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Ambiguity, mistake and Rainy Sky over Oxwich Bay

The lines between mistake, implied terms and ambiguity are blurred in Arnold v Britton.

In some ways adjudicators have it easy. Their decisions are difficult to challenge, private and are unlikely to be of any significance outside the scope of the project in question. This allows them a certain freedom to give a decision that, provided that it is legally sound, is fair. The same does not apply to the members of the Supreme Court, whose words will be pored over for guidance for decades to come.

This appears to have been in the minds of their Lordships when hearing the recent case of Arnold v Britton.

The issue

The  case concerns a number of holiday chalets in Oxwich Bay on the beautiful Gower Peninsula. Between 1977 and 1990 these chalets had been let under a series of 99 year leases. The service charges were subject to fixed inflation rates, some at 10% compounding annually, meaning that some lessees would be paying over £1 million per year by 2072. Unfortunately for the lessees, we have had a prolonged period of low inflation and the service charges have been rising at a rate well in excess of RPI. If inflation were to remain low for the remainder of the lease, the sums involved would eventually become truly ludicrous.

The main judgment was delivered by Lord Neuberger who concluded that the language was unambiguous, there was no obvious term that could be implied and no clear mistake in the drafting to be corrected. As a result he found that this was simply a case of the parties making a bad bargain, from which the courts would not save them. His decision and the seven factors he based his decision on seem eminently sensible and hold no particular surprises.

Where the case gets interesting is in the dissenting judgment of Lord Carnwath.

Dissenting judgment

As Lord Carnwath said, to call this a bad bargain is a gross understatement. He was clearly unhappy with the result and seemed uncomfortable with the fact that, in several cases, the offending terms had not been negotiated at arm’s length.

With clear language and nothing in the contract to suggest that the parties might have intended anything other than a fixed inflation adjustment, the existing rules of contractual interpretation precluded a “fair” result. So Lord Carnwath took the existing rules and gave them a good shake.

Historically, rectification, implied terms and contractual construction have always been treated distinctly:

  • The rules of interpretation allow you to construe ambiguous wording in the way that makes the most sense, but do not allow you to change the words.
  • Implied terms enable you to add additional provisions based on what the intention of the parties would have been had they thought about it, but cannot contradict an express term of the contract.
  • Rectification does permit you to change the words of the contract but it must be done to give effect to the clear intention of the parties.

In each case the court is trying to twist, embellish or correct the existing wording to give effect to the mutual intent of the parties. The court will not re-write the bargain reached to make it more reasonable. This idea is central to the common law ideal of freedom of contract.

By taking a pick and mix approach to the various rules, Lord Carnwath tried to get around this fundamental principle.

The obligation in the leases was based upon variations to the following formula:

“To pay to the Lessor… a proportionate part of the expenses and outgoings incurred by the Lessor in the repair maintenance renewal… and the provision of services hereinafter set out the yearly sum of…”

Lord Carnwath started with the idea that the express language of the contract could not reflect the intent of the parties. He argued that a reasonable observer would surely have been aware that a liquidated inflation mechanism had the potential to be commercially disastrous. He concluded that it was so commercially improbable that the parties would have agreed to fix the rate of inflation over a 99 year term “that only the clearest words could justify the court in adopting” this interpretation.

As the language does not lend itself to an alternative construction, the drafting must be the result of a mistake. If there is a mistake in the drafting, it can be rectified, but how?

How can you rectify mistakes in the drafting?

Lord Carnwath suggested that the insertion of the words “up to” at the end of the above formula would convert the fixed inflation mechanism into a capped one, giving a more commercially acceptable result for the lessees. He argued that the lessors would not suffer if inflation outstripped the cap as they could always reduce their expenditure on repair and maintenance. Amending the clause in this way “does not do so much violence to the contractual language as to justify a result which is commercial nonsense”.

To rectify the contract in this way, you need to show that the parties intended to cap inflation rather than fix it. Unfortunately, there was nothing in the contract or the evidence to suggest that this might have been the case. So how do you go about showing that this is what the parties must have intended?

The answer lies with Rainy Sky SA v Kookmin Bank, the touchstone of parties who have signed up to an ostensibly commercially unreasonable contract. This case gave rise to the principle that:

“If there are two possible constructions, the court is entitled to prefer the construction which is consistent with business common sense and to reject the other”.

Lord Carnwath then applied this principle not to two alternative constructions but to two alternative wordings of the clause and concluded that capped inflation was more sensible than fixed inflation. In doing this, Lord Carnwath was fully aware that he was mixing up the law relating to ambiguity and rectification, noting that “it may be unnecessary and unhelpful to draw sharp distinctions between problems of ambiguity and of mistake”.

The problem is that there is nothing to indicate that the parties ever intended to cap inflation: this alternative wording is an invention of the court. The principle being proposed is that, if the wording of the contract reflects a sufficiently bad bargain that it could not have been intended, the court may impose an alternative bargain on the parties. In short, the courts will save a party from a bad bargain.

Moreover, there seems to be a retrospective element to this dissenting judgment. If inflation had been running at 15% in the intervening period, leaving the lessor out of pocket, I doubt Lord Carnwath would have arrived at the same conclusion.

So where does this leave us?

Does this dissenting judgment offer scope for a further movement towards a “reasonable” civil code approach to enforcing contracts and away from common law principles of freedom of contract? In short, probably not. Lord Carnwath’s approach seems to have been stomped on quite thoroughly in the majority judgment, with the combined weight of four Supreme Court judges. Of course, someone may still try to run the argument…

Berwin Leighton Paisner LLP Simon Liddiard

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