Supreme Court reinforces the need to interpret clauses
29 July 2015
Contractual interpretation: Supreme Court reinforces the need to interpret clauses by the words used and their “natural meaning”
On 10 June 2015, the Supreme Court handed down judgment in the case of Arnold v Britton and others  UKSC 36, which concerned the interpretation of service charge clauses in a number of holiday chalet leases. Whilst this case ultimately concerned the interpretation of lease terms, the judgment is of much wider application as it was necessary for the Supreme Court to consider, apply, and set out the general principles of contractual interpretation.
This case concerned the interpretation of a service charge contribution clause in a number of leases granted over holiday chalets on a caravan park in South Wales between 1977 and 1991. Whilst the exact wording of the clause varied slightly in some of the leases, 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 fairly narrow, namely whether the figure of £90 stated in the above clause was to be read as a fixed amount, or as an upper limit 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, the tenants argued that the words “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”.
The Supreme Court was required to determine how this clause should be interpreted, in light of the different explanations offered by the landlord and tenant.
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. There was, however, one dissenting judgment which is dealt with below.
The Supreme Court’s approach and reasoning
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.
Lord Neuberger reinforced the need to interpret clauses within contracts according to their “natural meaning” and the clearer the natural meaning of the clause, the more difficult it is to justify departing from it. Lord Neuberger set out a number of other important principles of contractual interpretation including:
1. That reliance placed on commercial common sense and surrounding circumstances 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.
2. That commercial common sense should not 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.
3. 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.
4. 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, 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.
As stated above, there was one dissenting judge in this case (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.
Whilst every case will ultimately fall on its own facts, this judgment has reinforced the general approach that courts are likely to take when considering disputes requiring contractual interpretation. It is vitally important that parties to a contract carefully consider the language and words used in any draft and ensure that all parties have the same understanding of how important clauses will operate, before the contract is signed to avoid a dispute in the future and to avoid the stringent rules of interpretation.
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.