Interpreting business contracts: 'Commercial common sense' under the spotlight

25 June 2015

By Andrew White, Partner, and Esther Johnson, Solicitor

A new Supreme Court decision has sounded a note of caution regarding the role of 'commercial common sense' in interpreting business contracts under English law. This decision will clearly be very influential. 'Commercial common sense' is one of the criteria which courts can apply when seeking to uncover the meaning of an unclear or ambiguous provision. It was endorsed by Lord Clarke in Rainy Sky v Kookmin Bank (2011) where he held that if there are two possible interpretations of a contractual term, the court is entitled to prefer the interpretation which is consistent with business common sense and to reject the other. Since then, there's been an underlying concern in the courts that parties would misuse the 'commercial common sense' test to try to rewrite a deal they don't like.   

In Arnold v Britton the Supreme Court has now addressed this concern directly. Lord Neuberger has now stressed that even where the parties have entered into a contract which clearly has an unduly 'alarming' outcome for one of the parties from a commercial perspective, the court will not intervene where the natural meaning of the words is clear. In considering the meaning of a service charge provision which provided for a 10% annual increase (which would have the effect of allowing the lessors of chalets on a Welsh caravan park to charge service charges of over £500,000 by the end of term), Lord Neuberger noted that the provision in question was 'explicable' in the circumstances (the high rate of inflation in the 1970s when the leases were entered into provided some explanation for the approach of the parties at the time). The wording of the leases was also clear and it was not possible for the court to depart from the natural meaning of the agreement and insert words which were not there. He stressed that commercial common sense should not be invoked retrospectively; it was only relevant when considering the circumstances at the time that the contract was made.

Lord Carnwath, giving a dissenting judgement, thought that the agreement produced a result which was 'commercial nonsense' which the courts should avoid by the process of interpretation to achieve a 'sensible result'. The final decision of the majority of the Supreme Court, and the views of the dissenting judge in the case, demonstrate the continuing tension within the courts where a contract, on any common sense reading, produces an outcome which it would seem no reasonably minded party would have intended.  In this case, the majority of the Supreme Court concluded that despite the outcome, it wasn't for the court to intervene to correct what in effect had become a bad bargain. As Lord Neuberger stated, the 'purpose of interpretation is to identify what the parties have agreed, not what the court thinks that they should have agreed….it is not the function of a court when interpreting an agreement to relieve a party from the consequences of his imprudence or poor advice.'

Arnold v Britton & ors [2015] UKSC 36

 Image of Andrew White  Image of Esther Johnson
Andrew White
Esther Johnson