We understand the more rule of thumb formula proposed by the noble Lord, Lord Selsdon, and might consider it. It would be important to ensure that any requirements introduced could be enforced in a practical way. However, with regard to some of the intentions of the amendments, particularly of the lead amendment, we have difficulty in seeing how that could be done. Where managers neglect their responsibilities, we have an LVT procedure, which could replace them. We are also considering ways in which we could improve the standards of accountancy—of the presentation of the accounts and of the accuracy of the accounts—as addressed by the amendments of my noble friend Lord Richard and the noble Baroness, Lady Hanham. The whole issue could be looked at in that context, although much of it, as the noble lord, Lord Selsdon, said, is difficult to deal with through a simple legislative requirement.

Nevertheless, we will look at much of this area again. With that assurance, I hope that the amendments will not be pressed.

Baroness Gardner of Parkes

I thank the Minister for his reply, which gives me considerable encouragement. I agree that the amendment is far too detailed, but I was impressed that someone had put all that work into preparing it. If the legislation were amended in such a way as to give at least enabling powers to amend the Landlord and Tenant Act in order to create a reserve fund—particularly where leases are defective—that would be progress. It would go some way to protect people's money and to ensure that an excessive amount could not be taken into the reserve fund. That is as important as being able to have a reserve fund. The Minister's officials have been outstandingly good in applying their minds to these issues. I am confident that they will do whatever they can. I beg leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 139 [Consultation about service charges]:

[Amendment No. 238A not moved.]

On Question, Whether Clause 139 shall stand part of the Bill?

The Earl of Caithness

Clause 139 takes us on to consultation about service charges. I am not against the clause in principle. I simply seek clarification on two points of detail. I use the example of a block of flats in respect of which there are a number of different types of lease and different types of tenant. It introduces service charges at different levels for different purposes, which is not uncommon in London. When the trigger point has been reached under the regulations, is the landlord or managing agent required to consult all the tenants; or is he required merely to consult the tenant who has triggered the process?

In simple terms, let us assume that there is a charge. Let us assume that there is a block of flats in which the only person who will be liable to pay the charge is the person who owns the penthouse. It is the biggest flat; the rest are one-bedroom flats. Perhaps there are 10 such flats and a decent sized penthouse. Does the landlord have to consult the 10 people in the one-bedroom flats, who will now have nothing to do with it, or does he have to consult everybody within the block?

The second point is a matter of nit-picking detail—

[The Sitting was suspended for a Division in the House from 5.29 to 5.39 p.m.]

The Earl of Caithness

As I was saying, my second point is one of nit-picking detail. Subsection (2) of Clause 139, at line 19, refers to, a term of more than twelve months".

However, on pages 46 and 47 of the Explanatory Notes, paragraphs 228 and 229 refer to "12 months or more". Can the noble Lord, Lord McIntosh of Haringey, give me a definitive answer?

Lord McIntosh of Haringey

I take it that I do not have to give my long speech in defence of Clause 139 and attacking Section 20 of the Landlord and Tenant Act 1985. The Explanatory Notes are wrong. At the front, the Explanatory Notes state that they do not form part of the Bill, and in any such conflict the Bill is right and the Explanatory Notes are wrong.

In answer to the noble Earl's specific question about who has to be consulted, all tenants have to be consulted. I do not think that that is the answer he wanted.

Clause 139 agreed to.

Lord Lea of Crondall moved Amendment No. 239: After Clause 139, insert the following new clause—