Insurance Excess - Is this a service charge cost?
3rd March 2022
3rd March 2022
The cost of insuring residential developments has seen some sizable increases over the past few years and we are regularly advising Landlords and Leaseholders in relation to whether the cost of insurance procured by the Landlord RMC or RTM is reasonable.
In addition to the hike in the cost of the overall policy our clients are reporting sizable increases in excess limits applied for certain types of claim, with water damage and fire being the main culprits. In some cases these excesses are £5k, £10k or even £20k or more depending upon the insurer and the claims history of the block. This is a significant change from the position where excesses have commonly been in the hundreds rather than thousands.
Our clients/agents often report that, historically, insurance excesses have simply been covered by the Service Charge to which all Leaseholders contribute. However, with those excesses now in the thousands or tens of thousands of pounds, scrutiny of that historic approach is necessary to be clear that it is lawful and in order to avoid costly disputes.
So, the question is, is it lawful to use Service Charge/reserve fund monies to pay insurances excesses?
The answer is that, in most leases, it is probably not (and nor will it ever have been) lawful to use the Service Charge for such an expense no matter whether that cost was hundreds or thousands.
The different types of claim
There are two main scenarios to consider:
Where a claim is made upon the insurance policy obtained by the Landlord/RMC/RTM (“Landlord”) for damage to property within the block resulting from a matter falling within the repairing obligation of the Landlord.
In this scenario the excess applied by the insurer is more likely to be a cost falling within the Service Charge under the lease and to which all Leaseholders pay in their respective proportions. This is because the cause of the fault was within the Landlord’s repairing liability and the repair (in this case limited to the value of the excess) is therefore a Service Charge item.
Where the claim upon the insurance policy for damage to property within the Development resulting from a matter falling within the repairing obligations of a Leaseholder (for example a leaking bath or perhaps an inadequately plumbed in appliance within the Leaseholder’s demise) or as a result of default of the Leaseholder (ie accidental damage) then the excess to that claim applied by the insurer is almost always not going to be a cost that can be lawfully covered by the Service Charge.
The position at Scenario 2 above arises because, in most leases, the Leaseholder is responsible for repairing and keeping in repair the flat and all those things and matters within the flat. So if the Leaseholder’s washing machine leaks or a pipe exclusively serving the demise bursts and causes damage elsewhere in the building, then that issue, the cause of the damage, is likely to be within the repairing obligations of the Leaseholder and not the Landlord. Most leases will preclude the Service Charge from being used to address a matter which contractually the Leaseholder is bound to repair/resolve.
The same applies where the cause of the leak arises through a genuine accident - the overfilled bath for instance - as, whilst this is an unfortunate, unintended and entirely accidental event and does not result from a lack of repair, it is still an event that occurred through tenant default and thus not a matter falling to the Service Charge.
Lease Specific - Check the lease of the relevant properties
It is important to highlight here that the above is subject to the specific provisions of the relevant lease(s) and thus advice should be sought in each case. Whilst the above is more likely to be correct in most cases we have seen leases that do enable excesses, even in the case of tenant default or disrepair in the demise, to be funded through the Service Charge - but those are extremely rare in our experience.
So how is the excess covered and who pays it?
Where an excess has been incurred that is not a Service Charge cost (see Scenario 2 above) then it will be for the party claiming on the policy to address that excess causing a shortfall in the payment of the contractor’s costs. If so minded, and likely dependent on the level of the excess, the claiming party might then seek to recover any loss from the party responsible for the damage - i.e. not the Landlord but the defaulting Leaseholder.
The above is important because, if the Landlord covers the excess it then has to consider how, and whether, it has the ability under the lease to recover that sum from the defaulting Leaseholder who actually caused the damage. Very few leases will provide a useful provision in this regard and even if they do the Landlord is still looking at potentially costly litigation to recover that sum if the offending Leaseholder is unwilling to volunteer payment.
