A question we are asked regularly by RTM and RMC directors: does the law require the reserve fund to sit in its own bank account, separate from the general service charge account?
Service charge contributions, including reserve fund contributions, are held on statutory trust under section 42 of the Landlord and Tenant Act 1987 and must be kept separate from the landlord's or managing agent's own money in properly designated client accounts. Whether the reserve fund needs its own distinct account, separate from the general service charge account, depends on the lease and on good practice rather than one universal rule. Section 42A, which provides for designated accounts, depends on regulations that are not in force, so it should not be described as an operative duty. Most well-run blocks hold reserves separately for transparency and cleaner handovers.
Section 42 of the Landlord and Tenant Act 1987 provides that service charge contributions paid by tenants of dwellings are held by the payee on trust, to be applied for the purposes set out in the leases and, subject to that, for the contributing tenants. Reserve and sinking fund contributions collected as service charge fall within that framework.
The practical consequence is not optional. Building money is not the landlord's money and it is not the managing agent's money. It must be held in a way that keeps it identifiable and separate from the agent's or landlord's own funds, so that it can be accounted for and, on a change of agent, transferred.
Section 42A of the 1987 Act was inserted to require service charge contributions to be held in a designated account, but the substantive requirement depends on regulations that are not in force. Directors should therefore not describe a designated account as an operative statutory duty. The section 42 trust, the lease, and the professional codes are what actually bite.
There are two different questions here, and they get conflated constantly.
Separation from the agent's or landlord's own money. This is not negotiable. Client money must be held in properly designated client accounts, and agents subject to client money protection requirements and professional codes have detailed obligations about how those accounts are titled, reconciled and audited.
Separation of the reserve fund from the general service charge account. This is a different question, and the answer depends on the lease and on good practice rather than on a single statutory rule. Some leases expressly require the reserve to be held separately, or to be invested, or to be held in an interest-bearing account with interest credited to the fund. Where the lease says so, that is binding.
Even where the lease does not require it, most well-run blocks hold the reserve separately. It makes the fund visible to leaseholders and prospective buyers. It reduces the risk of long-term money being consumed by day-to-day cash flow. It makes interest attribution straightforward. It simplifies the year-end accounts and the reserve fund note. And it makes a change of managing agent considerably cleaner, because the balance being transferred is unambiguous.
Where money is pooled, the reserve should at the very least be separately identified in the accounting records and reported as a distinct balance, with a clear statement of what it is held for.
Read the lease first: does it require a separate or interest-bearing account, and who is entitled to the interest? Then establish who the account is actually with, how it is titled, and whether the title makes clear that the money is held for the client and its leaseholders. Ask for statements directly rather than relying on summaries. Confirm reconciliation frequency and who reviews it. Check whether client money protection is in place and ask to see the certificate. Consider whether deposit protection limits are relevant to the sums held, particularly where a large reserve is building towards major works.
Interest on reserve funds and the tax treatment of service charge trusts are technical areas, and the position can differ depending on how the fund is constituted. Boards should take accountancy advice rather than assuming interest is simply theirs to spend. Reserve funds should also be reported clearly in the annual service charge accounts, with the opening balance, contributions, expenditure and closing balance shown.
Reserve fund balances should be identified, evidenced by bank statements and reconciled to the transfer date. A refusal to transfer building money because of a fee dispute is a serious matter, and the trust framework is the reason why. Directors should keep the two issues separate: the fee dispute can be argued on its own merits without the building's long-term savings being used as leverage.
Setting up and reconciling compliant client accounts is routine work for a managing agent, and is included in our management service for RTM companies.
How this applies depends on whether you hold the money or contribute to it.
Stating that a designated account is legally required
Section 42A depends on regulations that are not in force. The trust under section 42, the lease and professional codes are the real obligations.
Letting reserve money fund day-to-day cash flow
Pooled money without separate identification makes long-term savings vulnerable to short-term deficits.
Accepting a balance figure without bank evidence
Statements and reconciliations are what prove the money exists and is held correctly.
Treating interest as the company's to spend
Entitlement to interest depends on the lease and the trust; accountancy advice is needed.
Most questions on this topic are management questions rather than legal ones, and the two are worth separating. A managing agent can tell you how something works day to day and what it will cost. A solicitor tells you what your rights are and how a Tribunal is likely to view them.
East Valley Properties provides management expertise, not legal advice. Where a matter turns on the wording of your lease or on formal proceedings, we will say so and work alongside your solicitor.
The official material behind this guide. We summarise it in plain English rather than reproducing it.
Service charge contributions are held on trust for the contributing tenants.
Designated account provisions, dependent on regulations.
Approved code covering client money handling and reporting.
Guidance on service charge funds, accounting and leaseholder rights.
Clear budgets, designated client accounts and year-end accounts leaseholders can actually follow. We can review your current arrangement at no cost.
Answered by Romain Maillard - Director, East Valley Properties
Romain manages residential blocks and estates for RTM companies, residents' management companies, share of freehold developments and freeholders across East London and Essex.
Published
This answer has been anonymised. Personal details, addresses and company names have been removed. Guidance is general and does not replace advice from a solicitor or surveyor on your specific block. East Valley Properties is a managing agent, not a firm of solicitors or legal advisers.
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