In this post I am going to take a brief look at the differences between a sinking fund and a reserve fund. Leases and service charges invariably contain reference to sinking or reserve funds as a means of spreading the cost of repairs and over the years, these funds have often been the cause of much confusion due to people assuming their description and purpose is virtually interchangeable.
A sinking fund, also commonly referred to as a replacement fund, is a fund created whereby monies are set aside periodically for the repair and replacement of wasting assets. Examples of wasting assets most frequently include large items of plant equipment such as lifts, heating and air-conditioning units.
Due to the nature of a sinking fund, it is best practice to collect the monies over the life of the item for which it is intended. Ideally, the items for which the monies are being built up for should be clearly set out to the tenant.
A reserve fund on the other hand is created to meet the anticipated future costs of maintenance and upkeep (usually periodically recurring items) in order to avoid fluctuation, or a large one off increase in the amount of service charge payable each year. This fund tends to be more short term in nature and is usually created for a specific purpose. Therefore, this type of fund can only really relate to costs that are reasonably expected during the term of a tenants individual lease.
An example of repeat maintenance could be the periodic redecoration of the common parts in a multi let office block.
It is easy to understand why the differences between a sinking fund and a reserve fund have caused confusion in the past, however, recent case law clarifies matters. The RICS guidelines ‘Service Charges in Commercial Property’ seek to improve general standards and seek to promote best practice, fairness and transparency but it goes without saying that, before entering into any agreement, tenants should take professional advice.