What is a reserve fund?
A reserve fund is a fund held by the landlord or manager on behalf of the leaseholders and is set aside to cover the cost of major works or other significant items of expenditure expected in the foreseeable future, usually a period of 10-20 years. These funds will usually be held in trust and should be represented in cash, which is readily available to meet expenditure. Private companies must hold all service charge monies in trust whereas registered social housing providers, will hold the reserve fund monies in trust although it will not be part of a statutory trust. This ensures that leaseholder monies are ring-fenced for the purpose designated in the lease and means reserve funds cannot be used to pay creditors in the event of the freeholder going into administration or liquidation.
What are the benefits of a reserve fund?
A reserve fund with a healthy balance will allow the landlord or manager to cover the cost of major works without demanding additional service charges from leaseholders in that particular accounting year. A well-managed reserve fund will also enhance the value of the property as prospective buyers will see this as an advantage over leasehold blocks without a reserve fund.
What provision will leases make for reserve funds?
The lease will usually state if there is an obligation to set up and maintain a reserve fund and the method for collecting contributions to this fund. The lease may allow contributions to be collected as part of the annual service charge, which must be reasonable in order to satisfy the requirements of the Landlord and Tenant Act. If the lease makes no provision at all for any type of reserve fund, the leaseholders could discuss whether the leases might be varied to allow a reserve fund. However, it should be noted that lease variations are difficult to achieve unless all of the parties including the landlord agree to the proposed changes. (Please see the LA Information Sheet 110 Lease Variations).
The other method of collecting contributions to reserve funds is a clause in the lease that allows an amount to be collected each time the property is sold which is more common in the retirement sector. The lease will usually require an amount based upon a percentage of the sale price, which might be multiplied by full years of ownership. In some cases this might be capped at a maximum fixed period of ten years.
Most leases will allow additional contributions to be made as part of the annual service charge if the landlord or managers find that the amount obtained from re-sales is insufficient to meet the costs of the major expenditure needed.
Calculation of contributions to reserve funds
Contributions to reserve funds from the service charge must be reasonable and if agreement cannot be reached with the landlord or manager then the leaseholder could ask the Leaseholder Association (LA) for advice or make an application to a First-tier Tribunal (FTT).
It is good practice for the landlord or manager to produce and update a Cyclical Maintenance Schedule (CMS). The CMS, which usually covers a 10-20 year period, should clearly show the predicted future works, the year they are expected to be required and the estimated expenditure. The CMS helps the landlord or manager to calculate the reserve fund contributions and also to demonstrate that the amount requested might be reasonable. The landlord or manager should send the leaseholders a copy of the CMS if a written request is made.
What information are the landlords or managers required to produce?
Regardless of whether the lease allows for this, the leaseholder has a legal right to request service charge accounts, also known as a summary of relevant costs, at the end of each accounting year. This summary must provide full details of any reserve fund, which would include the income to the fund, the separate items of expenditure and any interest that has accrued. The summary should also clarify the balance of the reserve fund on the last day of the accounting year. This figure should show the amount that is actually available in the reserve fund, as represented in cash, which will differ from any overall ‘reserves’ figure, which may typically include monies owed. A leaseholder also has a legal right to request supporting documents, which would include invoices and receipts relating to any reserve funds. (Please see the LA Information Sheet 103 Service Charges).
In addition to the above, it is considered good practice for the landlord or manager to provide leaseholders with a copy of the CMS, if a written request is made. As part of the budgeting process, the landlord or manager should consult with leaseholders regarding the annual amount to be transferred to reserve funds and consult on any proposal to change the method of calculating the reserve fund contributions. It is recommended that the landlord or manager should review the CMS annually and consider whether the amount in the reserve fund will be adequate to meet the future items of expenditure that are set out in the schedule.
Transfer of surpluses or recovery of deficits from the reserve fund
The lease may specify what action can be taken in respect of moving funds between the annual service charge account and any reserve funds. If the lease is silent on this matter, the guidance set out in the legislation and the government-approved codes of practice should be followed:
- The landlord or manager should not use reserve funds, which are specifically intended to meet the cost of major expenditure, to meet any deficit in the annual service charge, unless all of the leaseholders agree. A deficit occurs when the actual expenditure of managing the block proves to be greater than the estimated annual expenditure payable in advance as service charges.
- Unless the lease allows the landlord or manager should not transfer any surplus to the reserve fund. A surplus occurs when the estimated expenditure, mentioned above, proves to be more than the actual expenditure for that year.
What is the difference between reserve fund contributions, administration fees and transfer fees?
There has been some confusion in respect of payments landlords have demanded when a leasehold property is sold or transferred. There have been objections to clauses in leases, particularly in the retirement housing sector, which allow the landlord to make a transfer charge. The amount of the transfer charge is usually a percentage often multiplied by the number of years of ownership.
If the lease requires that the proceeds of a transfer charge are credited to the estates reserve fund this should result in lower annual charges and is not unreasonable in principle. However, reserve funds collected by means of a transfer charge are not service charges and cannot be challenged at the FTT.
If the lease specifies that a transfer fee is payable directly to the landlord for no service rendered and hence a windfall, it is more open to criticism. The Office of Fair Trading (now the Competition and Markets Authority) investigated these charges and concluded they could be unfair, although landlords may argue they are a core term of the lease, known to leaseholders at the time of completion. To date the issue has not been tested in the courts.
If the lease implies that a transfer fee is payable to cover the cost of administering the transfer of the lease to a new owner it must be reasonable and can be challenged at the FTT, especially if the landlord or manager seeks to make an additional charge for the same service, thereby getting a double recovery of the cost (Please see the LA Information Sheet 106 Administration Charges).
Following concerns about transfer charges in residential leases the government has engaged the Law Commission to investigate the subject, although it is not expected to publish its findings until 2017.
It should be noted that unless the lease specifies this, contributions to the reserve fund from annual service charges are not refundable when a flat is sold and they remain in trust for the benefit of the block or estate.
Please see the LA information sheet 101 Glossary for a precise explanation of the terms used in this information sheet.
Disclaimer: This is a very general explanation of the subject. Where issues are not governed by statute the information is our opinion or best practice. You are advised to seek professional advice before acting on the guidance contained herein. Whereas The Leaseholder Association endeavours to ensure that published information is correct, it does not warrant its completeness or accuracy. The Leaseholder Association assumes no responsibility or liability for any injury, loss or damage incurred as a result of any use or reliance upon the information and material contained herein.
Info Sheet: 105/2/15 ©Copyright