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Supreme Court upholds an orthodox approach to contractual interpretation 11 June 2015

The Supreme Court yesterday upheld the Court of Appeal’s decision in Arnold v Britton [2015] UKSC 36 – meaning that the landlord’s interpretation of the service charge clause has prevailed, absurd though it is.  Lord Neuberger reminded us:

“… while commercial common sense is a very important factor to take into account when interpreting a contract, a court should be very slow to reject the natural meaning of a provision as correct simply because it appears to be a very imprudent term for one of the parties to have agreed, even ignoring the benefit of wisdom of hindsight. The purpose of interpretation is to identify what the parties have agreed, not what the court thinks that they should have agreed.”

Background

The case concerns a series of leases of holiday chalets at a park in South Wales, for a term of 99 years from 1974.  There are a number of different versions of the lease but, in brief, the most pernicious of them requires the tenants to pay annual sums to the landlord that increase by 10% annually (from a starting point of £90).  The sums are expressed to be payable in respect of “… a proportionate part of the expenses and outgoings incurred by the Lessors in the repair maintenance and renewal of the facilities of the Estate and the provision of services hereinafter set out …”.

The startling impact of an annual increase of 10% was explained in my blog article on 20 January 2015 entitled “The danger posed by geometric progressions”.  By the end of the lease, the annual sum will exceed £1 million.  Surely this cannot be what the parties had intended when they entered into the leases, for two reasons.  First, the sum itself is absurd; secondly the sum bears no relation to the amounts that the landlord is likely to expend in providing the services.  This was the dilemma that the Supreme Court had to address.  Is the provision to be read literally, or is it permissible to interpret it in a more sensible way, which does not require the tenant of each chalet to be required to pay such improbable sums?  (For simplicity I will refer to “the tenant” in the singular, although there were a number of tenants under a number of leases.)

The role of the court was explained by Lord Carnwath (who delivered the dissenting judgment) as follows:

“… we must inquire (sic) ‘what a reasonable person would have understood the parties to have meant, that person being one who had ‘all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract’, and who would have also taken into account ‘the practical consequences of deciding that it means one thing or the other’.  Where necessary the reasonable observer can be invited notionally to take on the more active role of ‘officious bystander’, in order to interrogate the parties as to their common intentions.”

It is important to understand that when a court interprets a document, the parties’ actual intentions are irrelevant.  What matters is what they have actually included in the document.  To be honest, sometimes the two approaches can be difficult to distinguish.

The tenants faced two difficulties that ultimately even their experienced counsel (Timothy Morshead QC) was unable to overcome.  First, four of the five Supreme Court Justices did not accept that the disputed clause was ambiguous on the face of it.  Once a clause becomes ambiguous, it becomes permissible for the courts to move away from a purely natural interpretation.  Lord Neuberger explained (at [18]):

“… I accept that the less clear [the words] are, or to put it another way, the worse their drafting, the more ready the court can properly be to depart from their natural meaning.”

Secondly, in respect of some (although not all) of the leases, there was a conceivable explanation for the annual 10% increase: inflation in the 1970s and early 1980s was running in double figures (and peaked at 24% in 1975).  That meant that it was not entirely impossible that the parties had intended to include some form of inflation adjustment, and might conceivably have settled at 10% for simplicity.

The Supreme Court’s decision

Ultimately, the Supreme Court came down 4-1 in favour of the landlord’s interpretation.  One of the majority was Lord Neuberger, who gave the main judgment (on behalf of himself, Lord Sumption and Lord Hughes).  As would be expected, Lord Neuberger expressed “considerable sympathy” with the view that the tenant’s appeal should succeed – but did not believe that the tenant had demonstrated that its reading was the correct one.  The tenant’s interpretation was that the 10% increase annually in the service charge should be treated as a cap on the annual increase.  He said that the tenant’s interpretation would involve “departing from the natural meaning of [the clause], and it involves inserting words which are not there.”

The tenant may take some comfort – but, in the circumstances, probably not very much comfort – from the fact the one of the Justices, Lord Carnwath, agreed with the tenant’s interpretation.  He took the approach that I had mentioned in the last paragraph of my blog article – that the purpose of the clause was to enable the landlord to recover its actual costs of providing the services.  The two parts of the clause were mutually inconsistent, and the part that should take precedence was the requirement to pay the landlord “a proportionate part of the expenses and outgoings incurred by the Lessors in the repair maintenance renewal and the provision of services hereinafter set out”.

Accordingly, Lord Carnwath accepted the tenant’s interpretation of the clause: that the 10% increase in the service charge was to be treated as a cap on the annual increase rather than as a formula for calculating the annual payments.

Conclusions

One has to sympathise with the tenants in this dispute.  They are saddled with a contract under which they are required to pay increasingly large sums every year, effectively receiving nothing in return, for the residue of the term of 99 years.  There is no possibility of their coming up with those sums.  Fortunately it appears that the landlord has said, through her counsel, that she is willing to negotiate a variation of the leases to substitute (among other changes) an adjustment linked to CPI instead of the 10% fixed sum (although the extent to which this relieves the tenants does depend upon what they will be asked to concede in return, and also what sum is to be taken as the base figure – the payment in 2012 is said to have been over £3,000).

I was hoping that the Supreme Court would find a solution to the tenants’ difficulties, but it was not to be.  It is obviously unsatisfactory that two Supreme Court Justices can find two entirely opposing meanings to the same clause.  Pondering the judgment overnight, I have decided that it is difficult to identify which of the two Justices has taken the braver approach: Lord Carnwath, differing from his four colleagues in an attempt to do justice between the parties, or Lord Neuberger, persisting with an orthodox approach to a dispute over interpretation despite (I am assuming) an instinctive distaste on his part for the outcome that this has produced.

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