With new proposals to "unbundle" heat from service charge, what does this mean for landlords? This article looks at the interface between heat network regulation and existing Landlord and Tenant legislation.
This article is part of our Heat Network Regulation series which looks at key issues under the latest round of consultations published by Ofgem and the Department for Energy Security and Net Zero on 7 November 2024. If you have any involvement with a heat network, check how regulation will apply to you and whether you will be considered a heat network "operator" or "supplier".
Recovering the cost of heat
The heat network sector is diverse – with a range of commercial and contractual models that govern how heat and cooling is supplied and charged to end consumers. Heat charges may be recovered through separate customer supply agreements, under the terms of the customer's tenancy agreement or lease as a service charge or included as part of rent.
Ofgem is used to regulating licensed energy suppliers and the authorisation regime is closely based on existing protections for gas and electricity consumers. This model is most suited for energy service companies (ESCOs), likely to have similar structure, policies, and procedures in place – but with a high proportion of heat network suppliers expected to be private or social landlords, interface with existing landlord and tenant legislation needs to be considered.
"Unbundling heat charges" – what does this mean?
Ofgem is seeking feedback on "unbundling heat charges" from other service charges and rent – suppliers will need to charge separately for the supply of heat (based on individual consumption). This is not expected to cover maintenance or replacement costs, which presumably landlords can still recover through the service charge mechanism – but further detail is required.
The aim of "unbundling heat charges" is to ensure consumers are covered by all regulatory protections, particularly where existing housing and Landlord and Tenant legislation contradict proposals under the authorisation regime. It is not clear whether "unbundling heat charges" will achieve this – particularly for landlords that already issue bills based on actual consumption – or whether existing Landlord and Tenant legislation will be amended.
Further detail is required on what these proposals will look like and how they may apply to existing schemes. Ofgem are working across sectors groups and liaising with the Ministry of Housing, Communities and Local Government to understand how this could work in practice and what changes to existing legislation may be required.
Service Charge and Heat Networks – what are the issues?
Previous consultation responses raised concerns around poor outcomes for customers where heat is tied to rent or service charges.
One of the key issues raised is the ability for landlords to threaten tenants with eviction or forfeiture for non-payment of heat charges. This does not align with protections for vulnerable customers, including the disconnection ban for certain vulnerable customers (see our article on vulnerability for further detail).
In reality, it is only in exceptional circumstances where landlords would look to exercise these rights and raises new questions around how landlords are able to recover longstanding bad debt. This will be of particular interest to landlords or ManCos running smaller networks where non-payment may have a significant impact on their ability to provide services.
More specific issues will depend on how charges for heat are recovered:
Landlord and Tenant Act 1985
Variable service charges, where a landlord seeks to recover its actual costs incurred in providing heat or cooling (with each tenant paying an appropriate share), are regulated by the Landlord and Tenant Act 1985. If the 1985 Act applies, landlords must ensure that services charges are reasonably incurred, consult with tenants before entering into certain works or service contracts, and there is an 18-month time limit for recovering costs.
This raises questions around whether Heat Network Regulation will take precedence (and how this will be reflected in legislation) in the following circumstances:
- Back-billing: Ofgem is proposing to limit back-billing customers for consumption older than 12 months. This conflicts with provisions under the 1985 Act that require bills or demands for service charges to be issued within 18 months of the relevant costs being incurred. Service charges are typically charged based on estimated costs for the year, with a balancing charge issued after the year-end accounts have been prepared. If a 12-month back-billing limit is introduced, this would give landlords no time to reconcile their costs, prepare year-end accounts or issue any balancing charge demands after the end of the service charge year, and would only work in practice if heat charges are brought entirely outside of existing service charge legislation.
- 'Fair and not disproportionate' v Reasonableness: Section 19 of the 1985 Act provides that a service charge is only recoverable if it is reasonably incurred. It is not clear whether Ofgem requirements for "fair and not disproportionate" pricing will take priority over the "reasonableness" test. As landlords do not make a profit on service charge, it is not clear whether the "unbundling" proposals will mean that landlords can set tariffs higher than their actual costs, provided that Ofgem's pricing principles are followed. See our article on pricing proposals for further detail.
- Conflicting authorities: Tenants have the ability to challenge the reasonableness of service charges at the First-tier Tribunal. With proposals to uncouple consumption charges from fixed costs, this may mean that tenants are required to challenge variable and standing charges separately under two different regulatory regimes. There is also crossover between jurisdiction of the Energy Ombudsman and Housing Ombudsman, with further clarity required around which scheme will take precedence.
Fixed service charges
Fixed service charges are not subject to the 1985 Act, as they do not reflect the landlord's actual cost of delivery the services. Although fixed service charges (or circumstances where heat is included as part of rent) can often benefit the tenant in terms of price certainty, this recovery method does not align with several key proposals under the consultations, particularly around billing consumers based on their actual consumption.
Practical considerations - Heat Supply Contracts
The Implementing Consumer Protection consultation proposes that heat network suppliers will be required to have heat supply contracts or the "equivalent of a heat supply contract (e.g., terms in a lease or tenancy agreement)".
There is a list of specific information that should be included in a supply contract – including details of charges, circumstances where charges may be adjusted, compensation and refund arrangements, complaints handling processes, key performance indicators etc. This does not fit easily within a lease or tenancy agreement and is more suited to a separate heat contract approach – it is not clear what other forms of documents or communications will be sufficient.
For existing leases and tenancy agreements that cannot be easily amended, it remains to be seen how regulation will be applied retrospectively.
This article is part of our Heat Network Regulation series. Read our overview of the proposals under the latest round of consultations.
If you are concerned about any of the issues raised under the consultations or how regulation may impact you, please get in touch with a member of our Energy and Sustainability team.
