Lord Neuberger, President of the UK Supreme Court, has issued one of his presidential proclamations – which is what he does when he wishes to change the law from his lofty but unaccountable position. Nominally the case he was considering, Arnold v Britton & Others, was a simple enough matter regarding service charges for a set of chalets on the Gower peninsula: clause 3(2) of the lease said the price for work such as mowing grass, maintaining roads through the site and sewers &c was to be £90 in 1974 rising by 10% a year; how should this be interpreted nearly 40 years on when the annual figure was more than £3,000 per chalet and rising? (Inflation would produced a figure of less than £800 by 2012.)
If the charge were truly to rise by 10% a year the lessor would be making a very substantial surplus over the term of the lease thanks to compounding (Year 2: £90 + £9 = £99; year 3: £99 + £9.90 = £108.90 and so on annually.) As Davis LJ in the Court of Appeal noted:
“The figures before us are illustrative of the consequences. For a lease on a one year compounded uplift, the annual service charge payable was, for the year end 2012, some £3,060. At the same compounded annual rate of increase, the projected annual sum payable for service charges in the last year of the term stands to be some £1,025,004: this for modest holiday chalets, the use of which is restricted to half of each year.”
That’s a million pounds per chalet. There were 25 involved in the litigation but 91 in total, some with a less onerous system of payment for services. The outcomes would vary depending on when the leases were issued. Nevertheless, if the clause in the lease were allowed to stand, the lessors would have pulled in hundreds of millions in pure profit over the 99 years of the lease. This on a term of the lease which, it is axiomatic, should not be profit-making since it is merely for the lessor to recover expenditure on ongoing maintenance of the common facilities (see Lease – though holiday chalet leases aren’t covered by legislation for homes).
More realistically, though, the clause would actually lead to the destruction of the leases: lessees would eventually be unable to afford the money; the value of the lease to them would become zero since no one would buy chalets with such a burden attached; one by one the lessees would cease to pay and the lessor would go for forfeiture, getting the properties back to let them again. Adding another twist, the new leases on forfeited chalets, by a covenant attached to each of the 91 leases, had to be let on the same terms. Ultimately the business would be run into the sands of absurdity.
All this is pure common sense, and judges over the years have come up with a few common sense rules of construction (ie analysis) when considering contracts that have ambiguous terms – particularly when they give rise to manifest absurdity as in this case.
They should look at the “factual matrix” behind the contract (Lord Wilberforce Prenn v Simmonds  1 WLR 1381); they may look at the intention of the contract and the parties thereto (here to maintain the chalet site, not to make multimillionaires of the lessors); they may interpret it in a way that will keep the contract on foot; they will apply “commercial common sense” to the contract and as a means of understanding the intentions of the two parties to it (Lord Diplock Antaios Compania Naviera S.A. v. Salen Rederierna A.B.  AC 191); they may, if necessary, apply the contra proferentum rule – construe the ambiguity against the person seeking to rely on the words (here the lessor). See Gilje v Charlgrove Securities (2001 Court of Appeal).
All this seems to have been thrown to the four winds by Lord Neuberger. In Arnold v Britton he refused to construe clause 3(2) of the lease (see below) in any other way than its literal meaning – the lessees must continue to pay 10% extra per annum on a compounded basis. They must be squeezed until the pips squeak.
The lawyers for the lessees – tenants who hold 99-year leases on the chalets (the original ones commencing in 1974) – argued that there was clear evidence in the wording of the leases that the intention was for each lessee to share equally the cost of the lessor’s maintenance of the site. Some of the wording of other leases suggests this. Clause 3(2) should be read as if it were a maximum increase, only applicable if necessary to defray the full costs to the lessor. In cases of ambiguity “the court generally seeks to achieve the most commercially sensible result”, as Davis LJ had acknowledged in the Court of Appeal. Neuberger is scathing about this approach, saying it amounted to “inventing a lack of clarity”:
“We are invited to construe that which reads on a first consideration as a fixed service charge with an escalator to deal with future inflation, as a variable service charge which is subject to a cap to which the escalator applies. I find that very difficult. In my view there is nothing in the relevant context to support the construction of the clause as creating a cap, other than the view, which events have fully justified, that it was unwise of the lessees to agree to a fixed service charge with an escalator based on an assumption that the value of money would diminish by 10% per year.”
Yet he acknowledges that the “factual matrix” is very limited – the background as to why the 10% figure was chosen is not there, nor why some of the other leases vary from the 10% a year formula. But nothing persuades him that he should apply business common sense to the contract – which would have suggested it was there to ensure the grass was cut and the sewage pipes maintained, not to bankrupt the lessees:
“While commercial common sense is a very important factor to take into account when interpreting a contract, a court should be very slow to reject the natural meaning of a provision as correct simply because it appears to be a very imprudent term for one of the parties to have agreed, even ignoring the benefit of wisdom of hindsight. The purpose of interpretation is to identify what the parties have agreed, not what the court thinks that they should have agreed.”
