Resolving Disputes involving Residents Associations

Published on 18 Nov 2008 under category: article

Introduction

Disputes involving residents associations need special care. First, they are a type of neighbour dispute - and neighbours have to be able to co-exist. Secondly, the claimant party typically can be liable under contract or company law arrangements to underwrite the costs of the defendant party, which makes it less economic to incur costs.

These notes describe matters affecting all residents associations and they compare how different rules affect trust-constituted (or contract constituted) associations and corporate ones.

1. The “free rider” problem

An unincorporated association can only act through its trustees or contractual nominees, who will have personal liability for any debts incurred. Trustees or committees of such associations have no right of recovery against persons who take the benefits of their efforts – “free riders” – unless they are defending trust property. The same applies when a company is proposing to take action: unless it has a contractual right to call on its member for funds, which would have to be in its articles of association from its incorporation due to section 25 of the Companies Act 2006, it cannot force members to back any particular expenditure for which it otherwise lacks the funds. This puts voluntary residents associations at a severe disadvantage in any management dispute with an external lessor or managing agents. What tends to happen is that a minority of active and aggrieved lessees are faced with carrying the costs and burdens of litigating for the potential benefit of all the lessees in the block. Not surprisingly, most just give up and where the litigation does proceed there is a notable inequality of arms.

It might be considered a worse evil for individual lessees to be forced to incur large expenditure and risk. The nightmare scenario must be to be requisitioned to fund the bringing of a claim that you don’t agree with or wish to support, then that claim losing and then finding that you are also liable to pay the opposing party’s costs through the service charges! This disadvantage would be avoided if the reimbursement of expenses were available only after the benefit for the larger group had been achieved by the few, thereby placing risk on the active few while the expense is incurred. Even such an ex post facto claim to reimbursement is not recognised by any authority.

Rules of collective enfranchisement and the right to manage indirectly address this problem by providing effective means for reconstituting the relationships between owners of flats with their consent but only where those rights apply. Significantly, the owners of flats in blocks where the commercial element exceeds 25% or that are not self-contained, and where there are complicated apportionments of costs to be worked out as between the commercial lower parts and residential uppers, do not come under those statutory schemes and it is in these blocks that there is most need for equality of arms in disputes. (The fault-based jurisdiction of the LVT to appoint a manager under sections 21 to 24 of the Landlord and Tenant Act 1987 is typically unavailable to the residential lessees in such blocks due to the second test there that such appointment must be just and convenient in all the circumstances of the case – it being deemed unacceptable by the LVT to impose such a manager over a complex mixed-use estate; see Schilling & Others v. Canary Riverside Developments PTE LVT/AOM/012/006/03 - unreported.)

Parliament has never been moved to impose mandatory residents associations that would have the right to requisition funds for to making legal challenges against the lessors or managing agents.

2. Legal intervention in internal decisions

Unincorporated associations that hold property through trustees are subject to the court’s supervision in the event of any dispute between trustees over dealing with trust assets. Any trustee or person interested in the property concerned can apply to a court for directions under section 14 of the Trusts of Land and Appointment of Trustees Act 1996. A number of matters are laid down in section 15 of that Act for the court to consider when exercising its power under section 14.

There is no equivalent parallel jurisdiction for the court to resolve disputes which arise among members of a company. In the context of a company any disagreement is liable to be resolved by the majority vote of the decision-making organ concerned – usually the board of directors – and any disaffected party needs to show a breach of fiduciary duties or breach of the companies legislation in order to challenge a decision in court. Disagreements over a company’s policy and operational decisions are generally not sufficient to invite the court’s intervention under “unfair prejudice” powers.

Thus there is notably greater recourse to court review and protection for an aggrieved minority under a trust arrangement compared to the position under company law.

3. Recognised residents associations

An association of residential leaseholders can apply to the block’s landlord for formal recognition. Once an association has membership from at least 60% of the lessees in its block, it can obtain a certificate of recognition from a Rent Assessment Panel under section 29 of the Landlord and Tenant Act 1985. In exceptional situations a Panel can grant recognition to an association that has less than 60% membership.

Such a formally recognised association has various legal rights. These are: (i) to receive any consultation notice regarding future service changes and long term agreements concerning management matters under section 20ZA of the Landlord and Tenant Act 1985, (ii) to give notice requiring the landlord to produce a summary of service charge expenditure, (iii) to require consultation about the appointment or reappointment of managing agents, and (iv) to inspect accounts and receipts in relation to service charge expenditure. Only the third of these rights is not already held by individual lessees and a right to be consulted does not amount to much. (The fourth is often expressly provided in leases and would be available through rules of disclosure in any legal challenge to service charges.)

