The Supreme Court's decision in Arnold v Britton provides a salutary reminder of the reluctance of the English Courts to re-write "bad bargains" even if they have catastrophic unforeseen commercial outcomes for one of the contracting parties. This is in stark contrast to the more lenient approach Courts in civil law jurisdictions may take. However, rather than breaking new ground, the decision is an orthodox application of the existing English law principles of contractual construction, as summarised previously in Marley v Rawlings.

Blog by Alan Williams and Simon Hart

The dispute

The underlying dispute in Arnold concerned service charge covenants in leases of 25 chalets in a caravan park, granted between 1977 and 1991, which provided for an annual increase in the service charge paid by tenants. The wording of the relevant covenant in 21 of the 25 leases read:

"To pay to the Lessor without any deductions in addition to the said rent as a proportionate part of the expenses and outgoings incurred by the Lessor in the repair maintenance renewal and renewal of the facilities of the Estate and the provision of services hereinafter set out 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."

(In the other four leases, the service charge covenants were varied, pursuant to deeds of variation executed between 1998 and 2002, to have the same effect.)

The issue in dispute was whether the covenant provided (i) as the landlord contended, that the service charge payable by each tenant would increase each year of the term by 10% on a compound basis, or (ii) as the tenants contended, that each tenant should pay a fair proportion of the landlord's costs incurred in providing the services, subject to a maximum payment of £90 in the first year, increasing every year by 10% on a compound basis (i.e. that the words "up to" should be read into the provision). The basis of the argument put forward by the tenants was that the literal construction of the covenant put forward by the landlord produced "such an increasingly absurdly high annual service charge ..... that it cannot be right".

The law

Lord Neuberger gave the leading judgment in the decision. Paragraph 15 of the leading judgment summarises the principles applicable to contractual construction. While he does not expressly cite his own judgment in Marley v Rawlings, the principles set out in the leading judgment in Arnold are in essence those set out at paragraph 19 of the Marley decision, that in order to interpret a contract, the court is concerned to find the intention of the party or parties, which it should do by identifying the meaning of the words in light of (i) the natural and ordinary meaning of those words, (ii) the overall purpose of the document (iii) any other provisions of the document, (iv) the facts known or assumed by the parties at the time that the document was executed, and (v) common sense, but (b) ignoring subjective evidence of any party's intentions.

In Arnold, the leading judgment went on to emphasise some key factors relevant to its decision, including some which are of wider application in relation to the construction of contracts:

  • Commercial common sense should not be invoked to undervalue the importance of the language of the provision being construed.
  • When considering the key words, the worse their drafting the more ready the court should be to depart from their natural meaning. However, that should not justify the court searching for minor errors to facilitate a departure from the natural meaning of the words. Indeed: "If there is a specific error in the drafting, it may often have no relevance to the issue of interpretation which the court has to resolve".
  • Commercial common sense should not be invoked retrospectively: "The mere fact that a contractual arrangement, if interpreted according to its natural language, has worked out badly, or even disastrously, for one of the parties is not a reason for departing from the natural language. Commercial common sense is only relevant to the extent of how matters would or could have been perceived by the parties, or by reasonable people in the position of the parties, as at the date that the contract was made".
  • The purpose of interpretation is to identify what the parties have agreed and thus while commercial common sense was a very important factor to be taken into account a court should be very slow to reject the natural meaning of a provision ".... 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 ... a judge should avoid re-writing it in an attempt to assist an unwise party or to penalise an astute party".
  • Finally, if an event subsequently occurs which was plainly not intended or contemplated by the parties, judging from the language of their contract, if it is clear what the parties would have intended, the court should give effect to that intention.

The decision

The Supreme Court agreed with the landlord's construction by a majority of 4 – 1 (Lord Carnwath dissented). The leading judgement noted that "the natural meaning of the words used, at least until one considers the commercial consequences, seems clear". It went on to state that "Despite the unattractive consequences" the judge was unconvinced by the tenants' arguments, which involved "departing from the natural meaning" of the relevant provision and "inserting words which are not there".

It was highly relevant to the decision made that 21 of the 25 leases in question were granted between 1977 and 1991 at a time when annual rates of inflation were high. Given this context, the Court could see why a tenant might have agreed to a fixed annual increase of 10%, which might or might not exceed inflation. However, as the leading judgment stated:

"... If inflation is running at, say 10% per annum, it is, of course, very risky for both the payer and the payee, under a contract which is to last around 90 years, to agree that a fixed annual sum would increase automatically by 10% a year. They are taking a gamble on inflation, but at least it is a bilateral gamble: if inflation is higher than 10% per annum, the lessee benefits; if it is lower, the lessor benefits. On the interpretation offered by the appellants, it is a one way gamble: the lessee cannot lose because, at worst, he will pay the cost of the services, but, if inflation runs at more than 10% per annum, the lessor loses out."

The difficulty for the tenants in alleging that the construction put forward by the landlord was absurd, was that it was irrelevant for the purposes of construction (as it post-dated the execution of the leases), that the last 15 years of inflation have been much lower than 10%. The Court emphasised that although commercial common sense is a relevant factor in construing the meaning of a contractual provision, it cannot be invoked retrospectively. The judgment noted that the fact that a contract, when interpreted according to its natural language, had had a disastrous result for one of the parties was not a reason to depart from its natural language, and stated that commercial common sense was only relevant as at the time of the contract (as it was or could have been perceived by reasonable people in the position of the parties), not with hindsight.

Therefore the Court found that, despite the potentially disastrous consequences for the tenants (with service charges expected to be running at over £550,000 per annum by 2072 for a lease granted in 1980) there was no principle of interpretation which would entitle a court to: "....re-write a contractual provision simply because the factor the parties catered for does not seem to be developing in the way the parties may well have expected".

Comment

Although it has not changed the existing English legal position, this decision by the Supreme Court underlines that the English Courts will shy away from attempting to re-write a "bad bargain" merely because it has unforeseen or even disastrous consequences for the parties. Rather the Court will construe the contract, as it stands, using the words of the relevant provision as a starting point, and taking into account the commercial context at the time the contract was entered into, without the benefit of hindsight.