Interpretation of service charge clauses

Arnold v Britton ([2015] UKSC 36) concerned the construction of the service charge clauses in a number of long leases of chalets in a caravan park. The clauses in question required the lessees to pay, as a proportionate part of the landlord’s costs in providing the relevant services, GBP 90 plus VAT in the first year. This sum was to increase by 10% per annum. The startling result was that the GBP 90 had become GBP 3,366 by 2012 and would rise to GBP 1,025,004 by 2072 (the final year of the leases). It was possible that the sum payable by even one tenant occupying on these terms would exceed the actual cost of the provision of services for the whole estate. The leases of most of the chalets on the estate had been granted earlier than the disputed leases. These earlier leases provided for the initial GBP 90 to rise by 10% every three years (or by roughly 3% per annum). These earlier leases were referred to as the ‘triennial leases’. The clause in the triennial leases gave rise to very much more modest liabilities; even by 2072, the service charge would only have risen to GBP 1,900. These figures are taken from the table in Lord Carnwath’s dissenting judgment (see below).

The first question was whether the landlord’s interpretation of the service charge clause (in line with the above description) was correct so that there would be an automatic increase at 10% per annum. The tenants contended for an alternative construction. They pointed to the fact that the obligation was to pay a proportionate part of the landlord’s cost in providing the services and argued that the compounded GBP 90 merely provided a cap on the amount that was to be paid. The majority of the Supreme Court agreed with Lord Neuberger and rejected this interpretation. The wording of the provision was clear and the fact that it had disastrous consequences for the tenants did not entitle the court to rewrite the clause.

The second question was whether, as the tenants contended, an implied term should be read into the service charge clause. The leases contained a recital to the effect that they were intended to be ‘upon terms similar in all respects to the present demise’. The leases contained a covenant (in clause 4(8)) by the landlord  that the leases of the other chalets ‘shall contain covenants on the part of the lessees thereof to observe the like obligations as are contained herein or obligations as similar thereto as the circumstances permit.’ The questions were whether this created a building scheme or letting scheme and, if so, whether this gave rise to an implied term that would affect the interpretation of the service charge clause. The tenants argued that there was an implied term in the disputed leases to the effect that they were on the same terms as the triennial leases and that this prevented the landlords from increasing the service charge in the disputed leases at a rate that exceeded the rate of increase in the triennial leases.

First, Lord Neuberger was prepared to accept that the relevant terms did indeed create some kind of building or letting scheme and that it was ‘envisaged that there would be a degree of reciprocity and mutual enforceability between the lessees of chalets when it came to the covenants they entered into.’ ([49]). Building schemes can only cover restrictive covenants in the case of freehold land. Lord Neuberger thought it might be possible that they would extend to positive covenants in the case of letting schemes. Even if this were possible, however, it was questionable whether a covenant to pay a service charge or any other sum of money could be within the ambit of a scheme ([51]). In any event, there were other obstacles that, in Lord Neuberger’s view, prevented the tenant’s argument from succeeding: the relevant lease terms appeared to relate to future lettings (not past lettings like the triennial leases); even if there were an implied term as contended for it could not override the obligations that the tenants had expressly assumed; and clause 4(8) referred to ‘like’ or ‘similar’ terms and so envisaged the possibility of some degree of variation. More fundamentally, the implied term that was the best fit with the relevant provisions was to the effect that the triennial leases contained the same service charge provisions as the disputed leases (and not vice versa). While there was a good argument in favour of such an implied term, this did not help the tenants under the disputed leases; they suffered no damage as a result of a failure to impose the same term in other leases.

Lord Neuberger’s judgment contains a section ([14] – [23]) reviewing the major authorities on contractual interpretation. Amongst the points made in this section is that he is ‘unconvinced by the notion that service charge clauses are subject to any special rule of interpretation.’ ([23])

On the major question, the view of the majority is summed up thus:

‘In my judgment, there is no principle of interpretation which entitles a court to re-write a contractual provision simply because the factor which the parties catered for does not seem to be developing as the parties may well have expected.’ ([41] per Lord Neuberger).

Lord Carnwath gave a dissenting judgment. He inclined to the view that service charge clauses did merit special treatment to ensure that they give effect to their intended purpose and to guard against ‘unfair and unintended burdens being placed on the lessees.’ ([123]) Service charge clauses in many residential leases are subject to controls imposed by legislative scheme. There was no obvious policy reason to explain the fact that the disputed leases did not fall within the ambit of this legislation ([90] – [92]).

Lord Carnwath identified the following features of the factual matrix: the huge service charge liabilities that the tenants holding under the disputed leases would face in the later years of the terms and the gross disparity between these sums and those payable under the triennial leases ([104]); the service charge uplift was intended to respond to the very high inflation of the 1970s but the disputed leases were mainly granted between 1977 and 1991 at which time it was possible to anticipate lower rates of inflation ([106]); the lessees were taking the leases as a long term investment and so it is likely that they would have made enquiries of existing lessees (holding under the triennial leases) about their experiences and the costs associated with living on the estate  ([107]).

Something clearly had gone wrong in the drafting of the clause given the disconnection between the idea of contributing a proportionate part of the cost of providing the services and the obligation to pay a fixed sum each year ([125]). It was inconceivable that the lessees under the disputed leases would gamble on inflation being close to or exceeding 10% per annum for over 90 years ([139]). They would have known of the change from the triennial formula to the annual formula in their own leases and the likelihood is that they would have understood it as amounting to a cap or upper limit on their service charge liability ([142]). If questioned by the officious bystander they would have articulated this understanding ([143]).

Michael Lower

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