Is ‘service charge’ the same as a ‘rent charge’?

Often there is confusion amongst parties as to whether an obligation to pay service charge is classed as an estate rentcharge. An estate rentcharge can have severe impact on the ability to sell and charge the land and consideration will need to be given on development sites as to the best way to secure service charge payments.

Although the Rentcharges Act 1977 provides that all existing rentcharges are to be extinguished by 2037 and no new rentcharges can be created, estate rentcharges are an exception to this. They are being used more and more in practice which is causing concern to mortgagees.

An estate rentcharge is typically used on freehold residential developments to provide a mechanism for developers/ management companies to enforce positive obligations (i.e. the payment of a service charge).

Rentcharges can make lenders nervous because they can technically give a management company the ability to take possession of a house if, for example, there is a default in payment. The automatic statutory remedies which are available for an estate rentcharge are severe and can prejudice the lender’s security.

An alternative method of securing service charge payment would be to have an obligation on the owner to obtain a deed of covenant when they sell the property from the incoming party to confirm that they will comply with the obligations in the transfer, specifically to pay service charge. This would usually be secured by a restriction on title requiring a certificate from a conveyancer to confirm that this has been provided.

There is no direct authority to confirm that a service charge is not an estate rentcharge. However, under s1 of the Rentcharges Act 1977, a rentcharge is defined as any annual or periodic sum charged on or issuing out of land except rent reserved by a lease or any sum payable by way of interest. Whilst it could be argued that an obligation to pay service charge is an annual or periodic sum, it is difficult to establish that it is charged on or issuing out of land as a positive obligation on its own.

We await a case to confirm the point and reassure lenders that the value of their security is not affected when using a service charge mechanism which requires a deed of covenant to be provided from an incoming buyer rather than an estate rentcharge.

If you are considering the best way to protect service charge payments on your development or the impact of an estate rentcharge on a property you are considering buying get in touch with one of our team here.