Contract disputes are an unfortunate but real part of business life. Parties and their advisers therefore need to understand how their business agreements will be interpreted by the courts. The following key issues and questions should be borne in mind by real estate practitioners when drafting terms.

Say what you mean

When interpreting a contract, a court must determine the meaning it conveys to a reasonable person with all the background knowledge reasonably available to the parties at the time the contract was made. The courts consider the actual words used and the wider context (including how the clause fits into the contract as a whole, the parties’ background knowledge at the date the contract was made and the commercial context). Remember that a contract will be interpreted as at the date it was entered into rather than with the benefit of hindsight.

There has been debate over the years about the weight afforded to considerations of commercial common sense, with recent cases suggesting a trend towards greater emphasis on the words used rather than what a court might consider to be a commercially sensible meaning. If the words are clear and unambiguous, the court should give effect to them even if the result seems commercially unlikely.

Arnold v Britton and others [2015] UKSC 36; [2015] EGLR 53 illustrates this trend. It concerned the interpretation of a service charge provision in a number of 99-year leases of chalets in a holiday park. The service charge provision provided for the payment of “…the yearly sum of ninety pounds… for the first year of the term… increasing thereafter by ten pounds per hundred for every subsequent year or part thereof”.

The Supreme Court held that the clause required tenants to pay a fixed sum of £90 for the first year, increasing annually by 10% on a compound basis. This meant that the annual service charge would be more than £500,000 by the end of each lease and the total service charge contribution over the lifespan of each lease would be more than £11 million.

The court noted that the fact that a contract turns out to be a bad bargain for one party is not a reason for departing from the language used. Courts should be slow to reject the natural meaning of a provision simply because it appears to be an imprudent term for a party to have agreed.

Marks & Spencer plc v BNP Paribas Securities Services Trust Co (Jersey) Ltd and another [2015] UKSC 72; [2016] EGLR 8 also illustrates the courts’ reluctance to imply terms into contracts. Here the tenant exercised a break right and the landlord refused to refund rent paid in advance for the period beyond the termination date. Although there was no express obligation in the lease for the landlord to refund the apportioned rent, the tenant argued that such a term should be implied. The court held that the tenant was not entitled to a refund. A term will only be implied if it satisfies the case of “business necessity” or if it is “so obvious that it goes without saying”.

Drafting points

  • Use clear and consistent language
  • Check that calculations work in practice
  • Check cross-referencing and avoid vague terms (eg “such sums”, “as below”)
  • Ensure that it is clear what happens in all situations

Are all the provisions enforceable?

Exemption clauses

The Unfair Contract Terms Act 1977 (UCTA) regulates clauses seeking to limit or exclude liability in business-to-business (B2B) contracts. Certain provisions, such as those excluding or limiting a party’s liability for personal injury or death resulting from negligence, are never allowed and will always be unenforceable. Others, such as exclusions or limitations of liability in standard terms, will only be enforceable if reasonable. In determining reasonableness the court will look at the provision’s wording as well as the parties’ relative bargaining power.

Saint Gobain Building Distribution Ltd (t/a International Decorative Surfaces) v Hillmead Joinery (Swindon) Ltd [2015] All ER (D) 226 highlights the risk of relying on terms and conditions that have not been negotiated. Here the High Court held that extensive exclusion wording in a supplier’s standard B2B terms did not meet the reasonableness requirement in UCTA. This was the case even though the standard terms provided the buyer with alternative remedies (replacement of the defective goods or compensation up to the invoice value of the goods). A provision excluding all liability for indirect or consequential loss was also held to be unreasonable and ineffective against a counter-claim for loss of business and the costs of diverted staff time.

Courts take a much stricter view of exemption clauses in consumer contracts. The Consumer Rights Act 2015 requires contract terms and notices to be fair. A contract term or notice will be regarded as unfair if it causes a significant imbalance in the parties’ rights and obligations under the contract to the detriment of the consumer.

Drafting points

  • Exclusions and limitations in B2B standard term contracts will only be enforceable if they pass the UCTA reasonableness test.
  • Review standard terms and conditions to ensure that these are not unduly one-sided
  • Any cap on liability needs to be at an appropriate level, depending on the circumstances and potentially how the cap compares to others in the same sector

Penalty clauses

Provisions that provide for penalties if contractual obligations are not met are generally unenforceable, whereas liquidated damages clauses are enforceable.

It used to be the case that broadly anything except a genuine pre-estimate of loss was a penalty, until the Supreme Court relaxed the rules on penalties in Cavendish Square Holding BV v El Makdessi; Parkingeye Ltd v Beavis [2015] UKSC 67; [2016] EGLR 15. The court held that a provision requiring payment by one party to another on breach of contract can be enforceable provided it is not out of all proportion to the legitimate interests of the innocent party. Applying this in ParkingEye to an £85 charge levied on a motorist for overstaying a period of free car parking, the court held that the car park owners had a legitimate interest in deterring users from overstaying so as to manage the car park efficiently. The £85 charge was not out of proportion to that interest and was not a penalty.

The court also clarified that the penalty rule only regulates remedies available for breach of contract, not sums that are payable on the happening of a particular event. For example, a provision that requires a party to pay damages for late completion is capable of being a penalty, whereas a provision that provides for a bonus to be payable for early completion would not be.

Drafting points

  • Review drafting in light of the new broader test for penalties; is the remedy proportionate to the legitimate interest it is designed to protect?
  • Include a statement in the contract that the parties consider the liquidated damages amount to be proportionate to the innocent party’s legitimate interest
  • Consider re-drafting the liquidated damages provision to provide for the sum to be payable if a particular event happens, rather than as a result of breach of contract
  • Keep a record of how the liquidated damages amount was arrived at

Is the contract valid?

Marlbray Ltd v Laditi and another [2016] EWCA Civ 476; [2016] PLSCS 152 provides a reminder of the importance of not only checking documents are properly executed by individuals with authority to sign on behalf of the contracting parties, but also expressly providing for joint and several liability where one party purports to sign on behalf of another.

In Marlbray a husband signed what purported to be a contract on behalf of himself and his wife for the purchase of a unit in an aparthotel. The husband paid a deposit but he and his wife were unable to obtain a mortgage so could not proceed. The developer terminated the contract for breach and kept the deposit. The husband argued that the sale contract was unenforceable because his wife had not authorised him to sign on her behalf. The court accepted that the contract was not enforceable against his wife. Since the contract included a provision that the named purchasers were jointly and severally liable, the whole of the contract was enforceable against the husband.

Drafting points

  • When signing on behalf of another party, check that written authority from that party exists
  • When selling property to joint purchasers, ensure the contract includes express provision for joint and several liability, particularly if one purports to sign on behalf of both

This article was published in Estates Gazette in August 2016.