Paying the price for leasehold disputes

Leasehold disputes can result in difficult and expensive litigation. Whatever the outcome, both landlords and tenants will be concerned about who will, ultimately, pay those costs. Most commercial and long residential leases contain provisions about the recoverability of the landlord's legal costs, often by way of a service charge demand. A landlord can become unstuck in the forest of case law and statutory provisions that govern whether or not he can recover his costs. Sometimes it will be necessary to proceed through the Leasehold Valuation Tribunal (LVT). Traditionally styled as a 'no costs arena', the recent Court of Appeal case of Freeholders of 69 Marina v Oram and Ghoorun [2011] EWCA Civ 1258 has enhanced the prospects of a landlord seeking to claw back his legal costs incurred in the tribunal.

The lease in dispute in Freeholders of 69 Marina contained a typical covenant for the recoverability of the lessor's costs in relation to section 146 of the Law of Property Act 1925 notices and any subsequent action for forfeiture.

This form of clause (in this case, clause 3(12)) is found in many leases, whereby the tenant covenants: 'To pay all expenses including solicitors' costs and surveyors' fees incurred by the landlord incidental to the preparation and service of a notice under section 146 of the Law of Property Act 1925 or incurred in or in contemplation of proceedings under section 146 or 147 of the Act notwithstanding in any such case forfeiture is avoided otherwise than by relief granted by the court and to pay all expenses including solicitors' costs and surveyors' fees incurred by the landlord of and incidental to the service of all notices and schedules relating to wants of repair of the premises...'

The freeholders served service charge demands for repairs which the defendants challenged. The freeholders therefore commenced proceedings before the LVT which were successful. Despite this, neither defendant paid. The freeholders therefore brought a successful claim against them, including a claim for the costs of pursuing the defendants in the LVT.

On second appeal, it was held that the freeholders could recover the costs incurred in the LVT from the defendants. This was surprising because no section 146 notices had been served at the time of the first hearing, but were served before the first appeal before the circuit judge.

The Court of Appeal went through the statutory regime relating to service charges in detail, noting that section 168 of the Commonhold and Leasehold Reform Act 2002 limits the right of a landlord to serve a section 146 notice on the tenant of a dwelling house held under a long lease unless it has been 'finally determined... that a breach of the [covenant or condition] has occurred'. Before a section 146 notice could be served the freeholders had to go to the LVT; according to the chancellor of the High Court: 'Given that the determination of the tribunal and a section 146 notice are cumulative conditions precedent to enforcement of the lessee's liability for the freeholder's costs of repair as a service charge, it is, in my view, clear that the freeholders' costs before the tribunal fall within the terms of clause 3(12).'

The 2002 Act, which compelled the parties to go to the LVT, came into force on 30 September 2003. The leases commenced in 1985, before the Act was even contemplated.

This ruling circumvents the general 'no costs' regime of the LVT and is quite different to what had been established practice in that tribunal. For example, in Creswell v 18 Wilbury Road (Hove) Ltd CHI/OOML/2009/001, the LVT noted that when the lease was entered into before the 2002 Act commenced it was not a requirement for there to be a determination of the court before a section 146 notice could be served. The LVT in that case construed the relevant clause narrowly. It did not consider that the clause referred to, for example, writing letters before action before a money claim or the money claim itself as these were not necessarily 'for the purpose of or incidental to or in contemplation of the preparation and service of a notice under section 146 of the Law of Property Act 1925'.

The Court of Appeal in Freeholders of 69 Marina has therefore greatly expanded the scope of a very common clause to include costs arising from a 'no costs' arena.

This is unfortunate, especially where many leases entered into before the 2002 Act was even proposed will contain a very similar clause.

Unintended consequences

This decision should be read alongside the very different outcome in Agricullo Ltd v Yorkshire Housing Ltd [2010] EWCA Civ 299, where a differently constituted Court of Appeal prevented the landlords from recovering their costs under a very similar clause where a section 146 notice was in fact served.

