[2024] UKUT 120 (LC)

It is difficult to avoid the conclusion that the FTT did not fully appreciate the legal background to the decision it had to make. As we have seen, at paragraph 21 it expressed the view that it had no jurisdiction to assess the propriety of the allocation of the gym costs to the residential service charge (see paragraph 53 above). At paragraph 26 it then explored, quoting Woodfall, the considerations relevant to an assessment of whether costs have been reasonably incurred, which did not form part of either party’s case. At its paragraph 28, set out at paragraph 56 above the FTT used the language of reasonableness, yet also referred to Wednesdbury test, and left the reader uncertain whether it was looking at rationality in the Braganza sense or at objective reasonableness.

In what follows I am discussing solely the decision about what happened after 2020, on the basis that from 2013 to 2020 inclusive the appellants’ challenge fails because they had agreed to pay the gym costs charged to them (although in paragraph 113 and following I come back to that period of eight years and consider what is the outcome if that analysis is incorrect)

I begin with two points about the gym lease:

The first is that the respondent bought the property subject to the gym lease as well as to the commercial and residential leases. In that respect it stepped into the shoes of the previous freeholder. Insofar as the terms of the gym lease were generous to the gym tenant the respondent took on that generosity by stepping into the contractual shoes of its predecessor vis-à-vis the gym tenant.

The second is that in granting the gym lease the landlord was not under any obligation to act reasonably or even rationally towards the existing lessees. It was free to make a gift if it wanted to, as is any freeholder of property that is not already subject to a lease; in fact it did not quite make a gift, since the gym tenant had to pay rent, but at any rate the then landlord was entitled to grant the gym lease on whatever terms it wished.

But that did not change its obligations to its existing lessees. Turning to those obligations, I agree that the lease contemplates a two-stage decision-making process. First the landlord, acting reasonably, must allocate charges between the Residential Service charge and the building service Charge; then it must determine a “fair proportion” for each leaseholder to pay. The FTT had to assess whether the landlord in taking those two decisions complied with the lease.

I do not agree with Mr Morris that those two decisions are as completely isolated from each other; nor do I agree that they are subject to a different test. He said that the landlord has to act reasonably in designating a cost as a Residential Service Charge Item, and in that context “acting reasonably” means Braganza rationality; the requirement of fairness attaches only to the determination of the proportion of such an item that each leaseholder is to pay. The appellants’ challenge is only to that initial designation, and the FTT was therefore right to assess it only in terms of Braganza rationality. It did not have to be fair.

I disagree with Mr Morris’ analysis.

As I explained in my analysis of the law above, in my judgment an express requirement to act “reasonably” in exercising a discretion conferred by a lease is likely to refer, and should be understood to refer to, objective reasonableness. Otherwise the word is redundant; otherwise the interpretation runs counter to what Lord Briggs said in Aviva. In ordinary language “reasonable” does not mean “rational” in the narrow Braganza sense; there is nothing in the language of this lease to indicate that “acting reasonably” means “acting rationally”, and nothing in the circumstances to indicate that the original parties – lessee as well as lessor – intended to sanction an outcome that is unfair to the tenant. Mr Morris argued that that was a sensible construction because there would be various commercial considerations relevant to the initial designation of residential service charge items so that the landlord had to be allowed more latitude at that stage. I can see that the landlord might have liked that, but I fail to see any reason why the lessee would have agreed to it. Had the parties intended that, they would have said so and would have used the word “rational” or some other term to indicate that objective reasonableness was not required.

Moreover, the text itself does not isolate the two decisions in the way that Mr Morris suggests. A Residential Service Charge Item may be one that is payable not in whole but in part by the residential lessees (see the definition of Residential Service Charge Item). As I pointed out at paragraph 10, if the item was designated as payable in part by the residential lessees and in part by the commercial lessees then it would be a Building Service Charge Item. So what is contemplated here is that the item is payable in part by the residential lessees and in part by someone else – whether the landlord or some other tenant, for example the gym tenant in circumstances where the gym was let on a lease with a normal service charge provision (at the time the residential leases were drafted the gym was not let). In that case the lease provides that the residential leaseholders must pay a “fair proportion”, not of their part of the cost but of the cost itself, because it is the cost itself that is the Residential Service Charge Item.

