Case No. UKUT-282-(LC)-UTLC-Case-Number:-LC-2022-117

The principal authority: Waaler27.It is not in dispute that the principal authority on the meaning of “reasonably incurred” in section 19(1) is the Court of Appeal’s decision in London Borough of Hounslow v Waaler [2017] EWCA Civ 45. In order to put the arguments into the proper context I therefore start with that decision, although it is not quite where Mr Loveday’s argument begins.28.The Court of Appeal had to decide whether service charges in respect of repairs and improvements were payable; the fact that some of the works were improvements rather than repairs made no difference to what it had to decide, which was the meaning of “reasonably incurred”. The landlord argued that the subsection imposes merely a test of rationality, rather than a more demanding test of reasonableness.29.Lewison LJ, with whom Patten LJ and Burnett LJ agreed, explained that in order for the service charge to be payable pursuant to the terms of the lease, the landlord must have acted rationally. He referred to the decision of the Supreme Court in Braganza v BP Shipping Ltd [2015] 1 WLR 1661. He quoted Rix LJ in Socimer International Bank Ltd v Standard Bank London Limited [2008] Bus LR 1304 at paragraph 66:“… pursuant to the Wednesbury rationality test, the decision remains that of the decision-maker, whereas on entirely objective criteria of reasonableness the decision-maker becomes the court itself.”30.Lewison LJ then set out at paragraph 22 the explanation of rationality given by Lord Sumption in Hayes v Willoughby [2013] UKSC 17, [2013] 1 WLR 935 at paragraph 24:"Rationality is not the same as reasonableness. Reasonableness is an external, objective standard applied to the outcome of a person's thoughts or intentions. The question is whether a notional hypothetically reasonable person in his position would have engaged in the relevant conduct for the purpose of preventing or detecting crime. A test of rationality, by comparison, applies a minimum objective standard to the relevant person's mental processes. It imports a requirement of good faith, a requirement that there should be some logical connection between the evidence and the ostensible reasons for the decision, and (which will usually amount to the same thing) an absence of arbitrariness, of capriciousness or of reasoning so outrageous in its defiance of logic as to be perverse."31.Therefore, said Lewison LJ in Waaler at paragraph 23, “… In my judgment Hounslow's contractual ability to undertake improvements whose cost is to be passed on to the lessees is constrained by these principles. In my judgment therefore the rationality test applies both to a choice as between different methods of repair and also to a decision whether to carry out optional improvements.”32.He then went on to ask whether the test under section 19(1) is different:“24.That, however, leads on to the next question: is the question whether costs are reasonably incurred within the meaning of section 19 to be answered by reference to an objective standard of reasonableness, or by the lower standard of rationality?If the landlord incurs costs that are not justified by applying the test of rationality, then the costs in question will fall outside the scope of the contractually recoverable service charge. The Landlord and Tenant Act 1985 must have been intended to provide protection against costs which, but for its operation, would have been contractually recoverable. It follows in my judgment that merely applying a rationality test would not give effect to the purpose of the legislation. The statutory test is whether the cost of the work is reasonably incurred.”33.Counsel for the landlord in Waaler argued that “what was critical was the landlord’s decision-making process” (paragraph 28). That argument was rejected at paragraph 28 on the basis that if all the court is to do under section 19 is to look at the landlord’s process, that is “in effect a test of rationality”, so that section 19 would be achieving no more than does the test for contractual liability. Section 19 does indeed go further than that; at paragraph 37:“… whether costs have been reasonably incurred is not simply a question of process: it is also a question of outcome.”Mr Loveday’s argument in the appeal34.Mr Loveday started from the decision of the Lands Tribunal in Forcelux Limited v Sweetman [2001] 2 EGLR 173, which was referred to by Lewison LJ at paragraph 32 of Waaler as follows:32.[Forcelux] concerned the recovery of insurance premiums. The member said:"[39] In determining the issues regarding the insurance premiums and the cost of major works and their related consultancy and management charges, I consider, first, Mr Gallagher's submissions as to the interpretation of section 19(2A) of the 1985 Act, and specifically his argument that the section is not concerned with whether costs are "reasonable", but whether they are "reasonably incurred". In my judgment, his interpretation is correct, and is supported by the authorities quoted. The question I have to answer is not whether the expenditure for any particular service charge item was necessarily the cheapest available, but whether the charge that was made was reasonably incurred.