On 10 June 2015, the Supreme Court handed down its judgment in the case of Arnold v Britton and others [2015] UKSC 36, which concerned the interpretation of clauses relating to service charges.  The judgment has wide application, but is of particular relevance to the TMT sector. It is an important reminder of the risks created by, and the Court’s approach to resolving, ambiguity concerning how the cost of service charges will change over the course of a long-term contract.  The judgment reaffirms the Court’s focus on an assessment of the natural meaning of the words used, even if it means the outcome is severe to one party.

What?

The case concerned the interpretation of a service charge contribution clause in a number of leases granted between 1977 and 1991. The majority of the leases provided that the tenant  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 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 [sic] for every subsequent year or part thereof”.

The issue between the parties was whether the figure of £90 stated in the above clause was to be read as a fixed amount or cap. The landlord (Arnold) claimed that the clause provided for a fixed annual charge of £90 for the first year, increasing each subsequent year by 10% on a compound basis.  The tenants (Britton and others) argued that the clause should be read as requiring them to pay a fair proportion of the landlord’s costs, subject to a maximum of £90 in the first year, which then increased every year by 10% on a compound basis.  In other words, they argued that “up to” should be read into the clause between the words “the provision of services hereinafter set out” and“the yearly sum of Ninety Pounds…”.

Finding of the Supreme Court

The Supreme Court found in favour of the landlord’s interpretation, namely that the clause provided for a fixed annual charge of £90 for the first year, increasing each subsequent year by 10% on a compound basis.

The leading judgment was provided by Lord Neuberger who confirmed that service charge clauses were not subject to special rules of interpretation and therefore the general rules of contractual interpretation should apply.  As for those general rules, the court reaffirmed 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 them to be using the language in the contract to mean” and it does so by focusing on the words of the relevant provision in their documentary, factual and commercial context. That meaning has to be assessed in light of (i) the natural and ordinary meaning of the clause; (ii) any other relevant provisions of the agreement; (iii) the overall purpose of the clause and the agreement; (iv) the facts and circumstances known or assumed by the parties at the time that the agreement was executed; (v) commercial common sense; but (vi) disregarding subjective evidence of any of the party’s intentions.

Lord Neuberger then emphasised several important factors when considering (i) to (v) above:

  • Reliance placed on commercial common sense and surrounding circumstances at the time the contract was formed should not be invoked to undervalue the importance of the language used. The exercise of interpreting a provision involves identifying what the parties meant through the eyes of a reasonable reader and that meaning is most obviously to be gleaned from the language of the provision which the parties had control over. 
  • Commercial common sense should not to be applied retrospectively even if a contractual provision has worked out badly for a party, if interpreted according to its natural language.  Similarly, 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. The purpose of interpretation was to identify what the parties have agreed, not what the court thinks that they should have agreed and a judge should avoid re-writing it in an attempt to assist an unwise party or to penalise an astute party.
  • When interpreting a contractual provision, only facts existing at the time that the contract was made, and which were known or reasonably available to both parties, should be taken into account. 
  • In some cases, where an event 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, then the court will give effect to that intention.

In considering the above factors, and despite the acknowledged unattractive consequences to the tenants, the Supreme Court was unconvinced by the tenant’s argument as it would have involved departing from the natural meaning of the clause and inserting words that were not there. 

Lord Neuberger noted that in considering the words used by parties in a clause, interpretation should be based on what a reasonable person, with the benefit of relevant background knowledge, would understand the clause to mean. The question for the court was not whether a reasonable and properly informed tenant would enter into such an undertaking as that would involve the possibility of re-writing the parties' bargain in the name of commercial good sense.

Dissenting judgment

There was one dissenting judgment (by Lord Carnwath) who referred to previous authorities which suggested that where a particular construction leads to a very unreasonable result, that should be a relevant consideration. It was clear to Lord Carnwath that something had gone wrong in the drafting of the service provision as, in his view, it was inconceivable that a potential purchaser would have been willing to accept a prediction of continuing inflation at that level for over 90 years, and to take that as a basis for undertaking a contractual obligation lasting for the rest of his life and beyond without any escape route.

However, if the tenants had understood the clause to be a “cap”, the agreement to this clause is understandable whereas the alternative would have seemed absurd and unreasonable to both.

In concluding the dissenting judgment, Lord Carnwath found that the consequences of the landlord’s interpretation were so commercially improbable that only the clearest words would justify the court in adopting it. He therefore disagreed with the majority judgment.

So what?

For any long-term contract, such as outsourcing agreements, the price to be paid in relation to service charges and how that may change over time is of fundamental economic importance.  Ambiguity and the resulting mis-interpretation in relation to such mechanisms can result in severe commercial difficulties and will inevitably lead to disputes.  The present case is another clear reminder of the importance of clarity. The Supreme Court has also provided a useful affirmation of the approach it will take to resolving such issues and provided valuable additional refinement.

It is interesting to note in this case that given the passage of time, the parties were unable to adduce evidence of the surrounding factual context or contemporaneous documentation.  This may have restricted the breadth of the court’s assessment.  It also prevented any argument as to common or unilateral mistake in relation to the drafting and precluded a possible remedy of rectification. This highlights the critical importance of systematic document retention.

Lastly, whilst the dissenting judgment offers some hope to parties seeking to rely on arguments around “commercial common sense” rather than literal interpretation, it seems clear that the preferred approach will always be for the court to interpret clauses according to the natural meaning of the words used, regardless of whether this results in a bad bargain for one of the parties.