Reserve funds - best practice for commercial landlords
Author: Cara Beveridge & Charlotte Nock
Applies to: England and Wales
Many leases provide for a landlord to create a reserve fund of service charge contributions to cover recurring costs such as maintenance, cleaning and redecoration.
These funds are distinct from a sinking fund which is designed for costly rainy day items such as replacing lifts or air-conditioning plant.
A reserve fund helps to balance the financial burden on the tenant, as it avoids fluctuations to their service charge contributions, and gives greater certainty to the landlord that funds will be available in advance to cover the day to day cost of providing services.
The recent case of Caribax Ltd v Hinde House Management Company Ltd reminded us that residential landlords are obliged to hold reserve funds on trust for their tenants and must give effect to the service charge terms of the lease.
But what is the position for a commercial landlord?
RICS Code of Practice for Commercial Properties
The Code serves to identify best practice for commercial leases. There is no specific requirement in the Code for a commercial lease to have a reserve fund. However, the recommended position appears to be the same as for residential landlords, albeit on a voluntary basis.
The Code provides that if a commercial tenant contributes towards a reserve fund, such funds should be held in a separate trust account (from the landlord's own general monies) and interest should be accrued to that separate account. The aim is to protect the reserve fund and ensure such funds are not used to meet the landlord's debts should they ever face insolvency.
If the Code recommendations are followed, the implications for commercial landlords are potentially wide. Not only will there be a higher administrative burden to open up a separate account, the landlord will also be subject to the obligations of a trustee as well as having to deal with the tax treatment of any trust funds.
The Code also recommends that a commercial landlord should provide clear annual budgets and reconciliation accounts for any reserve funds. This means that a landlord will need to keep careful records of any payments made from a reserve fund and (depending on the terms of the lease) at the end of the lease to return any surplus reserve fund to the tenant.
Even if the Code best practice recommendations are not followed, a prudent landlord should always check and be clear of the extent of its service charge obligations under the terms of a lease. Failure to comply with its, responsibilities (may lead to a breach of the lease, and exposure to action from its tenant.
This document is for informational purposes only and does not constitute legal advice. It is recommended that specific professional advice is sought before acting on any of the information given.