In the case of Arnold v Britton & Ors [2015] UKSC 36 the Supreme Court considered the degree to which ‘commercial common sense’ can be deployed in contractual interpretation as they endorsed leases in which the service charge, which began at 90 per year, increases by 10% a year regardless of the actual costs of providing those services.

All 91 chalets at Oxwich Leisure Park are let for a period of 99 years from 25/12/74 on verysimilar terms. The service charge for 66 of the chalets is reviewed every three years, but for the remaining 25 chalets, the service charge is reviewed annually.

The service charge provisions provided for an increase of 10% per year which put the service charge for each chalet at over 1 million per annum by the time the lease terms ends in 2072. The lessees argued that they were obliged to pay a proportion of the lessor’s expenses subject to a maximum cap of 10% on any annual increase. To facilitate this, the words “limited to” or “up to” should be implied into the clause which would allow the lessor to recover the costs and not to make a profit.

The leading judgment of Lord Neuberger emphasised that the words used in the clause were a strong indication that a fixed sum is due and service charge clauses are not subject to any special rule of interpretation. He stated seven principles of contractual interpretation he considered relevant:

1. Commercial common sense should not be invoked to undervalue the importance of the language of the provision, apart from in very unusual cases. To interpret a provision you must identify what the reasonable person would understand the parties’ intentions as.

2. The more ambiguous the provisions are, the easier it is for the court to depart from their natural meaning. However, the court should not search for drafting ambiguities; a specific error in the drafting may often have no relevance to the issue of interpretation which the court has to resolve.

3. Commercial common sense should not be invoked retrospectively. Just because a contractual arrangement has not worked out, does not give cause for departing from the natural language.

4. Commercial common sense should be taken into account however the court must consider the natural meaning of a provision. The courts must avoid attempting to assist an unwise party or to penalise an astute party.

5. A contract is a bilateral arrangement therefore, only facts known or reasonably available to both parties at the time the contract was made can be taken into account in interpreting the contract.

6. When an event subsequently occurs which was not contemplated by the parties, if it is clear what the parties would have intended, the court will give effect to that intention.

7. There is no general principle that service charge clauses should be interpreted restrictively.

It was held that the service charge provision imposed a liability for an annual service charge and explained how it was to be assessed (a fixed sum with a fixed 10% annual increase). Lord Neuberger commented that the parties had taken a bilateral gamble on inflation. The court could not re-write the contractual provision simply because the factor which the parties catered for did not develop in the way in which the parties expected. If inflation was higher than 10% per annum, the lessee benefited; if it was lower, the lessor benefited. However, the lessor was disadvantaged because, at worst, the costs of the services will be paid, but, if inflation ran at more than 10% per annum, the lessor loses out. He commented that the service charge clause was not “normal” however it may now be somewhat easier to persuade the court that a particular service charge clause should be construed as permitting a profit.

None of the statutory provisions which protect tenants against unreasonable service charges applied in this case. The statutory regulation of service charges provided by ss18-19 of the Landlord and Tenant Act 1987 applies only to those which are variable in amount; the Unfair Contract Terms Act 1977 excludes from its ambit contracts relating to the sale of land; and the Unfair Terms in Consumer Contracts Regulations 1994 and 1999 were not in force at the material times.

Further to the Supreme Court’s decision, the lessees of the 25 chalets whose service charge is reviewed annually, by the end of the lease will be liable for approximately 1 million liabilities and face escalating service charges which are out of proportion to the costs the lessor incurs. The only solution is for these tenants to surrender their lease which is consensual between lessee and lessor, or through forfeiture which requires unilateral action by the lessor. Neither option can be forced on the lessor of the park, consequently the tenants are required to pay an increasing sum, which if they fail to pay could be enforced against other properties they own.

Holiday home agreements are often entered into informally as a result of discussions between the landlord and incoming leaseholder. Therefore, as it is the outgoing leaseholder, not the landlord, who is the vendor it is advisable that all discussions are reported to the incoming leaseholder’s solicitor and legal advice is obtained before acting upon any verbal agreements or discussions. It is also advisable to agree a variable charge or if a fixed charge is insisted upon, the increase is made by reference to an agreed index (such as the Retail Price Index or Consumer Prices Index) to ensure the fixed sum does not increase by a set percentage each year.

If you have any queries, please contact:

Lee Pearce on or 01206 719669

Joe Brightman on or 01206 719609