Such formal recognition carries no further significance in giving the association concerned any title to sue. By way of example, if there is a claim in negligence against a manager appointed by the LVT – and presumably later removed from office - that claim will reside in the lessees and have to be prosecuted by them individually unless of course they each assign it to some other person.

4. Disputes between an association and an external party

The obvious and most common external party that may fall into dispute with an association is the block’s landlord. These disputes often involve questions over the correct amount of service charges payable and in residential situations they generally proceed through the Leasehold Valuation Tribunal and on appeal to the Lands Tribunal. There is a “no costs” rule in those two forums and so it may not be economic to engage solicitors as you would when litigating before a court. James Brenan can provide support to litigants in person at limited costs.

Typical types of dispute between a residents association and a block’s landlord are as follows:-

Challenging service charges
Challenging a landlord’s choice of insurer
Seeking the appointment of a manager under Part 2 of the Landlord and Tenant Act 1987
Seeking an acquisition order in respect of the freehold under the same Act.
Applying for the right to manage under the Leasehold Reform, etc Act 2002, assuming that an RTM company has been set up.

5. Residents associations as landlords

Many recent changes to the law have been hostile to landlords and enable lessees to buy their landlords’ reversions, with the result that a large and growing proportion of blocks of flats are coming under lessees’ control - though very often this is with less than full participation by all lessees in the block. This change-over from having an external investor as the landlord to having the lessees themselves or their nominated body is far from an end to all problems. In reality it only exchanges one set of problems with another. The most obvious new problem is the lack of a decisive single voice or, put in another way, the arrival of potentially endless conferring and debate and internal politicking over freehold and management matters.

There is a new risk for a residents association that takes over management, in that all victories for individual lessees will be at the group’s expense. Suppliers of works and services still have to be paid regardless of the outcome of any dispute among the body of lessees. Moreover, some suppliers disappear or become insolvent before they have delivered value, having taken payment in advance - although this is avoidable by agreeing in all contracts not to pay until value is received.

A further permutation, which gives rise to potentially worse difficulties, is to have an association owning and running a block that only represents some of the flat owners within it. Minority, non-participating, owners can jeopardise the freehold ownership by the majority by taking points over their service charge liabilities that, if successful, can force the majority to subsidise the services rendered to the minority in order to avoid the worse fate of their association becoming insolvent.

Having such an association as the block’s landlord can alter the legal meaning and effect of the leases for the flats in the block. First, in Embassy Court Residents’ Association v. Lipman (1984) 271 EG 545 the Court of Appeal ruled that a vaguely worded “sweeping-up clause” in the service charge provisions of a lease enabled a residents association as landlord to recover managing agents’ fees, when it was accepted that this outcome would not have arisen if the reversions had been owned by an external landlord. Second, in Hannon v. 169 Queens Gate Limited [2000] 1 EGLR 40 it was held, in the context of a dispute over a landlord’s right to build an additional flat in its retained space, that ownership of the lease reversions by a lessees’ company is a factor in favour of implying such a right to build. (The law is unclear as to the position when the company is not fully representative of flat owners.)

Aside from those two instances of special interpretation, disputes between such associations as landlords and their lessees will turn on the ordinary meaning and application of the leases involved - taking into account the background facts, known as “the factual matrix”, from the date of the lease. Once the residents association for a block has become its freeholder litigation becomes a particularly unattractive method for resolving its internal disputes, for reasons explained already, and these should best be dealt with by alternative means, such as mediation.

In extreme cases of mismanagement it can be worthwhile for individual residents to use the fault-based appointment of manager procedure, under the Landlord and Tenant Act 1987. This involves serving a preliminary warning notice on the landlord (and on any mortgagee) unless it is not reasonably practicable to do so. After a reasonable period the tenant or tenants can apply to the Leasehold Valuation Tribunal, nominating a particular person to manage, showing their grounds and that such appointment will be “just and convenient”. However, even if that were successful, such an appointment is always liable to be “trumped” eventually by the majority of residents. The majority can set up an RTM (right to manage) company and again take back a management of the block from the LVT-appointed manager; section 97 of the Commonhold and Leasehold Reform Act 2002 provides that the LVT-appointed manager may no longer exercise any functions of the RTM company. It would be a nightmare of course for these scenarios to unfold within a block where the freehold is already owned by residents. The possibility of them stands as a warning to residents that they should resolve their differences quickly and amicably.

Those who found and design residents associations should consider doing this in such a way as to minimise the potential for litigation to arise later over any internal matters, using state-of-the-art drafting of constitutional documents that ensure such things as transparency of decision-making, equality of information and influence among all members (so that each member is a director in small to medium sized associations), safeguards against any one party buying up any significant or controlling number of flats and the like. The disparity between sizes of flats and whether this should be reflected by affording weighted voting rights in decisions (both at board level and general meeting level) are matters for consideration in each case.

