19 July 2019

Service charges – an added burden on top of a mortgage for new homeowners, but should they be worried if they fail to pay up?

Monika Borek, a solicitor in Wilkin Chapman’s property team, looks at the legal truth as a growing number of properties on private housing developments come with a requirement to pay this extra annual charge.

What is this ‘service’ charge and why does it exist? Sales of new homes within residential developments will often come with an obligation for the homeowner to pay a service charge. It is usual for this payment to be made to a Management Company, which is responsible for collecting the charges to maintain the infrastructure of the overall development, along with the upkeep of any communal green areas.

What is concerning those who are buying? While the buyers accept this extra charge as part and parcel of purchase, the solicitors acting on their behalf will often contact the sellers’ legal representatives to request an amendment to the provisions in the ‘Plot Transfer Deed’, which gives the Management Company the right to re-enter the property if the service charges are not paid on time, because this creates what is known as an ‘Estate Rentcharge’, and most lenders will not accept it.

What is the background to this? Subject to limited exceptions, no new Rentcharges can be created on or after 22 August 1977 (section 2, Rentcharges Act 1977) and certain types of Rentcharges already existing at that date will automatically be extinguished in July 2037. However, the creation of new estate Rentcharges is an exception permitted by the Act. And the most common use of estate Rentcharges today is to protect the payment of service charges.

So how does this ‘Rentcharge’ work in practice? It works by imposing a charge on the property requiring the landowner (freehold owner) to pay the service charge to the rent owner (the Management Company). If the landowner fails to pay the service charge, the rent owner has a right to enforce the payment by using a mixture of common law, statutory and other remedies agreed by the parties. Different remedies are available depending on whether the rent owner is seeking to enforce for non-payment of rent or breach of other covenants given in the deed creating the Rentcharge.

What does this mean if service charge payments are not made? Usually, in the circumstances described above, the provision in the Transfer Deed envisages statutory remedies under section 121 of the Law of Property Act 1925, which include right of entry into possession and the granting of a lease of the charged land on trust. What is more, if the clause in the Transfer Deed does include an express right of entry which is exercisable following breach of other positive covenants and not just the covenant to pay the rent, this means that the rent owner can, in effect, forfeit the estate of the owner of the charged land. The court has a general equitable jurisdiction to grant relief against forfeiture and it is understood that relief will normally be granted on terms that the breach is remedied. In addition, section 146 of the Law of Property Act 1925 applies to re-entry for breach of any covenant other than the covenant to pay the rent.

So, why could this be seen as a potential problem for the lenders (ie those supplying the mortgage)? Well, buyers’ solicitors’ suggest that this kind of clause in the Transfer Deed may be a breach of paragraph 5.12.1 of the CML Handbook, which requires that all existing charges must be redeemed on or before completion and that, on completion, the mortgagee requires a fully enforceable first charge by way of legal mortgage over the property.

Why it is highly unlikely that there will be any problem? A Rentcharge is an annuity secured on specified land and is an incorporeal hereditament. It is not a legal mortgage as defined in section 205 of the Law of Property Act 1925 but comes under the definition of ‘rent’. It will not therefore breach the requirements of paragraph 5.12.1 of the CML Handbook. The right of entry constitutes a freestanding proprietary interest, which is distinct from the Rentcharge to which it relates. It ranks as a legal entitlement in land if created by deed, which in most cases it is. Whilst the properly protected Rentcharge will take priority over any mortgage granted on the purchase of the new property, the fact that the mortgagee will have a right of relief against forfeiture for non-payment of the Rentcharge should give the mortgagee sufficient comfort to enable it to lend.

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