Sinking and reserve funds can have adverse tax consequences, particularly on mixed use schemes and have been a source of a number of disputes. We have in recent times therefore seen less enthusiasm from landlords to include them in leases and tenants will typically resist them.
Whilst it is less common to encounter sinking and reserve funds in new estate set ups, they may be inherited by tenants through assignment or may remain in place on the grant of a renewal lease. It is also possible that, with increased pressure on landlords to make their buildings more energy efficient, landlords will want to retain or put in place sinking or reserve funds to meet the costs of their obligations in this regard. It remains to be seen if this is something landlords will consider and tenants will accept, however.
In basic terms, a sinking fund is an account established to accumulate money over time for the replacement or repair of a significant asset that has a predictable life span (not exceeding 50 years), usually plant or machinery, or an element of structure. It is intended to pay for a cost that is known, thus the fund then diminishes as the money is spent on its intended purpose. A sinking fund should have a detailed forecast of the anticipated expenditure and an asset lifecycle plan. Replacement should be carried out based on technical assessments of condition of the asset in question.
A reserve fund is for unexpected repairs or unanticipated expenditure. As the expenditure connected with a reserve fund is unknown, a more general estimation of costs is required.
The RICS Professional Statement provides useful guidance on how the two funds should be operated and the parties should seek to ensure that the guidance is followed when agreeing to sinking or reserve fund provisions, making reference to this at heads of terms stage.
Tenants are not typically entitled to a refund of contributions made to sinking or reserve funds and so any sums paid into the funds which have not been used during the term of the lease will be retained by the landlord. If the landlord disposes of their interest in the property a reserve or sinking fund should be transferred to a new owner.
Given that a tenant may pay into such funds and not see the benefit of any repairs, sinking and reserve funds are more commonly found in leases with longer terms. We sometimes see a split in the lease where no sinking or reserve fund is applied in relation to the premises, with a fund in place for the wider estate and common parts.
If you require any further advice on sinking or reserve funds, service charge provisions or lease terms in general, please get in touch with our commercial real estate team.
