Where does the money live? Service charge trust accounts and your legal duties

When leaseholders pay their service charge, where does the money actually go? In too many blocks, the honest answer is "somewhere in the managing agent's accounts, and it's not entirely clear how it sits alongside other clients' money." That opacity is not just uncomfortable — it is, in many cases, legally wrong.

The law is clear on this point, even if practice sometimes diverges from it. Service charge contributions are held on a statutory trust. The money belongs to the leaseholders, not the manager. When an RTM company takes over, the trust obligation transfers to it. Understanding what this means in practice — and what it demands of volunteer directors — is one of the most important things a self-managing block can get right from day one.

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The statutory trust: Section 42, Landlord and Tenant Act 1987

The legal basis for the trust is Section 42 of the Landlord and Tenant Act 1987. The section provides that:

• Service charge contributions held by a landlord or manager are to be held on trust for the contributing leaseholders.
• Reserve fund and sinking fund contributions are held on the same basis.
• The money must be held in a designated account at a relevant financial institution — a bank or building society — and kept separate from the manager's own money.
• Any interest earned on the funds follows the trust: it belongs to the leaseholders, not the manager.

The phrase "relevant financial institution" means a recognised bank or building society; the account must be dedicated to the service charges of the building in question, not pooled with other clients' funds in a single catch-all account.

This is the legal underpinning for a simple but important principle: the money is the leaseholders' money. It was collected from them for specific purposes — maintaining their building, insuring it, building up reserves — and it must be kept available for those purposes. The manager is a steward, not an owner.

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Why the trust structure matters

Protection against misuse

A properly maintained trust account means that, in principle, the money cannot be spent on anything other than the building's proper running costs. If a manager attempts to use service charge funds to cover their own business costs, or to cross-subsidise another client's building, that is a breach of trust — a serious legal wrong.

Protection against insolvency

If a managing agent becomes insolvent, service charge funds held on a properly constituted trust should not form part of the agent's estate available to creditors. The money belongs to the leaseholders, not the agent. In practice, the protection only works if the agent actually maintained a properly segregated account. Where agents have pooled clients' money — which happens, though it shouldn't — leaseholders can find themselves unsecured creditors of an insolvent company, competing with everyone else. Proper trust accounting is the safeguard.

Accountability

A designated account with clean records makes it straightforward to demonstrate to leaseholders exactly what has been collected and what has been spent. This is both good practice and, under the Landlord and Tenant Act 1985, something leaseholders can demand to see.

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When the RTM company takes over

When an RTM company acquires management, the trust obligations transfer with the management functions. The RTM company becomes the manager. Its directors — typically volunteer leaseholders — become responsible for maintaining the trust account properly.

This is a real legal responsibility. It is not bureaucratic box-ticking.

As soon as the RTM company takes over, it should:

1. Open a designated service charge account in the block's name at a recognised bank or building society. This account should be separate from any general company bank account.
2. Transfer existing balances from the previous manager's client account to the new account — this is part of the handover process.
3. Keep clean records of what has been collected, what the interest (if any) has been, and what has been spent and on what.
4. Never commingle service charge funds with the company's own money (if the RTM company has any separate operational funds).

The reserve or sinking fund — amounts collected over time for large future expenditure like roof replacement or lift refurbishment — is also held on the same trust and must be kept in a designated account. Many blocks hold the reserve fund separately from the working service charge account simply to avoid any ambiguity about its purpose.

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Director responsibilities

RTM company directors are directors under the Companies Act 2006. They owe statutory directors' duties: to act in the company's interests, to exercise reasonable care and skill, to act within the company's constitution. Those duties extend to the financial management of the company — including the proper stewardship of service charge funds.

Practically, this means directors need to:

• Understand the trust obligation. The money collected is not the company's to deploy freely. It is held for specific purposes defined by the leases and the management functions.
• Maintain the designated account. Know where the account is, who has access, and what the balance represents at any point.
• Produce compliant demands. Service charge demands must meet the requirements of the Landlord and Tenant Act 1985 (and, in due course, any new format requirements under forthcoming regulations). An invalid demand can mean money is not technically due until the demand is corrected.
• Keep records accessible. Leaseholders have statutory rights to request a written summary of service charge costs and to inspect the accounts. You need to be able to respond.
• Budget responsibly. Under the reasonableness requirement in the Landlord and Tenant Act 1985, service charges must be reasonably incurred and for works carried out to a reasonable standard. Demanding more than is reasonably needed, or spending on unnecessary works, exposes the RTM company to challenge at the First-tier Tribunal.

