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Following on from the Case Preview (here), the Supreme Court handed down judgment in Arnold v BrittonStephanieSmith & Ors on 10 June 2015 in which the appellants’ appeal was dismissed by a majority of 4-1.

By way of summary, the appellants, Britton & Ors (the lessees), represented 43 lessees under 25 long leases of holiday chalets at Oxwich Leisure Park near Swansea. The respondent, Mrs Arnold, was the freehold owner of the leisure park and the lessor of the above leases (the lessor).

Interpretation of express term

The dispute centred on the interpretation of the service charge clauses contained in those 25 leases (entered into at various times over the years) which generally provided for the lessees to pay to the lessor an annual sum in respect of expenses and outgoings incurred by the lessor for repair and maintenance of the park.

Five sample leases contained slight variations of the same clause, which read, by way of example:

Clause 3(2): “To pay to the Lessors without any deductions in addition to the said rent 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 thereafter set out the year 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 thereof”.

The variations of this clause included the word “as” appearing before the words “a proportionate part” and also rather than “every subsequent year” a number of the leases provided for “every subsequent three year period”.

The lessor sought declaratory relief that on the true construction of clause 3(2) of the leases the lessees were obliged to pay a fixed yearly sum which increased at the rate of 10% per annum, irrespective of the actual cost to the lessor of providing the relevant services.  Conversely, the lessees contended that clause 3(2) should be construed to give rise to a variable service charge provision, based on a proportionate part of the lessor’s expenses actually incurred each year, subject to a maximum yearly cap on increases of 10%.

The lessees had won at first instance but lost on appeal both to the High Court (before Morgan J) and latterly the Court of Appeal.  The lessees appealed to the Supreme Court, which heard the appeal on 26 January 2015.

The issue between the parties was whether the figure of £90 (as inflated) should be read as a fixed amount, or as an upper limit or cap.  That depended on whether one could read into the service charge clause such words as “limited to” or “up to” before the reference to £90.   The Court of Appeal had previously agreed with Morgan J’s decision that this “… would involve subverting the proper process of construction of the language actually used and would in truth involve the court rewriting the bargain the parties ha[d] made.”

Thus, their Lordships were tasked with applying canons of construction in circumstances where the outcome of a “literal” approach to such construction would produce what the lessees contended was a perverse result (namely, that by the end of the term of the lease, they would be obliged – depending on which variation of the service charge clause applied – to pay millions of pounds in service charges when the actual expenditure on such services could be as little as nil in any given year).

Implied term

At the invitation of the Supreme Court, the lessees additionally argued that clause 4(8), which required leases of chalets to be granted subject to identical or similar obligations, substantially mitigated the effect of clause 3(2) of their 25 leases because

1. a term was implied into their leases to the effect that clause 3(2) was in the same terms as clause 3(2) of the leases of chalets which had already been granted in the light of,

  • clause 4(8),
  • the opening words of clause 3 (“The lessee hereby covenants with the lessor and with and for the benefit of the owners and lessees from time to time during the currency of the term hereby granted of the other plots on the estate so far as the obligations hereinafter mentioned are capable of benefitting them …“) and,
  • paragraph (2) of the recital in each of their leases (the chalets on the Leisure Park were intended to be subject to leases “upon terms similar in all respects to the present demise”), and

2. in those circumstances, the lessor was precluded from recovering more by way of service charge than would be recoverable under the terms of the service charge provisions in the earliest leases, i.e. £90 plus 10% compounded every three years (rather than each year).

On the construction issue, the majority (Lord Neuberger, Lord Sumption, Lord Hughes and Lord Hodge) held as follows:

  1. the natural meaning of the words used was clear: the first half of clause 3(2) (up to and including the words “hereinafter set out“) stipulated that the lessee was to pay an annual charge to reimburse the lessor for the costs of providing the services, and the second half of the clause identified how that service charge was to be calculated. It was only once the commercial effect of that interpretation played out that concerns arose.
  2. The fact that the second half of clause 3(2) resulted in the service charge being a fixed sum was readily explicable by reference to the fact that it avoided disputes associated with determining a variable sum;
  3. Likewise, the provision for a fixed increase in the annual sum was also readily explicable: the parties assumed that the cost of providing the services in sterling terms would increase.
  4. The fact that, in the future, the service charge sum might substantially exceed the parties’ expectations at the time of the grant of the lease was not a reason for giving the clause a different meaning;
  5. The mere fact that a court might be confident that the subsequent effect or consequences of a particular interpretation were not intended by the parties did not justify rejecting that interpretation.
  6. It was tempting to see the two halves of clause 3(2) as mutually inconsistent in their effect (on the ground that the first half of the clause required the lessee to pay a “proportionate part” of the cost to the lessor of providing services, whereas the latter half required the lessee to pay a sum which could exceed the whole of that cost) but this argument involved the court inventing a lack of clarity in the clause as an excuse for departing from its natural meaning, in the light of subsequent developments.
  7. Were it not for the percentage increases of 10% per annum specified in the 25 service charge clauses which are being considered on this appeal, coupled with the subsequent history of inflation in the United Kingdom, that would be the end of it.
  8. Lord Neuberger was unconvinced by the argument that it was inconceivable that a lessee would have agreed a service charge provision which increased so drastically because a lessee could have taken the view that a fixed rate of increase of 10% per annum on a fixed initial service charge, at a time when annual inflation had been running at a higher rate for a number of years was at least acceptable.
  9. There was no principle of interpretation which entitled a court to re-write a contractual provision simply because the factor which the parties catered for did not seem to be developing in the way in which the parties expected.