6. Internal management disputes

Typical issues that can give rise to internal disputes are as follows:-

- a lessee’s right to alter or extend his/her flat;

- an allegation that a lessee has committed a breach of a lease covenant;

- the association’s failure to take action against a particular lessee or supplier of services in alleged breach of duties;

- the development or exploitation of retained space;

- terms on which the association may agree to sell some land, rights or air space to a lessee or neighbour;

- an allegation of a secret profit being made by a director or trustee in the placing of a contract or of negligence by a director or trustee.

Internal disputes call into play the rules of contract and trusts or of company law, as well as the interpretation of leases of individual flats – which can be seen as separate and parallel regimes of legal accountability. The existence of these parallel regimes combined with the annual recurring nature of service charge disputes and the complexity of questions in dispute can make any litigation protracted and expensive, sometimes giving rise to a succession of claims over several years. The Court of Appeal’s judgment in Morshead Mansions Limited v. Mactra Properties Limited [2007] 2 BCLC 88 is instructive as to the pitfalls and costs of such litigation – referred to there as a blood bath. That case arose from an earlier one which had been comprised by the tenant party receiving a write-off of certain service charges, and it was specifically caused because the landlord company (of which the tenant was a member) exercised a right under its articles of association to make a levy for the same amount against the tenant (in its capacity as company member) as that just written-off. The tenant argued that such a levy was by implication excluded and disallowed by the earlier compromise of landlord and tenant claims. However, the tenant lost in both the High Court and the Court of Appeal. This story is a salutary warning as to the need for far reaching legal advice when considering the scope of any proposed litigation and, eventually, any terms for its settlement.

Parties in these disputes often play for high stakes. Landlords attempt to forfeit leases. Tenants can seek an acquisition order under sections 25 to 34 of the Landlord and Tenant Act 1987, alleging in effect recalcitrant breach of duty, whereby their nominee purchases the reversion at a price fixed by an LVT which will not include anything for marriage value.

Landlords can fortify themselves in anticipation of such disputes by including provisions in leases to allow their legal costs to be recovered through the service charges. This has been upheld as valid by the Lands Tribunal in Schilling v. Canary Riverside Developments PTE LRX/65/2005.

7. Confidentiality of professional advice and appointment of solicitors

In the context of trust-constituted associations, trustees can seek such professional advice as they see fit and rely on either a provision in the trust instrument or an order of the court - under the Trusts of Land and Appointment of Trustees Act 1996 (generally) or a Beddoes Order (in advance of litigation) - to recoup the costs from trust assets. Dissenting minority trustees are able to be excluded from being privy to the advice taken by the majority by virtue of the simple fact that they are not the solicitor’s client in that situation.

The position is more difficult when the reversions are owned through a company and the board of the company is divided over some litigious issue, with one faction wishing to spend company money on the litigation. In this scenario, it will be the company that retains solicitors rather than any individuals. When the majority of a board of directors want to seek legal advice at the company’s expense and to keep the advice confidential from a dissenting director, this would have to be facilitated by a special arrangement because any director is normally entitled to see all company papers and correspondence. If the majority are to proceed in this way and in the absence of any special provision in the company’s articles of association, the majority directors should seek the minority director’s agreement first, with the threat that he/she would otherwise have to be voted off the board. A company’s articles can include provisions to enable the majority of the board to seek such advice, and/or to appoint a sub-committee to obtain such advice. Furthermore, shareholders’ agreements can lay down procedures for dispute resolution, such as expert determination or compulsory mediation.

Company law normally gives the power of decision whether or not to sue to a company’s board of directors, though this may be constrained by a special resolution (75% of votes) passed by the general meeting of members.

Once solicitors correspond or issue proceedings on a company’s behalf they warrant their authority. This assertion of authority by solicitors should not be challenged in proceedings except on the clearest of evidence and after taking counsel’s opinion.

8. Alternatives to litigation

Litigation is now properly regarded as a last resort method for dispute resolution - only to be used if all else fails, due to its large and often disproportionate expense and risks. This is true most especially for disputes involving neighbouring owners and members of one common group.

The first alternative to litigation is of course neighbourly discussion – initially without involving solicitors and then, if necessary, putting agreed questions and the full range of views and information before solicitors for advice. If this does not resolve the matter then the disputing factions will usually go to separate solicitors for advice and representation, and the board of directors or a majority of that body may use the company’s funds to pay for legal services - depending on what the constitutional documents have to say on this.

The second alternative to litigation is pre-action correspondence and voluntary disclosure of information. A court can even make an order for pre-action disclosure as a way to enforce this. It is therefore necessary for the pre-action correspondence to be as objective as possible so that the real causes of underlying conflict - whether of fact, law, expert opinion in a particular field, or a mixture of those - can be clarified, investigated and hopefully resolved.

