Last year’s Supreme Court decision in the case of Arnold v Britton [2015] provides useful guidance as to how the courts will interpret contracts. Whilst this was a landlord and tenant case concerning the interpretation of service charge clauses, it is actually a case about the essentials of how the courts will approach the interpretation of contracts. 

Facts

The case concerned long leases of chalets at Oxwich Leisure Park on the Gower peninsula in South Wales which had been granted between 1977 and 1991. Each lease contained a covenant by the tenants to pay service charge and whilst the covenant differed slightly between the leases the majority of the leases provided that the tenant was to pay:

a proportionate part of the expenses and outgoings incurred by the Lessor in the repair maintenance renewal…and the provision of services hereinafter set out in the yearly sum of Ninety Pounds and value added tax (if any) for the first Year of the term hereby granted increasing thereafter by Ten Pounds per hundred for every subsequent year or part thereof”

The landlord’s interpretation of this provision was that the clause provided for a fixed annual charge of ninety pounds for the first year then increasing each subsequent year by ten per cent on a compound basis. 25 of the tenants disputed this as such an interpretation would result in them paying over £500,000 in service charge per annum by 2072.

Decision

The Supreme Court (by majority of 4-1) declined to interpret the leases in a way which protected the tenants from the consequences of the service charge provisions and sided with the landlord.

In his leading judgment, Lord Neuberger, President of the Supreme Court, commented that when “interpreting a written contract, the court is concerned to identify the intention of the parties by reference to “what a reasonable person having all the background knowledge which would have been available to the parties would have understood [those intentions to be] using the language in the contract”. A court will do that by assessing the meaning of the words used, here in the service charge provision, in light of:

  1. the natural and ordinary meaning of the clause;
  2. any other relevant provisions of the contract;
  3. the overall purpose of the clause and the contract;
  4. the facts and circumstances known or assumed by the parties at the time that the document was executed; and
  5. commercial common sense; but
  6. disregarding subjective evidence of any party’s intentions.

Overall the court’s stance was that the wording of the lease was adequately clear such that there was no need for the court to step in and re-write the bargain the parties had agreed between themselves, even if that was now a bad bargain for one of the parties, by departing from the natural meaning of the words used. The clearer the natural meaning of a clause, the more difficult it would be to depart from it.

The court also set out some key factors relating to the interpretation of contracts:

  • Commercial common sense should not be used to undervalue the importance of the language of the contract – especially as the parties have control over the language they use but not over the interpretation of their contracts by the court.
  • The less clear that the wording of a contract is, the more ready the court would be to depart from the natural meaning of that wording (and vice versa).
  • Commercial common sense should not be applied retrospectively. The court should look at how the contract would have been interpreted when it was made using the facts known or reasonably available to the parties at that time.
  • Commercial common sense is a very important factor to take into account when interpreting a contract, but 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 court also pointed out that when the leases were granted, inflation was running at a very high level and that the tenants were perhaps keen to have a cap on their outgoings. Unfortunately the arrangements set out in the leases then began to unravel for the tenants after the rate inflation fell and remained low.

Implications

Whilst there is no new law here and the decision ultimately turns on the interpretation of the particular lease in question, this decision is a helpful reminder of the rules and interpretation of written contracts. In particular, it is a clear demonstration of how the court should apply the principal of commercial common sense.

That principle should only be applied by the court when the meaning of the relevant provision is ambiguous. Commercial common sense is not a relevant consideration where the natural meaning of the language used is clear, even if this would result in commercially detrimental consequences. At the end of the day the court will not step in to save a party from a bad bargain.

KEY POINTS

  • When negotiating a contract consider from the outset what rights, obligations and liabilities each party is to have now and in the future.
  • Then consider how those rights, obligations and liabilities are to be stated in the contract and ensure that language and drafting used carefully reflects the intentions of the parties now and in the future and that both parties are in agreement.
  • If there is to be a mechanism for the calculation of a payment for instance, work through the formula or mechanism in the contract first using theoretical figures to check that it will not result in a disproportionate or unintended consequence, before the contract is signed.
  • Ensure that the contract reflects the parties intentions before it is signed otherwise the court may take a literal interpretation to the drafting used and that may not reflect the parties agreement later down the line.