Background
The Supreme Court has handed down judgment in a service charge case that has major relevance to contractual interpretation in general. The central issue concerned when the Court should give weight to commercial sense in constructing agreements.
Facts
The case centred on a service charge clause contained in 21 99-year leases of holiday chalets on the Gower Peninsula in Wales which were granted between 1977 and 1991. The tenants appealed a decision by the Court of Appeal that the clause should be read literally.
The clause had two limbs: the first stated that the lessee would pay to the lessor an annual service charge in respect of services provided by the landlord and the second detailed how the service charge would be calculated. This calculation had the effect of taking an initial £90 per annum and compound increasing this amount by 10% every year. At first glance it may seem innocuous. However, using the power of mathematics, the upshot (or downshot) of this would be a service charge of £550,000 per annum by 2072 for a holiday chalet. In Wales.
Decision
The Court of Appeal applied a literal interpretation of the relevant service charge provision. The tenants appealed to the Supreme Court relying on commercial sense being relevant to interpretation in order to relieve them of the increasingly penal service charge and no doubt inability to market the chalets.
However, the Supreme Court dismissed the appeal by a majority of 4:1. The Court confirmed that the usual principles of interpretation apply. The Court confirmed that there are no special rules in respect of service charges that mean construction of such provisions is always in favour of tenants. The normal rules of contractual interpretation are therefore relevant. Interpretation of such provisions must be objective and based on what a reasonable person would ascertain from the documents on the facts and in the circumstances at the time the agreement was made. The parties' assertions of subjective intent are not relevant to the question of interpretation. The principle of commercial sense, which is based on the conclusion that the reasonable business person would draw, is only to be applied where there is uncertainty as to the meaning of the language. Where the meaning is clear, the Court will not perfect a bad bargain, even where the outcome seems oppressive as was the case here. The Court also clarified that service charge provisions should not be subject to any special or restrictive rules of construction.
On the facts, the tenants had entered into bargains that were clearly worded. According to the Supreme Court majority, the tenants had gambled on inflation and lost. A number of the tenants had taken their chalets at a time when inflation was higher than 10%. Had inflation continued on such a trend, their bargain would have been a good one. However it did not, and their bargain was a bad one, which was insufficient to authorise the Court to re-write it. Whilst with economic hindsight the tenants' bargain demonstrated poor judgment (at least as it presently seems), the tenants' eyes were open when they entered their leases - they took the risk and it didn't pay off. The Court deals with law, not hard luck stories.
Points to consider
When negotiating a service charge, or indeed any provision, it is important to pay a great deal of attention to the wording and mechanisms used. Where a fixed formula is used, it is prudent for hypothetical examples to be calculated for the whole term of the lease to ensure it will not lead to potentially detrimental consequences for the tenant. If in doubt, run any numbers through a surveyor or accountant in order to fully understand potential liability.
When balancing commercial sense and the plain language of the agreement, the scales will be tipped towards the latter. The court will only invoke the principle of commercial sense where there is ambiguity in the written wording of the contract and it will be applied at the date of the contract rather than retrospectively. The decision confirms that where the wording as drafted is unambiguous, the recourse for a party trying to argue that the document does not accurately reflect the parties' intention would have to be via a claim for rectification. This of course is extremely difficult where there is a clear construction but little or no clear evidence of the parties intending a different meaning.
Interestingly, Lord Carnwath dissented. His interpretation acknowledged the clarity of the second limb but allowed for commercial sense to limit the actual amount the landlord could recover. In other words, the landlord was entitled to the fixed amount to the extent that it was a proportionate element of the overall costs of providing the services. This position was attractive in reading a commercially sound result (in the context of today's historic low inflation rate) and the interpretation is far from inconsistent with the language of the relevant position. Unfortunately Lord Carnwath was isolated in his viewpoint and the majority's commercially harsh decision stands.
Whilst the Supreme Court emphasised its position of refraining from interfering with bad commercial bargains where there is no ambiguity in the language, it did acknowledge the lack of statutory protection in this area. It will be interesting to see whether Parliament will intervene to protect tenants against wholly disproportionate service charges under the Landlord and Tenant Act 1985. In the meantime the estate roads of Oxwich Holiday Park in the Gower Peninsula will likely be paved in gold, though it will be no holiday camp for the tenants affected.
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.