In his dissenting judgment, Lord Carnwath observed that “something has gone wrong with the drafting [of clause 3(2) of the leases], at least in the original wording… and (apart from the change of inflation formula) was repeated in [subsequent leases]. The clause imposes an obligation to pay, but contains two different descriptions of the payable amount: by reference, first, to a “proportionate part of the expenses and outgoings incurred by the Lessor in the repair maintenance renewal and the provision of services …”, and secondly, to a “yearly sum” determined by reference to a fixed formula. There are two linguistic problems. First, there is no grammatical connection to show the relationship between the two descriptions. Secondly, they are mutually inconsistent. A figure can be determined as a proportionate part of some other variable amount, or it can be a yearly sum, fixed by a predetermined formula; but it cannot be both. There is an inherent ambiguity which needs to be resolved.”

His Lordship’s approach to construction was premised in part on Lord Clarke JSC’s summary of the relevant principles in Rainy Sky SA v Kookmin Bank [2011] UKSC 50, paras 14-30.  In particular, Lord Carnwath noted:

  1. it was only if the words used by the parties were “unambiguous” that the court had no choice in the matter of interpretation;
  2. The fact that a particular construction leads to a very unreasonable result was a relevant consideration. The more unreasonable the result, the more unlikely it was that the parties could have intended it, and if they did intend it the more necessary it was that they should make that intention abundantly clear: Wickman Machine Tools Sales Ltd v L Schuler AG [1974] AC 235, 251;
  3. If detailed and syntactical analysis of words in a commercial contract was going to lead to a conclusion that flouted business common sense it must yield to business common sense”: Antaios Cia Naviera SA v Salen Rederierna AB (The Antaios) [1985] AC 191, 201
  4. One cannot rewrite the language which the parties have used in order to make the contract conform to business common sense. But language is a very flexible instrument and, if it is capable of more than one construction, one chooses that which seems most likely to give effect to the commercial purpose of the agreement”: (Co-operative Wholesale Society Ltd v National Westminster Bank plc [1995] 1 EGLR 97, 99).

In the light of the above and his subsequent consideration of the implication of terms to give a contract business efficacy, Lord Carnwath observed the following:

  1. If the intention in the first half of clause 3(2) was to indicate no more than the purpose of the payment, one would have expected some such general words as “by way of contribution to the services“, not a detailed and specific formula.
  2. Conversely, if the character of the contributions was to be that of payments determined by reference to a fixed formula and nothing else, the description in the first half of the clause was neither accurate nor useful. Proportionality had no part to play in such a fixed calculation, nor any relation to reality after 1980, if the court’s interpretation was correct.
  3. It was not easy to explain the purpose of the specific reference to “expenses and outgoings incurred” by the lessor on a defined range of services, unless it was intended to play some material part in the calculation of service charges.
  4. The second half of clause 3(2) was either,
  • a fixed amount which in effect supplanted any test of proportionality under the first part (the majority view), or
  • it was an upper limit to the assessment of a proportionate amount (Lord Carnwath’s view).

In deciding the answer to d) above, his Lordship observed that “we must inquire ‘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.”

His Lordship’s conclusion was, in essence, that a construction of the clause, which treated £90 (adjusted for inflation) plus 10% as a cap, was preferable when the alternative led to such commercial absurdity that the parties could not be taken to have intended such a result.

Comment

The tension in this litigation arose from the desire to obtain a common sense outcome on the one hand and the public interest in certainty as to when the courts will be willing to encroach upon the principle of freedom of contract on the other.

The service charge clause in this case may have been ill conceived but it was not “ambiguous” as to its effect.  This decision makes plain that the fact a contractual arrangement lacks foresight is not a basis for departing from what the parties intended on the natural meaning of the words they used.

The upshot is that, it is for the contracting parties (and, importantly, those drafting agreements on their instruction) to have in mind the practical consequences of the contract and to say what they mean and mean what they say.

Of particular interest to housing lawyers is the fact that there is an express departure (at [23]) from the “restrictive” interpretation of leases which was commonly thought to be the conventional and proper approach to the construction of service charge clauses in a residential context: see e.g. Gilje v Charlegrove Securities Ltd [2001] EWCA Civ 1777; Paddington Basin Developments Ltd v Gritz [2013] UKUT 0338 (LC); Wembley National Stadium Ltd v Wembley London Ltd [2007] EWHC 756 (Ch); McHale v Cadogan [2010] EWCA Civ 14.

Lord Neuberger held,

“I am unconvinced by the notion that service charge clauses are to be subject to any special rule of interpretation. Even if (which it is unnecessary to decide) a landlord may have simpler remedies than a tenant to enforce service charge provisions, that is not relevant to the issue of how one interprets the contractual machinery for assessing the tenant’s contribution. The origin of the adverb was in a judgment of Rix LJ in McHale v Earl Cadogan [(above)], para 17. What he was saying, quite correctly, was that the court should not “bring within the general words of a service charge clause anything which does not clearly belong there”. However, that does not help resolve the sort of issue of interpretation raised in this case.”

It is the author’s view that this is unlikely to result in wildly different outcomes in the vast majority of cases but it assists in dispelling an obdurate approach to interpretation – most often encountered when a large corporate or public landlord appears against an individual.