Assethold Limited v Alexandra Adam & Ors.

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.

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.

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.”

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:

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.”

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.”

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 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:

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”.

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.

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.”

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.

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.

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.

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.

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.

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.

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.

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.

Mr Loveday also takes issue with the way in which the FTT applied the test, even if his primary argument fails. As discussed, there is a two-stage test and the FTT had to look both at process and at outcome, which it did in its paragraphs 80 and 81.

At its paragraph 80 (set out above at my paragraph 25) the FTT judged that on receipt of the Hydrock report, seeing how different was its conclusion from that of its earlier reports and of other reports of which it was aware, the sensible thing to have done would have been to commission a further report. “In failing to instruct a second report itself, the tribunal concludes that Assethold probably failed to act reasonably.”

We noted above (at paragraph 33) that the Court of Appeal in Waaler took the view that the assessment of a landlord’s process is a rationality test. Mr Denehan argued strenuously that in the circumstances the only rational reaction to the Hydrock report was to commission another one in light of the report’s own flaws and of the content of the other reports available to the landlord including Hydrock’s previous report, given that there had been no change of circumstances since the previous reports had been delivered.

There are two difficulties with that submission. The first is that the final Hydrock report, and the assessment of risk as “intolerable”, was not said to be made on the basis that circumstances had changed. It was a report based on a different inspection, in which different processes were followed and different aspects of the building examined. So the fact that this report reached a different conclusion from Hydrock’s and 4sites’s previous reports did not mean that there was a contradiction and did not itself mean that the latest report was wrong. The other difficulty is that I fail to see how any landlord, faced with a report from a reputable company signed by three professionals saying that the fire risk in the building was intolerable, could be said to be irrational for putting interim measures in place pending further reports or remedial work.

It might well be that a confident landlord, noting some of the flaws in the report that were evident to the careful but unqualified reader – in particular that the report was using standards appropriate for buildings more than 18m high, and that the risk matrix had been misapplied (see paragraph 23 above) – might have decided to do nothing pending a further report and that that would have been a rational choice in the circumstances. But I accept Mr Loveday’s argument that it was rational to act as this landlord did, and I take the view that the FTT’s conclusion to the contrary could not have been justified on the evidence before it.

Turning to the FTT’s assessment of the outcome, in the second stage of the test, at its paragraph 81 the FTT concluded that because the Hydrock report was (to put it bluntly) wrong, the landlord’s decision to follow its advice was not reasonable. It did not look at a range of reasonable choices of outcome open to the landlord (Waaler paragraph 37), because it took the view that only one response could have been reasonable. That is not an automatically incorrect application of the test; there might well be cases where there truly is only one reasonable response. But did the FTT rationally conclude that this was such a case?

The FTT went on to explain in paragraph 81 that it accepted the argument that

“these costs were unnecessary, and that unnecessary costs will not have been reasonably incurred”.

Mr Denehan argued that this was right. “The First Tier Tribunal could only objectively assess the outcome of Assethold’s decision-making process by making a finding as to whether or not the waking watch was objectively necessary” (skeleton, paragraph 28). And Parliament intended that the landlord, rather than the tenants, should take the risk under section 19(1)(b) of professional advice being incorrect just as the landlord rather than the tenant takes the risk of the work done not being of a reasonable standard.

I disagree. What the FTT had to decide was whether it was objectively reasonable for the appellant to have put a waking watch in place as an interim measure in reliance upon the report in March 2015, in the light of what it knew or could readily have found out and of what the report said. Instead, the FTT made a decision on the basis of the hindsight provided by the evidence of the parties’ expert witnesses and following their cross-examination. As it turned out, as the FTT found, the report was wrong and it held that therefore expenditure incurred in reliance upon it could not have been reasonably incurred. That is an objective assessment, but it is one that depends upon the hindsight provided by the leaseholders’ expert witness. What the FTT had to look at was not what it knew as a result of the proceedings, but at whether the expenditure was reasonable in the circumstances and on the basis of the information available when the cost was incurred.

I have already said that to put in place an interim safety measure in response to a report that said the fire risk was “intolerable” cannot be said to have been irrational on the information then available. Nor can it be said to have been unreasonable. What the FTT had to decide was whether setting a waking watch in both buildings, pending further work or investigation, was a reasonable response to the advice the landlord received. It need not be the only reasonable outcome. But on the facts of this case only a supremely confident landlord would have done anything else. It had a report signed by three fire safety professionals telling it that the risk to life from fire was “intolerable”. There were obvious points to query, and the landlord’s agent raised some of them. But the writers of the report stood their ground and the final report made the same recommendation as the draft. I fail to see that the adoption of one of the interim measures recommended could be described as unreasonable, provided it was adopted purely as an interim measure, for as long as was needed either to implement the report’s main recommendations or to establish on taking further advice that they were not needed. There is no appeal from the FTT’s finding that that period was one month.

Accordingly, while the FTT applied the correct test, on the evidence available to it it misapplied that test and its decision is set aside.

It is open to the Tribunal to substitute its own decision, and it will be clear from what I have said that I take the view that the landlord followed a rational process in commissioning and following the Hydrock report, and that the outcome – setting the waking watch as an interim measure – was a reasonable one. Moreover, Hydrock recommended that that watch be put in place for both blocks, and since they are contiguous I take the view that it was reasonable to set up a watch for both. That cost was therefore reasonably incurred, subject to the assessment of the standard of service provided under section 19(1)(b).

The FTT has already addressed that issue and has found that the quality was such that only half would be recoverable. Accordingly, the sum of £14,000 was reasonably incurred by the landlord within the meaning of section 19(1)(a).