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Arnold v Britton and commercial common sense

The decision of the Supreme Court in Arnold v Britton [2015] UKSC 36; [2015] 2 W.L.R. 1593 (judgment 15th June 2015) 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 provides 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 be 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 or not; that application of course can normally be made without exposing the lessee to any risk as to costs.  There is however no such protections for occupiers whose leases provided for payment of a fixed sum by way of service charge.

Whilst long leases of flats typically contain variable service charge clauses, long leases of chalets on 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 is and is not a caravan see in Murphy v Wyatt [2011] 1 WLR 2126, CA) 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 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 80s and at time when inflation was quite high, 99 year leases of chalets on the Oxwich Leisure Park on the Gower peninsular were created, all of which contained a clause requiring the lessee to pay a fixed service charge which would increase at a compound rate of 10% each year in some cases, or at a compound rate of 10% every three years in others. A typical clause required the lesseeL

“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% 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 such 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 costs of the specified services with the specified sum being no more than a cap. The lessor disagreed and commenced a Part 8 claim in the county court seeking a declaration that the clause required payment of the fixed sum and not any lesser variable amount. The claim was dismissed. 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 of this decision is, as the Court recognised, extremely unfair and indeed absurd. Where does that leave “commercial common sense”?

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 at p913:

“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] 1 AC 1101 where Lord Hoffmann said at para. [35]

Finally, of course, we have the decision in Rainy Sky SA v Kookmin Bank [2011] 1 WLR 2900 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, see Lord Clarke at para. [21].

The lead judgment in the Supreme Court in the Arnold case was given by Lord Neuberger PSC with whom Lord Sumption and Lord Hughes JSC 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] – [23]. As always with a Neuberger judgment they are a model of simplicity and clarity which 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 of all, at para. [18] 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.

Secondly, at para. [19] 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,

Thirdly, at para. [20] Lord Neuberger emphasised that:

“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, which is of particular relevance to property lawyers, Lord Neuberger at para. [23] 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 the nothing had gone wrong with the drafting of the service charge clause and it could not be rewritten in the way the tenants contended for. When considering the background facts it was relevant, they pointed out, that inflation in 1970s when most of the leases were granted was running at well over 10%.

The overall point the Court is making is that one has to start with the language, and if it is clear and not ambiguous, 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) on holiday parks. Unfortunately, most people do not involve solicitors in their purchase of 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 para. [65], 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.