The Supreme Court’s recent decision in Arnold v Britton serves us a useful reminder that the courts will not allow commercial common sense to override an unambiguous contract provision, even when this approach may result in disastrous consequences for one party.
Facts of the
The case concerned the interpretation of service charge provisions in the leases of a number of chalets at Oxwich Leisure Park in South Wales. Britton and others were the tenants of 25 such chalets, each let on a lease for a term of 99 years granted between 1974 and 1991.
Each lease contained a service charge covenant. The language used in the service charge covenant differed slightly between the leases but a typical covenant was worded as a covenant to 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 for every subsequent year.”
The current landlord, Arnold, considered that the service charge covenant clearly obligated the tenants to pay an initial annual service charge of £90, increasing at a compound rate of 10% each year thereafter. On the basis of this interpretation, each tenant’s annual service charge would be in excess of £500,000 by 2072.
The issue on appeal was whether Arnold’s reading of the provision was correct. Britton and the other tenants contended that the clause obligated them to pay a fair proportion of the landlord’s cost of providing the services required, up to a maximum of £90 in the first year and an increase each year thereafter of 10% on a compound basis, i.e.: that the formula provides a cap, rather than a fixed level of service charge to be paid by the tenants.
The decision of the Supreme Court
The Supreme Court considered the landlord’s reading of the clause to be correct. In reaching this decision the court made a number of observations. Firstly, when interpreting a contractual provision, the court should ascertain the parties’ intentions with reference to “what a reasonable person having all the background knowledge which would have been available to the parties would have understood them to be using the language in the contract to mean.” The meaning of the words used should be determined in light of the factual, commercial and documentary circumstances known or assumed by the parties at the time of making the contract, but subjective evidence of the parties’ intentions should be disregarded.
Secondly, while commercial common sense is a valid consideration when interpreting a contract, it cannot be used as a justification to depart from the natural, unambiguous meaning of a clause in a situation where one party has made a bad bargain, however catastrophic the outcome.
In this case the tenants had failed to properly understand the potential impact of the compounding 10% per annum increase and consequently they made a very bad bargain. Nevertheless, as this was unambiguously what they had agreed, the court held that the tenants should be bound by the clause and that there was no scope to retrospectively apply commercial common sense to it, stating,
“Experience shows that it is by no means unknown for people to enter into arrangements which are ill-advised, even ignoring the benefit of the wisdom of hindsight, and it is not the function of a court when interpreting an agreement to relieve a party from the consequences of his imprudence or poor advice. Accordingly, when interpreting a contract a judge should avoid re-writing it in an attempt to assist an unwise party or penalise an astute party.”
Contrast with Rainy Sky v Kookmin
The judgment in Arnold v Britton can be contrasted with the 2011 Supreme Court ruling in Rainy Sky SA v Kookmin Bank, which was hailed as a triumph of commercialism over literalism. The judgment in the latter case established that where there are two possible constructions of a contractual provision, the court can prefer that which is most consistent with commercial common sense, and reject the alternative.
The key factor that distinguishes Rainy Sky v Kookmin from Arnold v Britton is that the former concerned an ambiguous contractual provision whereas the clause in issue in the latter was considered to be unambiguous. Therefore, where there is uncertainty in the drafting, the courts will certainly consider commercial logic and may well allow this to take precedence over the natural meaning of the words used. By contrast, where the drafting in dispute is unambiguous, such as was the case in Arnold v Britton, the courts will not permit commercial common sense to override the clear meaning of a contractual provision notwithstanding that this may spell disaster for one of the parties.
This is a cautionary tale to contracting parties to look very carefully at what is being agreed, as the English courts will not assist the victim of an unambiguous bad bargain.