When the tenant, Yorkshire Housing Ltd, received the notice, they served a counter notice claiming the benefit of the Leasehold Property (Repairs) Act 1938, which (under section 1(3) of the 1938 Act) had the effect of preventing the landlord from bringing any proceedings for forfeiture or re-entry without the leave of the court. The landlord, Agricullo, never sought leave. There then followed negotiations between the parties which resulted in Yorkshire Housing effecting the repairs.

Agricullo subsequently pursued Yorkshire Housing for the legal and other costs arising from the breach of the repairing covenant until the date that the repairs were finished. It was Yorkshire Housing's argument that, once the counter notice had been served, because no further steps could be taken by Agricullo either to forfeit the lease or to claim damages, there could not be any proceedings in place to which these charges or costs could relate. In response, Agricullo argued that they never abandoned reliance on their section 146 notice, which remained in place until the repairs had been completed.

The Court of Appeal accepted Yorkshire Housing's submissions that there could not be any proceedings contemplated of, or in relation to, section 146, because of the effect of section 1(3) of the 1938 Act. By dealing with the problem by negotiation, Agricullo took the steps subsequently taken outside the ambit of the costs clause. As a consequence, the landlord was unable to recover its costs.

Both Freeholders of 69 Marina and Agricullo demonstrate that the statutory machinery that governs the enforceability of repair and service charge covenants can have unintended consequences for what, at first blush, appear to be straightforward and obvious costs clauses. Both landlords and tenants should consider how enforcing a repair or service charge covenant would actually take shape when advising on and drafting costs clauses; after all, these clauses are intended to govern where the costs of enforcement fall.

The Court of Appeal noted in Agricullo that the landlord could have worded the covenant by reference to the enforcement of the tenant's repairing covenants, giving the example of the one found in Riverside Property Investments Ltd v Blackhawk Automotive [2005] 1 EGLR 114.

In that case, the lease contained clauses that the tenant would first, 'pay all proper costs and expenses (including solicitors costs and surveyors fees) incurred by the lessor in or incidental to the preparation and service of any notice or schedule relating to dilapidations and whether not the same is served before or after the expiration of the said term', and second, 'pay all costs and expenses incurred by the lessor in or in connection with the enforcement of any of the lessee's covenants and conditions herein contained whether during the currency of or after the termination of the said term'.

In fact, in that case, some costs were disallowed as they did not either go to the enforcement of the lessee's covenants or a schedule of dilapidations.

Clarity is key

A Riverside Property-style cost clause did avail the landlord in Plantation Wharf Management Company Ltd v Jackson and Irving [2011] UKUT 488(LC), where the Upper Tribunal overturned the LVT's decision that, as it failed to mention legal costs explicitly, it could not therefore be used to recover them. The Upper Tribunal recognised that the primary, if not the only, proper method of the enforcement of covenants against tenants is by bringing legal proceedings. It would be difficult to envisage this without also contemplating the employment of lawyers.

It is trite law that a costs clause in a lease has to be clear and unambiguous in making provision for the recovery of legal costs as part of the service charge. This is sensible and fair as the tenant might well end up paying for his landlord's costs even if he is successful, subject to a potential application under section 20C of the Landlord and Tenant Act 1985 to disallow the landlord's costs. Clearly, the costs clauses in Riverside Property and Plantation Wharf were sufficiently unambiguous because they made direct reference to the costs of enforcing the lessee's covenants. When drafting leases, it is important to ensure that these clauses are clear as they are potentially worth more than most other service charge items. Despite the (eventual) outcome in Plantation Wharf, it is important to include reference to recovering legal costs if this is what is desired.

Freeholders of 69 Marina comes out of leftfield because the costs clause in that case lacks the unambiguous connection between the costs and the covenant that other cases demanded. It is, however, a decision of the Court of Appeal that courts will have to apply. When advising on costs clauses, therefore, remember the mechanics of enforcement as well as the detail of the covenant itself.