To avoid this issue the Landlord should, where possible, authorise, but not conduct, the claim to the insurer in the first instance or at least not be the party who provides instructions to the contractors employed to address the damage. Instead, the Landlord should require the Leaseholder to make and conduct the claim itself (perhaps with authorised assistance from the managing agent) and, importantly, be the point of contact for the contractor when, at the end of the matter the contractor is looking to someone for the payment of the excess withheld by the insurer. The shortfall is then for the claiming Leaseholder to recover from the party responsible for the damage, a matter between neighbours with which the Landlord need have no involvement. Whether or not that is possible or practical will depend on the terms of the lease and the policy (e.g. whether the Leaseholder is named and can conduct the claim), as well as the particular circumstances (e.g. whether the damage solely affects the demised premises or also includes the Landlord’s reserved property).
What if the above is not received well by the Leaseholders?
The above, despite being correct in the case of a majority of leases, may prove to be unpopular if enforced. Accordingly, what options are available to the Landlord, if it is so minded, to enable it to provide an outcome where the excess on any claim against the insurance, whether through tenant default or otherwise, may be a legitimate and lawful Service Charge cost to which all Leaseholders pay in their respective proportions. There are a couple of options.
1. Variation of the leases to enable the cost to be a lawfully Service Charge
The leases at the relevant development may enable a unilateral amendment that will facilitate such a change. If no such provision is present in the relevant leases then the Landlord might offer a voluntary variation to each lease. Note though that, because you would not wish to see some Leaseholders liable and some not, this really only works if there is a 100% up take. The Landlord might also look at an application to the Tribunal under s35 or s37 Landlord and Tenant Act 1985 to amend the leases to include a suitable provision. s.35 is unlikely to assist as there is no fault here with the lease. s.37 would require 75% of the Leaseholders to support the amendment and not more than 10% to oppose it, and even then there is no guarantee that the Tribunal would accept the proposed variations.
Our view is that the which ever of the above routes are considered the Landlord should expect an objection from at least some of the more forward thinking Leaseholders for two reasons. Firstly, there needs to be a consideration of the excesses now in question. Most excesses for water leaks, or other regular types of claims leading to large costs, are commonly in the region of £5k, £10k or £20k for many blocks. Where a block has a history of a certain type of claim then those residing in the block need to consider what effect that will have on the annual Service Charge if the Service Charge is to absorb those excesses year on year. It should also consider the negative effect of high Service Charges on the values of the flats.
The second reason relates to the effect of taking the burden away from the defaulting Leaseholder. Is a Leaseholder going to be so worried about the damage that a leak from their incorrectly plumbed in washing machine has caused to two neighbouring flats if, by virtue of the change in the lease, that Leaseholder were relieved from paying the huge excess on each claim. If the Service Charge picks up these sums then is the Landlord creating a situation where, in fact, it may see more claims as Leaseholders appreciate that there is no personal financial liability if they mismanage their home.
2. Treat the excess as “just part of the overall cost of insuring” the Development
This is a common suggestion and one with some merit depending upon the leases granted in any block. Our view is that, whilst this might apply in Scenario 1 above, it is less likely to apply in relation to Scenario 2 issues due to the provisions in most leases as referred to above. But it may be possible. Again, each case needs considering on the terms of the particular leases and the particular circumstances.
The same issues referred to in Option 1 above apply where the result of this option is to remove the burden of excess payment from the defaulting Leaseholder and the inevitable effective increase in annual Service Charge.
Just because something may have always been dealt with in a certain way in the past does not make it correct then or now. In the past insurance excesses have often been relatively small and may well have slipped under the radar if they have been applied incorrectly. Now though, with significant increases in the level of those excesses, the potential for dispute is greater as the presence of large individual payments becomes wholly more visible. It is therefore imperative that you check what you are currently doing against what the lease actually permits you to do as a Landlord or Manager AND that you take steps to ensure that any past incorrect dealings with insurance excesses are not repeated moving forward. In any given case, specialist advice should be taken to avoid any challenges.
This legal update is provided free of charge for information purposes only; it does not constitute legal advice and should not be relied on as such. No responsibility for the accuracy and/or correctness of the information and commentary set out in the article, or for any consequences of relying on it, is assumed or accepted by any member of KDL Law or by KDL Law as a whole.
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