The Supreme Court was quite active last year and in relation to the “law of contract”. Three key decisions on contractual construction, penalties, and implied terms came from 2016 and will impact many forward pleadings.

Construction

Arnold v Britton [2015] UKSC 36 concerned service charge provisions within 99-year leases.

Some provisions characteristically required the tenant: ‘To pay to the Lessor… a proportionate part of the expenses… incurred by the Lessor in the repair maintenance [etc] hereinafter set out the yearly sum of Ninety Poundsfor the first year… increasing thereafter by Ten Pounds per Hundred for every subsequent year…’

The landlord opposed the tenant explaining that the construction of the clause meant a service charge of a fixed sum of £90 was due for the first year, thereafter increasing at 10 percent compounded annually.  The startling result was that a lease granted in 1980 would have a service charge of over ½ million per annum by 2072.

Lord Neuberger concluded that the words used plainly bore the landlord’s construction.

Seven points of general application in construing contracts were identified:

  • Commercial common sense should not be invoked to diminish the importance of the contract’s language;
  • The less clear the actual wording, the more likely the court will be to depart from its natural meaning;
  • Commercial common sense must be assessed at the date of contracting and not applied retrospectively, even if a bargain has worked out ‘disastrously’;
  • The court should be ‘very slow’ to reject the natural meaning of language simply because a term appears imprudent: the ‘purpose of interpretation is to identify what the parties have agreed, not what the court considers that they should have agreed’;
  • Surrounding background circumstances can only be considered if they existed at the time of the contract and were known or reasonably available to both parties;
  • As regards unanticipated or unintended events, if it is clear what the parties would have intended, the court will give effect to that; and
  • Service charges are in no special category for construction purposes.

In respect to Penalties

A noteworthy decision was reached in Cavendish Square Holdings BV v Talal El Makdessi; ParkingEye Limited v Beavis [2015] UKSC 67. The two cases were radically different

In a joint judgment, Lord’s Neuberger and Sumption held the law of penalties should not be abolished – neither should it be extended. The clash between a ‘penalty’ and ‘a frank pre-estimate of loss’ was determined to be false, flowing from a misapplication of Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79. While a facility founded a genuine pre-estimate of loss it would not be a penalty, the opposite also did not necessarily follow.

The real test was ‘whether the impugned provision is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation’. So, the rule only regulates contractual remedies, not the primary obligations, and should not be extended to allow a party to escape a bad bargain.

Implied terms

Marks and Spencer plc v BNP Paribas Trust Company (Jersey) Limited and another [2015] UKSC 72 concerned a characteristic break clause in a commercial lease. For the break to be effective, the tenant needed to give notice, ensure there were no arrears the tenant, therefore, had to and did, pay the December quarter in full, and then brought proceedings to recover the ‘overpayment’ preferable to 25 January to 24 March. The tenant argued there was an implied term that the landlord would refund the ‘overpayment’.

Lords Neuberger and Sumption gave the joint leading judgment and potted the law of implied terms. There are two types of a contractual implied term: the 1st is a term implied ‘in the light of express terms, commercial common sense, and the facts known to both parties at the time the contract was made’, and the 2nd concerns terms implied by law into certain classes of relationship.

The law in this area (in particular Lord Simon’s five-fold test in BP Refinery (Westernport) Pty Ltd v Shire of Hastings (1977) 180 CLR 266 (PC)) represents ‘a clear, consistent, and principled approach’. However, some further guidance was given. A term would only be implied if it satisfied the test of business necessity, or was so obvious a term that it went without saying. For the necessity requirement, the test is not ‘absolute necessity’: the test is whether, without the term, ‘the contract would lack commercial or practical coherence’.

It is not necessary to satisfy ‘necessity’ and ‘obviousness’ (Lord Simon’s second and third requirements), but ‘it would be a rare case where only one of those two requirements would be satisfied’. Lord Simon’s three other requirements, however, did have to be satisfied in every case: the term must be reasonable or equitable, be capable of clear expression, and not contradict any express term.

The implication of a term is not critically dependent on proof of the actual intentions of the parties; rather, one is concerned with reasonable people in the parties’ position at the time of contracting. A term ‘should not be implied into a detailed commercial contract merely because it appears fair or merely because one considers that the parties would have agreed it if it had been suggested to them’ – those are necessary ‘but not sufficient’ grounds for implication.

Lord Hoffman’s view in Attorney General of Belize v Belize Telecom Ltd [2009] UKPC 10 – that the process of ‘implying’ a term was simply part of the exercise of ‘construction’ – was disapproved. The majority took the view that Lord Hoffman’s comments in Belize Telecom ‘should henceforth be treated as a characteristically inspired discussion rather than authoritative guidance on the law of implied terms’.

Applying these principles, the court concluded there were no grounds to imply a term requiring repayment into the lease. (As an aside, and putting to rest a long-running debate, it was also decided that rent payable in advance is not apportionable under the general law or by statute.)

It, therefore, appears the direction of travel, led by Lords Neuberger and Sumption, is towards freedom of contract and faithfully upholding the actual bargains reached by the parties, particularly in relation to commercial and professionally drawn contracts.

So, ‘commercial common sense’ is not a panacea to be used to bend the clear meaning of the parties’ bargain (see Arnold); the law of penalties has been clarified, enabling commercial parties (in particular) somewhat greater freedom of movement (Cavendish); and there has been a return to orthodoxy in relation to implied terms (Marks and Spencer).

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Posted on: 10th February 2016