FREE CHAPTER from ‘A Practical Guide to Alienation, Alteration and User Covenants in Commercial Property’ by Richard Clarke

CHAPTER ONE – THE INTERPRETATION OF LEASES

1. Legal disputes are often won or lost on the true meaning of a few sentences of text. It is therefore not surprising that the principles which govern the interpretation of legal documents have been considered by the courts at length over the centuries. Helpfully, it is not necessary to trace this lengthy history as in a series of recent cases the Supreme Court has authoritatively restated the applicable principles.

The modern approach to interpreting leases

2. In his well-known speech in Investors Compensation Scheme Ltd v West Bromwich Building Society¹, Lord Hoffman noted that recent cases² had brought about a “fundamental change” in the courts’ approach to interpreting legal documents: old technicalities had been discarded and, subject to one exception, documents should be interpreted by judges using the same “common sense principles by which any serious utterance would be interpreted in ordinary life.” Lord Hoffman summarised the principles³ as being that:

“(1) Interpretation is the ascertainment of the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract.

(2) The background was famously referred to by Lord Wilberforce as the “matrix of fact,” but this phrase is, if anything, an understated description of what the background may include. Subject to the requirement that it should have been reasonably available to the parties and to the exception to be mentioned next, it includes absolutely anything which would have affected the way in which the language of the document would have been understood by a reasonable man.

(3) The law excludes from the admissible background the previous negotiations of the parties and their declarations of subjective intent. They are admissible only in an action for rectification. The law makes this distinction for reasons of practical policy and, in this respect only, legal interpretation differs from the way we would interpret utterances in ordinary life. The boundaries of this exception are in some respects unclear. But this is not the occasion on which to explore them.

(4) The meaning which a document (or any other utterance) would convey to a reasonable man is not the same thing as the meaning of its words. The meaning of words is a matter of dictionaries and grammars; the meaning of the document is what the parties using those words against the relevant background would reasonably have been understood to mean. The background may not merely enable the reasonable man to choose between the possible meanings of words which are ambiguous but even (as occasionally happens in ordinary life) to conclude that the parties must, for whatever reason, have used the wrong words or syntax: see Mannai Investments Co. Ltd. V. Eagle Star Life Assurance Co. Ltd. [1997] A.C. 749.

(5) The “rule” that words should be given their “natural and ordinary meaning” reflects the common sense proposition that we do not easily accept that people have made linguistic mistakes, particularly in formal documents. On the other hand, if one would nevertheless conclude from the background that something must have gone wrong with the language, the law does not require judges to attribute to the parties an intention which they plainly could not have had…”

3. The Supreme Court returned to this issue in Rainy Sky SA v Kookmin Bank⁴. Lord Clarke, giving the unanimous judgment of the court, referred back to the Investors Compensation Scheme summary⁵ and agreed that:

   1. “The ultimate aim of interpreting a provision in a contract, especially a commercial contract, is to determine what the parties meant by the language used, which involves ascertaining what a reasonable person would have understood the parties to have meant”;

   2. The relevant reasonable person is one who has all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract⁶.

4. The issue for the Supreme Court in Rainy Sky was the role of business common sense when interpreting a commercial agreement. Lord Clarke, reviewing the authorities⁷, held the true principle to be that:

“The language used by the parties will often have more than one potential meaning. I would accept the submission made on behalf of the appellants that the exercise of construction is essentially one unitary exercise in which the court must consider the language used and ascertain what a reasonable person, that is a person who has all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract, would have understood the parties to have meant. In doing so, the court must have regard to all the relevant surrounding circumstances. 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.”⁸

5. Lord Clarke further explained that:

   1. Where the parties have used unambiguous language, the court must apply it, whether or not the result accords with commercial sense or amounts to a bad bargain for one of the parties⁹;

   2. However, the more improbable the result, the clearer the language required before the court will find that is the meaning the parties intended¹⁰. In others words, the court will strive to attribute clauses with a meaning which accords with business common sense;

   3. Correspondingly, the poorer the drafting, the less willing the court will be to be driven by semantic niceties to attribute to the parties an improbable and unbusinesslike intention.¹¹

6. In Arnold v Britton¹², the Supreme Court returned to the principles of interpretation in the context of leases specifically. As in the cases discussed above, Lord Neuberger recognised the role of the court as being to identify the intention of the parties by reference to “what a reasonable person having all the background knowledge which would have been available to the parties would have understood them to be using the language in the contract to mean”, assessed in light of: (i) the natural and ordinary meaning of the clause; (ii) any other relevant provisions of the lease; (iii) the overall purpose of the clause and the lease; (iv) the facts and circumstances known or assumed by the parties at the time the document was executed and (v) commercial common sense, but disregarding any subjective evidence of any party’s intentions¹³.

7. At paragraphs 16-23, Lord Neuberger emphasised seven factors relevant to the interpretative exercise:

   1. Commercial common sense and surrounding circumstances “should not be invoked to undervalue the importance of the language of the provision which is to be construed”¹⁴. Interpreting a provision involves identifying what the parties meant through the eyes of a reasonable reader, and save in an 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 direct control over the language they use in a contract;

   2. The less the clear the words used, the more willing the court will be to depart from their natural meaning. The clearer the natural meaning, the more difficult it will be to justify departing from it. Courts should not, however, search for “drafting infelicities in order to facilitate a departure from the natural meaning”¹⁵;

   3. Commercial common sense should not 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.”¹⁶

   4. Whilst commercial common sense is a very important factor for the court to take into account when interpreting a contract, a court should be “very slow” to reject the natural meaning of a provision “simply because it appears to be a very imprudent term for one of the parties to have agreed, even ignoring the benefit of wisdom of hindsight”. The purpose of the court is to identify what the parties have agreed, not what the court thinks they should have agreed¹⁷;

