Service Charges & Estate Management Update – June 2015
12th June 2015
Arnold v Britton  UKSC 36
There is no general principle that service charge clauses should be construed “restrictively”: service charge clauses are not subject to any special rule of interpretation. The alarming consequence of an interpretation (for example, as regards a lease granted in 1980, the service charge would be over £2,500 in 2015 and over £550,000 by 2072) was not a convincing argument for departing from the natural meaning of the clause. The lessees’ appeal was dismissed.
The appellant lessees appealed against the decision of the Court of Appeal ( EWCA Civ 902 – summarised in the August 2013 update) on the interpretation of their leases. The leases were long leases of holiday chalets at a leisure park. The relevant clause (clause 3(2)) in one of the leases was a covenant by the lessee in the following terms:
“To pay to the Lessors without any deductions in addition to the said rent 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 or part thereof.”
There were several minor variations of this clause in the leases of other chalets but all were very similar. The essential issue was whether the clauses provided for annual compounded increases, at the rate of 10 per cent, in the charges payable, as the respondent landlord contended (and both Morgan J and the Court of Appeal held); or whether the figure given in the clauses was a cap up to which the landlord could recover the actual expenditure on the provision of services. The tenants’ case was that the effect of compounding was that the service charge was already over £3,000 per annum for the relatively limited services provided for the holiday chalets and, by the last year of the lease, the total would be over £1 million. The tenants argued that this was uncommercial and nonsensical and so required the clause to be regarded and read as a cap. The landlord submitted that there was no evident ambiguity or mistake in the wording; the landlord’s interpretation was not absurd since at the time the leases were made and at times thereafter annual inflation exceeded 10 per cent.
Decision on Appeal
the Supreme Court (Lord Neuberger, Lord Sumption, Lord Hughes and Lord Hodge; Lord Carnwath dissenting) dismissed the lessees’ appeal. Lord Neuberger, giving the lead judgment, emphasised seven factors relevant to the construction of contracts:
- The reliance placed in some cases on commercial common sense and surrounding circumstances should not be invoked to undervalue the importance of the language of the provision which is to be construed.The exercise of interpreting a provision involves identifying what the parties meant through the eyes of a reasonable reader, and, save perhaps in a very unusual case, that meaning is most obviously to be gleaned from the language of the provision.Unlike commercial common sense and the surrounding circumstances, the parties have control over the language they use in a contract.And, again save perhaps in a very unusual case, the parties must have been specifically focussing on the issue covered by the provision when agreeing the wording of that provision.
- The less clear the relevant words to be interpreted are (i.e. the worse their drafting), the more ready the court can properly be to depart from their natural meaning.However, that does not justify the court embarking on an exercise of searching for, let alone constructing, drafting infelicities in order to facilitate a departure from the natural meaning.If there is a specific error in the drafting, it may often have no relevance to the issue of interpretation which the court has to resolve.
- Commercial common sense is not to be invoked retrospectively.The mere fact that a contractual arrangement, if interpreted according to its natural language, has worked out badly, or even disastrously, for one of the parties is not a reason for departing from the natural language.Commercial common sense 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.
- 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.Experience shows that it is by no means unknown for people to enter into arrangements which are ill-advised, even ignoring the benefit of 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 to penalise an astute party.
- When interpreting a contractual provision, one can only take into account facts or circumstances which existed at the time that the contract was made, and which were known or reasonably available to both parties.Given that a contract is a bilateral arrangement involving both parties, it cannot be right, when interpreting a contractual provision, to take into account a fact or circumstance known only to one of the parties.
- In some cases, an event subsequently occurs which was plainly not intended or contemplated by the parties, judging from the language of their contract.In such a case, if it is clear what the parties would have intended, the court will give effect to that intention.
- There is no general principle that service charge clauses should be construed “restrictively”: service charge clauses are not subject to any special rule of interpretation.Even if 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 Court held that the natural meaning of the clause 3(2) was clear: the first half of the clause provides that the lessee is to pay an annual charge to reimburse the lessor for the costs of providing the services which he covenants to provide, and the second half of the clause identifies how that service charge is to be calculated, namely as a fixed sum, with a fixed annual increase. The alarming consequence of this interpretation (for example, as regards a lease granted in 1980, the service charge would be over £2,500 in 2015 and over £550,000 by 2072) was not a convincing argument for departing from the natural meaning of clause 3(2).
This is a landmark case on the construction of service charge provisions. For many years, lessees have successfully argued that service charge clauses should be construed restrictively. Support for this proposition is found in Rix LJ’s judgment in McHale v Cadogan  EWCA Civ 14,  1 EGLR 51. Lord Neuberger explained that what Rix LJ 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”. This case makes clear that service charge clauses are not subject to any special rule of interpretation. It also clarifies that the courts must not, by invoking commercial common sense and the factual background, undermine the language of the provision in the contract.
Oliver v Sheffield City Council  UKUT 0229 (LC)
Where the lease specifically permits improvements, consultation and consideration of the interests of the leaseholders who will be expected to contribute is likely to be a necessary ingredient in demonstrating that the cost has been reasonably incurred.
In 2011 and 2012 the respondent landlord undertook a programme of major works, which included the removal of the original cladding material from the exterior of the blocks and its replacement with new cladding material, after structural strengthening. The project was eligible to receive a contribution from a commercial energy company as part of the Community Energy Savings Programme (“CESP”). Not all of the work on the estates was eligible for a CESP contribution. The leases required the leaseholders to contribute to the cost of works of repair or improvement carried out to their own blocks, and not to the Estate as a whole but the Council shared the benefit of the CESP funding across the Estate (regardless of which blocks benefited).
The LVT held that the costs of the major works had been reasonably incurred by the Council, and that the lessee was required to contribute towards them under the service charge provisions in her lease. The lessee appealed.
Decision on Appeal
The UT (Martin Rodger QC, Deputy President and P D McCrea FRICS) held (1) the element of improvement involved in the project to re-clad the Estates did not make any difference to the reasonableness of the Council’s decision to proceed with the work; (2) the treatment of the CESP funding had not been in accordance with the requirements of the lease.
Section 19 makes no express distinction between the cost of improvements and the cost of repairs but a different approach may be required to the issue of reasonableness when the works in question are repairs which the landlord is contractually obliged to carry out as against works of improvement over which it has a discretion: see Waaler v LB Hounslow  UKUT 0017 (LC). In this case, the UT went further: where the lease specifically permits improvements, consultation and consideration of the interests of the leaseholders who will be expected to contribute is likely to be a necessary ingredient in demonstrating that the cost has been reasonably incurred.