For the lessees he has little comfort. When they took the leases: “They are taking a gamble on inflation, but at least it is a bilateral gamble: if inflation is higher than 10% per annum, the lessee benefits; if it is lower, the lessor benefits.” So the purpose of the contract, in Neuberger’s view, was not to keep the site up to standard but, if at all possibly, to enrich one side or the other on the basis of a gamble.
“Commercial common sense” has a certain amount of objectivity about it. Once the purpose of the contract is ascertained, a judge can logically deduce how rational businesspeople would attain that result.
A gambling contract has no such logic too it. Gamblers are notably deluded and over-optimistic about their prospects – which is why they keep on gambling. And crucially, the bank always wins on the gaming tables. None of this offers itself to rational analysis, there is no “common sense” about it, so none of it should enter the judges’ arsenal as a principle of contractual construction.
It is notable that when the agreement was entered into, the 10% figure was rather less than inflation. The lessor was putting herself at a disadvantage from the start. How to interpret this?
Common sense suggests this was an acknowledgment that this was not intended as a profit-making clause and that the work required of her could be done at a reasonable rate assuming inflation would hover around 10%. Yet Neuberger’s remarkable new analysis from the gambling world, would suggest it was a “sucker bet”, drawing the lessees (or punters, as we should perhaps call them) into what they thought was a good deal slightly below the inflation rate, only to hit them when the rate came tumbling down. As notorious card sharp Canada Bill Jones once said: “It’s immoral to let a sucker keep his money”.
This interpretation, that the purpose of the clause was to gamble rather than ensure the upkeep of the site, cannot be right (and indeed the lessors have said they are willing to negotiate a more reasonable price for the work). Yet it seems to be the new legal doctrine Neuberger has gifted to the world of contract law.
He has set the “absurdity bar” very high, preventing “commercial common sense” intervening in large areas of business contracts. If owners of mere holiday chalets who enter court with a contract that is manifestly absurd and doomed to self-destruct can’t leave court with a workable document, who can from now on?
Instead of keeping the contract on foot he has left it to stagger aimlessly like a zombie until someone puts it out of its misery.
Neuberger has given some explanation of his judgment (November 2015). A resumé can be found here: Neuberger explains Arnold v Britton
Note: Neuberger is not always such a stickler for literal interpretation. See: Daejan v Benson: Supreme Court flies in the face of the legislation. Here he could not bring himself to read literally the Landlord and Tenant Act 1985 Section 20 which would have given lessees windfall gains in this case, when lessors failed to properly consult on works done to a block of flats under a service agreement.
See also Judicial anarchy on the village green to see how Neuberger plays fast and loose with longstanding principles of judicial precedent.
As well as the judgment outlined above, Neuberger issued a set of favoured rules for the judicial construction of contracts, arguably sweeping aside much judicial precedent (which even the President of the Supreme Court is not really supposed to do). He prefaces his judgment with seven points, most seeking to severely restrict the doctrine of commercial common sense in favour of literal interpretation, thus: “the reliance placed in some cases on commercial common sense and surrounding circumstances (eg in Chartbrook [ref below], paras 16-26) should not be invoked to undervalue the importance of the language of the provision which is to be construed”.
Commercial common sense, if it is to be used, should not be “retrospective”. It “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, as at the date that the contract was made”. In particular “a court should be very slow to reject the natural meaning of a provision as correct simply because it appears to be a very imprudent term for one of the parties to have agreed, even ignoring the benefit of wisdom of hindsight”.
His seventh point is particularly interesting:
“Seventhly, reference was made in argument to service charge clauses being construed ‘restrictively’. I am unconvinced by the notion that service charge clauses are to be subject to any special rule of interpretation. Even if (which it is unnecessary to decide) a landlord may have simpler remedies than a tenant to enforce service charge provisions, that is not relevant to the issue of how one interprets the contractual machinery for assessing the tenant’s contribution. The origin of the adverb [restrictively] was in a judgment of Rix LJ in McHale v Earl Cadogan  EWCA Civ 14, para 17. What he was saying, quite correctly, was that the court should not ‘bring within the general words of a service charge clause anything which does not clearly belong there’. However, that does not help resolve the sort of issue of interpretation raised in this case.”
Neuberger thus removes a whole area of ambiguity – the area between a “restrictive” interpretation and a wider interpretation – to limit or even obviate from the start some claims based on ambiguity or unclear language. He acknowledges here the unequal legal positions of the landlord and lessee – but far from offering anything to assist, in this case certainly, as in Daejan before it, he has weighted things decisively in favour of landlords.
The clause at issue
Clause 3(2) said this in the first set of 99-year leases for chalets at Oxwich Leisure Park is on the Gower Peninsula issued in 1977:
“To pay to the Lessors without any deductions in addition to the said rent [as] a proportionate part of the expenses and outgoings incurred by the Lessors 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 three years of the term hereby granted increasing thereafter by Ten Pounds per Hundred for every subsequent three year period [for the first year] or part thereof.”
