Service charges are typically budgeted for and collected on an annual basis. Many leases, however, also allow landlords to plan for future expenditure by collecting contributions towards a reserve fund and/or a sinking fund. These funds enable money to be set aside in advance, helping to spread the cost of major expenditure over a number of years rather than demanding a substantial one off payment from leaseholders. There is however a difference between the two funds.
What is a Reserve Fund?
A reserve fund is a general fund that can be built up to meet future expenditure on services or works that are recoverable under the terms of the lease. It usually appears as a separate item within the annual service charge budget.
Unlike a sinking fund, a reserve fund is not normally restricted to a single item of expenditure. It provides financial flexibility, allowing the landlord to meet unexpected costs or to prepare for anticipated major works without placing a significant financial burden on leaseholders in a single year.
What is a Sinking Fund?
A sinking fund also allows money to be collected in advance for future expenditure, but as mentioned earlier it is established for a specific purpose. For example, contributions may be collected over several years to pay for roof replacement, external redecoration or lift renewal.
The key distinction is that money held in a sinking fund should only be used for the specific purpose for which it was collected.
Final Thoughts
Reserve funds and sinking funds are generally beneficial for both landlords and leaseholders. They help ensure that major works can be carried out when required without the need for large, unexpected service charge demands. The Tribunal also generally recognises the practical value of properly established reserve funds.
However, the starting point is always the lease. A landlord can only collect and retain contributions towards a reserve fund or sinking fund if the lease expressly permits it.
If the lease contains no such provision, the landlord is unlikely to be entitled to retain those monies. Leaseholders may be entitled to seek repayment of contributions, or the landlord may have to distribute the funds back to those who paid them.
This can create significant practical difficulties, particularly where flats have changed hands over the years. We have acted in cases where landlords have had to trace former leaseholders in order to reimburse reserve fund contributions that had been collected without any contractual authority.
As with all service charge issues, the lease is the starting point. Before collecting contributions towards a reserve or sinking fund, ensure the lease permits it. If you are unsure, we can review your lease and advise whether the relevant provisions are in place.