Contrast the outcome if the “Residential Service Charge Item” were defined as a sum that the residential leaseholders had to pay, whether representing the whole or a part of the expenditure of the landlord. That is not what the lease provides; instead of that, it is the expenditure itself that is the Residential Service Charge Item, whether payable in whole or in part by the residential lessees, and each lessee is to pay a “fair proportion” of the whole, not just of that part payable by the residential lessees.

If “reasonable” means “rational” in this context, a literal reading of the lease therefore generates the absurd result that (1) if the landlord decides that part of the cost of, say, mending the roof or maintaining the gym, is payable by the residential leaseholders then must each pay a fair proportion of the whole, but that (2) the landlord may, acting rationally but not reasonably, allocate the whole of the cost to the residential leaseholders so that they then pay a proportion of the whole that is fair between themselves but is not a fair proportion of the whole.

That is, as I say, an absurd result and it indicates therefore that the parties in using the terms “fair proportion” and “acting reasonably” did not intend different ideas. Fairness was supposed to be a characteristic of the whole process.

I am conscious that I am making angels dance on pinheads here. I suspect the parties to the lease did not do that analysis, but that what they intended was at a more general level: that the lessee would pay a fair proportion of costs incurred by the landlord, whether or not they were shared with the commercial tenants or with any other party. As Mr Sandham put it, the two decisions bleed into each other; they are not hermetically sealed from each other. In designating costs as Residential Service Charge Items and then deciding how much each leaseholder is to pay, the landlord’s decision must be objectively reasonable.

Accordingly if the FTT intended to apply a Braganza rationality test it was wrong.

If the FTT did indeed intend to apply a test of objective reasonableness then in my judgment it reached the wrong outcome. It is manifestly unfair, and therefore not objectively reasonable, for the residential leaseholders to pay the whole of the gym costs after 2020 when they no longer have exclusive use of the gym. The landlord in 2013 decided to grant the gym lease in extraordinarily generous terms, and the respondent is now seeking to charge that generosity to the residential tenants. I cannot understand how that is not unfair.

I do not see any substance in Mr Morris’ argument that the arrangement was fair because the appellants could have enforced their right to use the gym against the gym tenant, in light of the precarious nature of their own right against the landlord (see paragraph 12 above).

Mr Morris argued that if he was wrong about the construction of the lease, nevertheless the landlord’s decision was objectively reasonable. Any other conclusion would mean that the landlord had to pay part of the gym costs itself. That is unfair as between the landlord and the leaseholders, and moreover such a conclusion would devalue the landlord’s lease.

As I have said, the respondent bought the freehold subject to the gym lease. It took on board its predecessor’s generosity to the gym tenant and is bound by that generosity so far as the gym tenant is concerned. The freehold, when the respondent bought it, was already devalued by the terms of the gym lease – which do not impose a service charge – and was already subject to the terms of the residential leases which enable the landlord to recover only a fair proportion of the gym costs. Its predecessor agreed to contribute the gym rent to the service charge and in effect conceded, until and including 2020, that the residential leaseholders should not have to pay the whole charge. And indeed the respondent accepted that that was the situation, in continuing to credit the gym rent to the service charge, although it has resiled from that position now that the resolution of the dispute with the gym tenant has led both to a rent holiday for the gym tenant and a substantial tranche of extra costs for the landlord. But the situation remains that the respondent has bought into the generosity of its predecessor and cannot visit the consequences of that generosity on the residential lessees.

So far as the years from and including 2021 onwards are concerned, the FTT’s decision that the landlord’s decision to charge the whole of the gym costs to the residential lessees was in accordance with the terms of the lease is set aside.

There is no scope for a tribunal to remake what the lease designates as the landlord’s decision. The respondent will have to try again, preferably in discussion with the residential lessees.

Finally I turn to the years 2013 to 2020, in case I am wrong and the appellants did not agree to pay the gym costs in those years. If I am wrong, then again the question is whether the charge imposed by the landlord was objectively reasonable. Until after the commencement of proceedings the appellants did not know what that charge was, but they had been content to pay subject to the landlord’s contribution of £5,000 per annum. Mr Sandham says that the charging system was prima face unfair. But I disagree. He has not made a prima facie case, by reference to the figures now disclosed, that the charge made for the gym was unreasonable.

Insofar as it related to the charges from 2013 to 2020 the FTT was right to conclude that the landlord’s decision was made in accordance with the terms of the lease, even though the route by which the FTT reached that conclusion was unclear.