Contract entitled landlord to raise service charge irrespective of increase in costs, says UK Supreme Court

Four out of five Supreme Court judges agreed that a provision increasing the amount of the service charge by 10% each year, regardless of any change in the cost to the landlord of providing services covered by the charge, was legally sound. In his leading judgment, Lord Neuberger said that courts could not rewrite contractual provisions simply because they did not seem commercially sensible for one party to have signed up to.

Property litigation expert Melissa Thompson of Pinsent Masons, the law firm behind Out-Law.com, said that the decision was a useful reminder of the rules governing interpretation of contracts and how these have been developed by the courts over the years.

"The Supreme Court's decision is a sensible one: the court's function is not to rewrite bad decisions and the terms were probably not considered unreasonable when the leases were entered into," she said.

"I have some sympathy with the views of Lord Carnwath, who dissented, saying that as the purpose of the charge was to recover costs then the charge should bear some resemblance to those costs. However, that was not what the clause said. Lawyers and their clients have to be able to rely on the wording of their contracts to tell them what their contractual obligations are. Although the decision seems harsh on the face of it, it does give certainty and that is what contracts should provide for," she said.

Tenants of 25 long-leased chalets in the Oxwich Leisure Park near Swansea had challenged a provision in their leases obliging them to pay a fixed yearly service charge subject to a compound annual increase of 10%. Most of these leases were entered into between 1978 and 1991. Other tenants in the same park who had entered into differently-worded contracts only had their service charges increased once every three years.

In his leading judgment, Lord Neuberger said that it was true that the provision had "an alarming consequence" for the tenants on the 25 leases affected. However, this was "not a convincing argument for departing from the natural meaning of the clause", he said.

"The reliance placed in some cases on commercial common sense … should not be invoked to undervalue the importance of the language of a provision which is to be construed," he said. "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."

"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," he said.

"In 1974, the inflation rate was running at about 20% so even 10% per annum would not have looked out of kilter at the time," said property litigation expert Melissa Thompson. "Also, even if you ran the figures forward for five or even 10 years they would not have looked too bad - it is only if you can remember how to do compound interest and run it for 50 or 75 years that the numbers start to look out of all proportion to the likely expenditure."

In a dissenting judgment, Lord Carnwath said that interpreting the contract in favour of the landlord resulted in consequences "so commercially improbable that only the clearest words would justify the court in adopting it".

"On the Court of Appeal's interpretation the parties were accepting, as a mathematical certainty, that by the end of the lease period each lessee's service charges would have totalled over £11m, more than 200 times the amounts payable by the existing lessees," he said. "Put the other way, if the assumed prediction were correct, the lessees of more than two-thirds of the chalets on the estate would by then have contributed 200 times less than the figure necessary for the lessors' expenditure to keep pace with inflation."

The landlord of the site intends to renegotiate the leases "for pragmatic if not for legal reasons", Lord Carnwath said. However, the case "seem[ed] to cry out for expert mediation", he said.