Arnold v Britton and commercial common sense

The decision of the Supreme Court in Arnold v Britton [2015] UKSC 36 has highlighted an important gap in the way the law governs the assessment and recovery of service charges in residential leases, as well as providing lawyers with invaluable guidance about how the concept of 'commercial common sense' fits into the task of interpreting contracts.

Sections 18 and 19 of the Landlord and Tenant Act 1985 provide that service charges which are variable (that is, payable under clauses which provide for the costs to vary according to the relevant costs of providing the services) are
only payable if they are 'reasonable'.

Under section 27A of the Act, lessees can apply to the first-tier tribunal for a determination of whether the amount of such a variable service charge is reasonable; that application can normally be made without exposing the lessee to any risk as to costs. There is, however, no such protection for occupiers whose leases provided for payment of
a fixed sum by way of a service charge.

While long leases of flats typically contain variable service charge clauses, long leases of chalets in holiday parks usually provide for fixed charges. Unless the chalet falls within the definition of a 'caravan' for the purposes of the Mobile Homes Act 1983 (for a useful summary of the history of the relevant legislation and what constitutes a caravan, see Murphy v Wyatt [2011] EWCA Civ 408), then the lessees, most of whom have already paid a substantial premium for the right to station the chalet on the plot that is leased to them, have no statutory protection or right to have an independent tribunal review of the reasonableness of the charges. That is something the defendants in this case discovered to their cost.

In Arnold v Britton, over the course of a few years in the 1970s and 1980s, at a time when inflation was quite high, 99-year leases of chalets in the Oxwich Leisure Park on the Gower peninsular were created, all containing a clause requiring the lessee to pay a fixed service charge, which would increase at a compound rate of 10 per cent each year in some cases, and at a compound rate of 10 per cent every three years in others.

A typical clause required the lessee: '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 renewal and the provision of services hereafter set out the yearly sum of £90 and VAT (if any) for the first three years of the
term hereby granted increasing thereafter by ten pounds per hundred for every subsequent three year period or part thereof.'

That seems fairly innocuous. However, for a lease granted in 1980, a service charge payment of £90 compounded annually at 10 per cent leads to a charge of £2,500 today, and over £550,000
by 2072.

The lessees claimed that an interpretation
of the clause which required such a fixed sum payment resulting in an absurdly high annual service charge could not be right, and that the clause should be read as requiring them to pay
a variable sum, being a fair cost of the specified services with the specified sum being no more than a cap.

The lessor disagreed and commenced a claim under part 8 of the Civil Procedure Rules, seeking a declaration that the clause required payment of the fixed sum and not any lesser variable amount. The claim was dismissed in the county court. However, the lessor's appeal to the High Court was allowed, and the decision upheld by the Court of Appeal and ultimately the Supreme Court.

The practical effect is, as the court recognised, extremely unfair and indeed absurd. Where does that leave 'commercial common sense'?

Lord Hoffman on meaning

The task of working out what agreements meant used to be straightforward: words meant what the dictionary said they meant and there were well-established principles of construction to help lawyers with their task. In the words of the well-known advertisement, contracts 'did what they said on the tin'. The task was an objective one, the parties' subjective intentions were irrelevant, and of course (unless it was an action for rectification) evidence of pre-contract discussions was inadmissible.

Speeches given by Lord Hoffmann in cases before the House of Lords towards the end of the last century were instrumental in modifying the inflexibility of the old rules. Famously, in Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896, he said:'The meaning which a document... would convey to
a reasonable man is not the same thing as the meaning of its words. The meaning of words is
a matter of dictionaries and grammars; the meaning of the document is what the parties using these words against the relevant background would reasonably have been understood to mean.'

The law was developed further in Chartbrook Ltd v Persimmon Homes [2009] UKHL 38, where Lord Hoffmann said: '[T]here is not, so to speak,
a limit to the amount of red ink or verbal rearrangement or correction which the court is allowed. All that is required is that it should be clear that something has gone wrong with the language and that it should be clear what a reasonable person would have understood the parties to have meant.'

Finally, we have the decision in Rainy Sky
SA v Kookmin Bank [2011] UKSC 50, where the Supreme Court explained that if there were two competing interpretations of a contract, the
court was entitled to prefer the one which was more consistent with business, or commercial, common sense.

Start with the language

The lead judgment in the Supreme Court
in Arnold was given by Lord Neuberger, the president of the Supreme Court, with whom Supreme Court justices Lord Sumption and Lord Hughes agreed; a separate judgment was given by Lord Hodge JSC, who agreed that the appeal should be dismissed, with Lord Carnwath JSC being the sole dissenter.

The key paragraphs in Lord Neuberger's judgment are 14 to 23. As always with a Neuberger judgment, they are a model of simplicity and clarity, and set out the relevant principles in (in this case seven) numbered propositions.

Four points are of particular importance - the first three of general importance to all lawyers,
and the last of particular importance to property lawyers. First, Lord Neuberger explained that the less clear the words are, the more ready the court will be to depart from their natural meaning. However, that does not justify a search for drafting errors in order to facilitate a departure from the natural meaning of words.

Second, he said that commercial common sense should not be invoked retrospectively: the concept 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, at the date the contract was made.

Third, Lord Neuberger emphasised: 'The purpose of interpretation is to identify what the parties have agreed, not what the court thinks they should have agreed. [W]hen interpreting a contract a judge should avoid re-writing it in an attempt to assist an unwise party or to penalise
an astute party.'

Finally, and of particular relevance to property lawyers, Lord Neuberger rejected the notion that service charge clauses should be construed 'restrictively'. They are, he said, not to be subject
to any special rule of interpretation.

Taking all of this into account, the majority in the Supreme Court concluded that nothing had gone wrong with the drafting of the service charge clause. It could not be rewritten in the way the tenants contended for. When considering the background facts, it was relevant, they said, that inflation in the 1970s, when most of the leases were granted, was running at well over 10 per cent.

The overall point the court was making was that one has to start with the language. If it is clear and unambiguous, then the parties are taken to have agreed the bargain that has apparently been made; commercial common sense only comes into play if there is an identifiable problem with the drafting, not if there is a problem with the outcome.

Where does this leave us? Specifically, it leaves the owners of the chalets in question with very expensive holiday homes which they cannot sell and an increasing financial burden. More generally, it focuses attention on the gap in statutory protection for owners of chalets (as opposed to mobile homes) in holiday parks. Unfortunately, most people do not involve solicitors when purchasing these chalets, but if instructed the advice is to consider the terms of the rent and service charge provisions very carefully.

Finally, as Lord Neuberger said at the end of his judgment, there appears to be a strong case for extending statutory provisions which protect tenants against unreasonable service charges to cases such as this. But that is a matter for parliament. SJ

John de Waal QC is a barrister practising from Hardwicke

@hardwickelaw