Case law: Supreme Court changes approach to interpreting commercial contracts
Monday 10th August 2015
Businesses disputing the meaning of clauses in commercial contracts may find the courts uphold the terms, even if they are commercially disastrous, following a Supreme Court decision.
Under leases entered into by tenants of chalets in a caravan park, the tenants had to pay a fixed service charge of £90 for the first year of the term, increasing by 10% every year on a compound basis. This meant that service charges for 2015 for a lease granted in 1980 were over £2,500, and would rise to around £550,000 by the end of the lease.
The tenants argued that this was such an uncommercial outcome it could not have been intended by the parties when they entered into the lease. There have been recent legal rulings in which the courts have interpreted the intentions of parties to a contract on the basis of whether the contract terms are commercially sensible, irrespective of the clear words used.
In this case, the Supreme Court resurrected the previous approach taken by the courts. It ruled that clear, unambiguous words in a contract should not be overturned merely because they are not commercially sensible – even if the outcome is commercially disastrous. It confirmed the following principles to be applied:
The aim of the court in construing a commercial contract is to ascertain objectively the aim of the parties.
For this purpose, the court must put itself in the position of a reasonable person in possession of all background information reasonably available to the parties at the time the contract was entered into.
When unambiguous, ordinary language has been used in a contract, the court will normally give effect to that language. It will not rewrite a bad bargain, or change what was agreed just because it was imprudent – or even if the outcome is disastrous
When there are two possible interpretations, the court will prefer that which made the most commercial sense at the time. However, commercial common sense and surrounding circumstances should not be used to reduce the importance of the words used.
These principles clarify that the courts will give words in a commercial contract their natural meaning, whether commercially sensible or not. Only if the words are ambiguous will they then look to commercial common sense to determine what the parties intended them to mean.
In this case, the court said the meaning of the service charge clauses had to be assessed in the light of:
the natural, ordinary meaning of the words used
other relevant provisions of the lease
the overall purpose of the clause, and the rest of the lease
the facts and circumstances known or assumed by both of the parties at the time
commercial common sense
Subjective evidence of either party’s intentions should be disregarded.
On this basis, given the clear words in the leases, the Supreme Court ruled in favour of the landlord.
Businesses entering into commercial contracts should be aware of how the courts will interpret them in the event of a dispute and draft them carefully to avoid uncertainty.
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