None of this requires a finance background. It does require organisation, attentiveness, and ideally the right tools.

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The reasonableness duty in brief

It is worth noting that the trust structure and the reasonableness duty under the Landlord and Tenant Act 1985 operate together. Section 42 LTA 1987 governs how the money is held. Sections 18–30 LTA 1985 govern what can be demanded and spent.

Under the 1985 Act, service charges are only payable to the extent that costs are reasonably incurred and works are carried out to a reasonable standard. Leaseholders can apply to the First-tier Tribunal to challenge charges they believe are unreasonable — and the Tribunal can determine that a charge is not payable, or only payable in part.

For a self-managing RTM company, the reasonableness duty is a good discipline as much as a legal constraint: spend money carefully, on things the building genuinely needs, at competitive prices, and document your reasoning. That is both the legal standard and the right way to run a building.

There is also the Section 20B 18-month rule: costs must be demanded within 18 months of being incurred (or leaseholders notified that costs will be demanded), or they may not be recoverable. Directors should track expenditure against demand cycles carefully to avoid losing the ability to recover costs they have legitimately incurred.

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How Reeve handles this

One of the practical challenges for self-managing blocks is keeping the trust accounting clean without specialist software or accounting expertise. Reeve is designed so that service charge funds always remain in the block's own designated trust account — Reeve processes demands and collections, but the money flows directly into and out of the block's account, not through Reeve's own accounts. Reeve never holds the money.

For Wadebridge Court — a 24-flat RTM block using Reeve OS — this means directors can see the service charge account balance, track what has been collected and spent, and produce demand schedules without ever losing sight of the fact that the money belongs to the residents.

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Common mistakes to avoid

Using the service charge account as a general operating account. The RTM company may have small running costs — filing fees, insurance for the company itself, perhaps accounting fees. These should not be paid from the service charge account unless they are legitimately within the service charge scope defined by the leases. When in doubt, get advice.

Leaving balances in the previous agent's account. After the acquisition date, the RTM company should promptly request transfer of all service charge and reserve fund balances. Delays leave the money under someone else's control longer than necessary.

Not paying interest into the correct account. If the designated account earns interest, that interest belongs to the leaseholders. It should either accumulate in the trust account or be allocated in accordance with the leases. It should not go to the RTM company's general funds.

Mixing reserve and working funds in a single account without clear records. Not illegal per se, but it creates confusion about what is available for day-to-day spending versus what is being held for long-term purposes. Separate accounts — or at least clear records — are strongly advisable.

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FAQ

Does the trust obligation apply to my RTM company once we take over? Yes. Once the RTM company is the manager, it holds service charge and reserve fund contributions on the statutory trust under Section 42 LTA 1987, in exactly the same way a managing agent does (or should).

What if the previous agent hasn't separated the money properly? This is unfortunately not unheard of. On takeover you should formally request an accounting of all funds held and their transfer to your designated account. If there is a shortfall or the funds appear to have been commingled, take legal advice promptly.

Can leaseholders see our accounts? Yes. Under the Landlord and Tenant Act 1985, leaseholders can request a written summary of service charge costs for the preceding 12 months, and can inspect the accounts, receipts, and other documents. As a self-managing company you should make this as easy as possible — it is your money too, after all.

How should we handle the reserve fund? Keep it in a designated account (separate from the working service charge account is best practice), document what it is being accumulated for, and treat any interest as part of the trust fund. When you draw on it, keep clear records of what you spent and why.

What happens if we accidentally spend trust money incorrectly? A breach of trust is a serious legal wrong. In practice, if a mistake is made and corrected promptly with no loss to leaseholders, the consequences are likely limited. But deliberate misuse or persistent carelessness could expose directors to personal liability. The practical safeguard is good systems and clear records — not waiting until something goes wrong.