The words in square brackets were added in leases issued for another set of 76 chalets in 1980 – the subject of the present case. The as is important since without it it looks as if the clause requires a proportionate part of the expenditure to be paid by each lessee (ie divided between each chalet lessee); with the “as” it looks as if it is say that the £90 plus 10% a year is the proportionate expenditure, or to be deemed such – even if it is not the actual amount spent on the lessor’s duties such as repairing roads through the site, mowing grass, maintaining sewer pipes, fences and so on.
Investors Compensation Scheme Ltd v West Bromwich Building Society  1 WLR 896;
Chartbrook Ltd v Persimmon Homes Ltd  1 AC 1101;
Attorney General of Belize v Belize Telecom  1 WLR 1988;
The old rules of construction
Lord Hoffmann: I think I should preface my explanation of my reasons with some general remarks about the principles by which contractual documents are nowadays construed. I do not think that the fundamental change which has overtaken this branch of the law, particularly as a result of the speeches of Lord Wilberforce in Prenn v. Simmonds  1 W.L.R. 1381, 1384-1386 and Reardon Smith Line Ltd. v. Yngvar Hansen-Tangen  1 W.L.R. 989, is always sufficiently appreciated. The result has been, subject to one important exception, to assimilate the way in which such documents are interpreted by judges to the common sense principles by which any serious utterance would be interpreted in ordinary life. Almost all the old intellectual baggage of “legal” interpretation has been discarded. The principles may be summarised as follows:
1) Interpretation is the ascertainment of the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract.
(2) The background was famously referred to by Lord Wilberforce as the “matrix of fact,” but this phrase is, if anything, an understated description of what the background may include. Subject to the requirement that it should have been reasonably available to the parties and to the exception to be mentioned next, it includes absolutely anything which would have affected the way in which the language of the document would have been understood by a reasonable man.
(3) The law excludes from the admissible background the previous negotiations of the parties and their declarations of subjective intent. They are admissible only in an action for rectification. The law makes this distinction for reasons of practical policy and, in this respect only, legal interpretation differs from the way we would interpret utterances in ordinary life. The boundaries of this exception are in some respects unclear. But this is not the occasion on which to explore them.
(4) The meaning which a document (or any other utterance) 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 those words against the relevant background would reasonably have been understood to mean. The background may not merely enable the reasonable man to choose between the possible meanings of words which are ambiguous but even (as occasionally happens in ordinary life) to conclude that the parties must, for whatever reason, have used the wrong words or syntax. (see Mannai Investments Co. Ltd. v. Eagle Star Life Assurance Co. Ltd.  2 WLR 945
(5) The “rule” that words should be given their “natural and ordinary meaning” reflects the common sense proposition that we do not easily accept that people have made linguistic mistakes, particularly in formal documents. On the other hand, if one would nevertheless conclude from the background that something must have gone wrong with the language, the law does not require judges to attribute to the parties an intention which they plainly could not have had. Lord Diplock made this point more vigorously when he said in The Antaios Compania Neviera S.A. v. Salen Rederierna A.B. 19851 A.C. 191, 201:
“… if detailed semantic and syntactical analysis that flouts business commonsense the contract must be made to yield to business commonsense.’
Hoffmann Investors Compensation Scheme Ltd v West Bromwich Building Society  1 All ER 98
Hoffmann in Chartbrook
It is of course true that the fact that a contract may appear to be unduly favourable to one of the parties is not a sufficient reason for supposing that it does not mean what it says. The reasonable addressee of the instrument has not been privy to the negotiations and cannot tell whether a provision favourable to one side was not in exchange for some concession elsewhere or simply a bad bargain. But the striking feature of this case is not merely that the provisions as interpreted by the judge and the Court of Appeal are favourable to Chartbrook. It is that they make the structure and language of the various provisions of Schedule 6 appear arbitrary and irrational, when it is possible for the concepts employed by the parties (MGRUV, C & I etc) to be combined in a rational way.
I therefore think that Lawrence Collins LJ was right in saying that ARP [Additional Residential Payment payable to the builder once flats were sold] must mean the amount by which 23.4% of the achieved price exceeds the MGRUV [Minimum Guaranteed Residential Unit Value]. I do not think that it is necessary to undertake the exercise of comparing this language with that of the definition in order to see how much use of red ink is involved. When the language used in an instrument gives rise to difficulties of construction, the process of interpretation does not require one to formulate some alternative form of words which approximates as closely as possible to that of the parties. It is to decide what a reasonable person would have understood the parties to have meant by using the language which they did. The fact that the court might have to express that meaning in language quite different from that used by the parties (“12th January” instead of “13th January” in Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd  AC 749; “any claim sounding in rescission (whether for undue influence or otherwise)” instead of “any claim (whether sounding in rescission for undue influence or otherwise)” in Investors Compensation Scheme Ltd v West Bromwich Building Society  1 WLR 896) is no reason for not giving effect to what they appear to have meant. (Chartbrook Ltd v Persimmon Homes Ltd  1 AC 1101; at 21,21)