If the pre-action correspondence route fails then parties should next choose between mediation, early neutral evaluation and binding expert determination.

Mediation involves a neutral expert investigating each party’s position, discussing their settlement options and advising the parties separately and jointly on the most sensible way of resolving their problems. In the right hands mediation is very effective but it can be manipulated by wealthy and risk-seeking parties.

Mediators are skilled at helping the disputing parties to appreciate their opponents’ viewpoint and in spelling out the drastic consequences of going to law, and looking for innovative ways to bring parties together. Mediators often succeed in forging a compromise without expressing their own opinions of the merits of the matter before them. Indeed, most mediators refuse to go that far.

Early neutral evaluation, whether by a specialist barrister or a recently retired judge, or by an acknowledged expert in some technical field, is an effective way of addressing disputes on esoteric questions of law or science - particularly questions that can be narrowly defined. Even though it may not be binding, to hear an authoritative critique of one’s position can sometimes move an otherwise determined disputing party.

Binding expert determination represents another way of resolving disputes without full litigation. It is particularly helpful in disputes over accounting for money and quality of building works.

9. Recoverability of legal costs through service charges

Questions can arise as to the meaning, effect and enforceability vis-à-vis the Unfair Terms in Consumer Contracts Regulations 1999 of lease clauses that enable a landlord’s legal expenses to be recovered via the service charges.

Under section 20C of the Landlord and Tenant Act 1985 a tenant can obtain an order that the landlord’s costs in any Court, tribunal or arbitration proceedings shall not be included within the service charge payable by the tenant or any other person specified.

However, there is doubtful benefit from such an order in situations where a residents association with 100% membership of lessees owns the reversion or freehold. Such costs would then stand to be paid from other funds available to the association, such as its ground rent income or its reserve funds. Moreover, if such an order were made and enforced in respect of the association’s costs of failed litigation, that could render it insolvent - which would jeopardise the ownership of the reversion or freehold.

There are few reported cases on the application of section 20C. Experience suggests that courts will not use it in such a way as to make it any easier for an individual member of the association to sue that association; instead the courts try to discourage all litigation. Thus, it is unlikely that a court would make such an order whereby one lessee – such as the claimant – is given exemption from paying towards particular legal costs incurred by the association of which he or she is a member.

This statutory discretion is wide and unfettered and therefore difficult to predict. It does not follow that all successful tenants will succeed under section 20C or that all successful landlords will defeat a section 20C claim.

10. Title-altering and document-altering litigation

Leaving aside the rules of rectification for errors in documents, there are two areas of the law containing rules that make this possible as between private parties: landlord and tenant law and company law.

A court can intervene and alter the service charge percentages between flats in a block where there has been some alteration to the respective sizes of the flats, as confirmed in Pole Properties Limited v. Fineberg (1981) 43 P&CR 121. Where the service charge percentages are inequitable from the outset of a block’s creation, as can happen when a developer has kept back a flat for himself, the court will not intervene – the rule caveat emptor or “buyer beware” applies.

The LVT has a power under sections 35 to 40 of the Landlord and Tenant Act 1987 to order leases within a block to be altered, first where it finds that they fail to make satisfactory provision concerning a list of estate management issues laid down in section 35 and secondly if an application to vary terms of all leases in a block is brought by 75% of owners within that block provided that the objecting owners are fewer than 10% under section 37.

Aggrieved lessees can also take action to force the appointment of a new manager, by application to the LVT under the 1987 Act, upon showing serious breaches of duty by the present regime and that it would be a just and convenient remedy.

If aggrieved lessees can form a majority within a self-contained block and come within other qualifying conditions they can exercise the right to manage under the Commonhold and Leasehold Reform Act 2002, or they can collectively buy out the freehold from the present owners using rights under the Leasehold Reform, etc Act 1993. That Act does not presently give all lessees in a block the right to participate in such collective enfranchisement.

If the dispute is between members of the same company, and the aggrieved party is able to allege “unfairly prejudicial conduct” against the board of directors or opposing faction of members of the company, the claim can be constituted as a petition before the court under section 994 of the Companies Act 2006.

This would give the court the power to make any order it sees fit, such as requiring one party to sell out or to buy out the other party - which would presumably refer to their lease as well as their interest in the company. There is no reported instance of such a forced sale of lease being required by the court under this company law jurisdiction.

The court also has power under section 996 of the Companies Act 2006 to order changes to be made in a company’s articles of association or to other documents of agreement between the parties to the litigation arising from the conduct of an unfairly prejudicial nature between members of the company.

11. Your choice of solicitor

As well as knowing all of the applicable substantive law regimes, legal advisors who operate in this area should be skilled in both drafting and dispute resolution. Thus no pure conveyancer, nor pure company lawyer, nor pure landlord and tenant lawyer, nor pure litigator would be able to serve you well enough.

James Brenan