Why reading a contract and working through the consequences is essential: in a recent case the Supreme Court gave a ruling which had disastrous consequences for one of the parties

When negotiating terms for a service charge or rent review increase, it is wise to work through the calculations for any prescribed method.  The case of Arnold v Britton and Others [2015] UKSC 36 is an eye opening reminder that a small fixed sum which is increased at a compound rate on an annual basis can quickly add up.

Arnold v Britton involved the interpretation of a service charge clause in leases of 91 chalets at a holiday park in South Wales. The tenants had taken 99 year leases on broadly similar terms from 25 December 1974.  A dispute arose over the service charge payable by the tenants.  The clause in question provided for the tenants to pay a proportionate part of the service charge expenses and outgoings incurred by the landlord in provision of the services for the holiday park, with an initial yearly sum of £90 to be increased by ten pounds per hundred for every subsequent year.

The Supreme Court had to decide whether to read the service charge provisions literally or to interpret them in a more tenant friendly way.  The tenants argued that the 10% annual increase was a cap, however the Court ruled (by a 4:1 one majority) that the natural meaning of the service charge was clear.  It found that on an objective basis, the reasonable reader of the clause would understand that the tenant was required to pay an annual service charge and to reimburse the landlord for providing the services to the holiday park. The service charge was a fixed sum, which increased at a compound rate of 10% per annum.  This ruling was given despite the fact that the service charge payable by the tenants was not proportionate to the service charge costs actually incurred by the landlord.

The practical consequence of the decision in Arnold v Britton, is that a small annual £90 charge increased at a compound rate of 10% per year, which had more than doubled ten years later, will increase to over £1 million by the end of the term of the leases.

In his judgment, Lord Neuberger who holds the position of President of the Supreme Court of the United Kingdom, emphasises that commercial common sense should not be used to undervalue the importance of the natural language of the provision which is in question.  Lord Neuberger also confirms that commercial common sense cannot be applied retrospectively to correct situations arising after the date of the contract.  The fact that an arrangement has worked out badly, or even disastrously for one of the parties does not justify departing from the natural meaning of the words used.  In the judgment Lord Neuberger states that the purpose of interpretation is to identify what the parties have agreed, not what the Court thinks they should have agreed.

Arnold v Britton shows that the courts will only intervene where the meaning of the relevant contractual provisions is ambiguous.  In summary, the courts will not step in with a purposive interpretation of a contract to rescue a party from a bad commercial deal where the wording of the contract is clear.

The case also confirms that there are no special principles for interpretation of service charge clauses in favour of tenants.

What are the lessons to be learnt from the case:

When agreeing terms for service charges or rents subject to fixed, compound or RPI increases, you should ensure that the wording or formula used works correctly by testing it with worked with examples.  This will help to ensure that what is agreed and documented correctly reflects the intentions of both parties and avoid situations such as the unfortunate one encountered by the tenants in Arnold v Britton.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.