[40] But to answer that question, there are, in my judgment, two distinctly separate matters I have to consider. First, the evidence, and from that whether the landlord's actions were appropriate, and properly effected in accordance with the requirements of the lease, the RICS Code and the 1985 Act. Second, whether the amount charged was reasonable in the light of that evidence. This second point is particularly important as, if that did not have to be considered, it would be open to any landlord to plead justification for any particular figure, on the grounds that the steps it took justified the expense, without properly testing the market."33. It is true that the member considered the landlord's decision-making process. But the important point is that he did not stop there. He also tested the outcome by reference to what the cost of cover was on the market. In other word's the landlord's decision-making process is not the only touchstone. The outcome was also "particularly important".”35.Mr Loveday observed that the Tribunal in Cos Services Limited v Nicholson [2017] UKUT 382 (LC) described those two questions as “necessarily a two-stage test”.36.Mr Loveday argued, on the basis of Forcelux, that the test of reasonableness, under section 19(1)(a), applies only to the issue of price. The landlord’s decision-making process and his practical choice of what to do fall within the first stage of the test and are required only to be rational.37.Mr Loveday’s arguments rested heavily on paragraph 23 of Waaler, which bears repeating:“… In my judgment Hounslow's contractual ability to undertake improvements whose cost is to be passed on to the lessees is constrained by these principles. In my judgment therefore the rationality test applies both to a choice as between different methods of repair and also to a decision whether to carry out optional improvements.”38.Mr Loveday therefore argued that the FTT was wrong to subject the landlord’s choice of what to do to the objective test of reasonableness, which led it to reject the cost of the waking watch because the flaws in the Hydrock report made that choice objectively unreasonable.39.Mr Denehan did not place a great deal of weight on this issue because his position was that the appellant’s actions in setting a waking watch rather than commissioning a further opinion were not even rational. But the point is important.40.Mr Loveday in relying upon paragraph 23 has wrenched it from its context. In paragraph 23 Lewison LJ was discussing contractual liability only. He went on in paragraph 24 to examine the different test to be applied under section 19, which goes beyond the contractual test and is an objective test of reasonableness.41.Accordingly, at paragraph 29, Lewison LJ rejected the landlord’s argument (set out at paragraph 28) that it had merely to apply a test of rationality, or Wednesbury unreasonableness, to the landlord’s decision about a proposed course of action. It made clear that to pass that test the landlord must not only have a reasonable decision-making process but must also achieve a reasonable outcome. It made no distinction between choice (what to do) and outcome (which contractor to choose on the basis of price); Lewison LJ’s words in paragraph 37, and in particular his reference to a choice of different methods, appear to me to be unambiguously referring to the landlord’s decision, or choice, as to what to do, not just to the cost of the work:“In my judgment, therefore, whether costs have been reasonably incurred is not simply a question of process: it is also a question of outcome. That said it must always be borne in mind that where the landlord is faced with a choice between different methods of dealing with a problem in the physical fabric of a building (whether the problem arises out of a design defect or not) there may be many outcomes each of which is reasonable. I agree with Mr Beglan that the tribunal should not simply impose its own decision. If the landlord has chosen a course of action which leads to a reasonable outcome the costs of pursuing that course of action will have been reasonably incurred, even if there was another cheaper outcome which was also reasonable.42.Mr Loveday relies on Forcelux; but in that case there was no choice as to what to do; the landlord had to insure. The only alternative outcomes were the difference insurers who charged different prices; the only outcome in issue was price, and the Tribunal decided unsurprisingly that the choice of insurer had to be reasonable. That does not mean that in a case where the landlord had to make a practical decision as to what to do (for example, whether to repair or replace defective window-frames) that choice between different outcomes would not be subject to the test of reasonableness in section 19.43.On the appellant’s case there would be no objective scrutiny of a landlord’s decision as to what action to take in carrying out repairs or maintenance or safety works. Any rational choice is acceptable, and the only scrutiny imposed by section 19(1) in addition to contractual enforceability is price. That flies in the face not only of common sense but also of the Court of Appeal’s decision in Waaler and of the plain words of the statute, because if Parliament in enacting a test of reasonableness had intended that the test of reasonableness should apply only to the choice between differently priced ways of achieving the chosen outcome, they would have said so.44.So a landlord in deciding what to do must follow a reasonable process and must then adopt a reasonable course of action. There may be more than one such course of action; the court or Tribunal is not to impose its own decision as to what should have been done. But even if the landlord followed a rational decision-making process, if the outcome of that process is not reasonable then the cost will not have been reasonably incurred.45.It follows that I do not accept Mr Loveday’s primary argument, that the FTT applied the wrong test. The FTT’s analysis of Waaler at its paragraph 78 (set out at paragraph 25 above) was correct. And it was entirely correct to say at paragraph 81 that the outcome of the landlord’s decision-making, meaning its choice of what to do, must also be reasonable. As we have seen, in order for expenditure to have been reasonably incurred under section 19(1) the landlord must have acted not just rationally but also reasonably in deciding what action to take as well as in deciding which contractor to use and how much to spend.