   5. When interpreting a contract, the court may only take into account facts or circumstances which existed at the time the contract was made and which were known or reasonably available to both parties¹⁸;

   6. Where an event occurs which was not intended or contemplated by the parties, if it is clear what the parties would have intended, the court will give effect to that intention¹⁹;

   7. There is no special rule of interpretation that service charge clauses should be interpreted restrictively²⁰.

8. In Wood v Capita Insurance Services Ltd²¹, the Supreme Court again confirmed the above principles²², which it declined to reformulate²³, and confirmed that there is no difference between the approaches set out in Rainy Sky and Arnold: they were saying the same thing.²⁴

The interpretation of leases protected by registration

9. When a lease is granted out of a registered title for a term of more than seven years, the disposition must be completed by registration.²⁵ Where a new lease is granted for a term of more than seven years out of an unregistered freehold or leasehold estate for valuable or other consideration, by way of gift, or pursuant to an order of any court, it must likewise be completed by registration.²⁶

10. Where a lease is registered at HM Land Registry, special considerations apply to its interpretation. As already explained, when interpreting a lease, the court will ask what meaning it would convey to a reasonable person having all the background knowledge available to both parties at the date of the lease, but excluding the content of previous negotiations. Where a lease is protected by registration, in addition to excluding the content of prior negotiations from the admissible background, the court should give no weight to extrinsic documents or circumstances which were not publicly accessible, even where the dispute is between the original parties to the lease.

11. This restriction originates from the decision of the Court of Appeal in Cherry Tree Investments Ltd v Landmain Ltd²⁷. In that case, by a facility agreement a lender granted a bridging loan to the defendant (Landmain Ltd), the registered proprietor of a property. The facility agreement provided that the defendant’s obligations should be secured by a legal charge over the defendant’s property, and varied the statutory power of sale implied into the charge by s101 of the Law of Property Act 1925. A legal charge was executed the same day which made no reference to the facility agreement. The legal charge was registered at HM Land Registry, but the facility agreement was not. The lender subsequently sold the property to Cherry Tree in reliance on the power of sale in the registered charge, read together with the modifications in the facility agreement. The validity of the sale relied upon the facility agreement having varied or extended the statutory power of sale in the legal charge. The Court of Appeal held that the court at first instance had been wrong to treat the registered charge as including the extended power of sale. Weight could not be given to the facility agreement when interpreting the registered charge.

12. Lewison LJ began by recognising that the true meaning of the charge could not depend upon whether the parties to the dispute were the original contracting parties or successors to the original parties/third parties:

“The question, then, is what does the registered charge mean? Whatever it means, it has always meant what it means. A contract cannot mean one thing when it is made and another thing following court proceedings. Nor, in my judgment, can it mean one thing to some people (e g the parties to it) and another thing to others who might be affected by it.”²⁸

13. Lewison LJ held the facility agreement to be admissible evidence and proceeded to address what weight the court should give to it. Concluding that no weight should be given to it, the context of the charge being protected by registration was held to be crucial. This was because:

“…The reasonable reader’s background knowledge would, of course, include the knowledge that the charge would be registered in a publicly accessible register upon which third parties might be expected to rely. In other words a publicly registered document is addressed to anyone who wishes to inspect it. His knowledge would include the knowledge that in so far as documents or copy documents were retained by the registrar they were to be taken as containing all material terms, and that a person inspecting the register could not call for originals. The reasonable reader would also understand that the parties had a choice about what they put into the public domain and what they kept private. He would conclude that matters which the parties chose to keep private should not influence the parts of the bargain that they chose to make public… a third party contemplating dealing with the land has no access to collateral documents.²⁹

14. The Cherry Tree principle has been subsequently applied to the interpretation of leases by the High Court in Murphy v LB of Lambeth³⁰. In Murphy, the court considered the extent of the property demised by a lease. The lease had been granted to the claimant’s predecessor in title pursuant to the right to buy, and a dispute arose between the successor in title and the local authority freeholder over whether the demise included a basement. One of the issues before the court was whether a notice served pursuant to s125 of Housing Act 1985 (“s125 notice”) as part of the right to buy process and which described the property subject to the right to buy should be given weight when interpreting the lease. The s125 notice made no mention of the basement, whereas the recitals to the lease did. The local authority sought to rely on the s125 notice, particularly where the lease was expressly stated to be made under the Housing Act 1985.

15. Applying Cherry Tree, the court held that no weight should be given the s125 notice: the lease was subject to registration and any purchaser of the lease would not be entitled to see a s125 notice.³¹

The interpretation of leases where there are mistakes in the drafting

16. Mistakes in the drafting of legal documents can be corrected by means of an action for rectification, the workings of which are outside the scope of this book. However, in limited cases an obvious drafting mistake can be corrected through interpretation, rather than by an action for rectification.

17. For a drafting mistake to be corrected by interpretation, there must be a clear mistake on the face of the document and it must be clear what correction ought to be made to cure the mistake.³² These requirements were confirmed by Lord Hoffmann in Chartbrook v. Persimmon Homes Ltd³³, who explained that the ability to correct mistakes by construction is part and parcel of the process of interpreting a document, not a separate branch of the law or a summary version of an action for rectification³⁴. It follows that, in deciding whether there has been a clear mistake, regard may be had to the admissible background and context – the court is not confined to the text of the instrument itself³⁵.

18. The ability to correct the literal meaning of a provision where it is clear both that a mistake has been made and what the provision was intended to say is now sometimes referred to as the ‘Chartbrook principle’³⁶.

19. Two important restrictions to the Chartbrook principle should be kept in mind:

    1. That a lease provision lacks commercial commonsense is not by itself enough to show that there has been a clear error in the language used. Nor is it sufficient that it was imprudent for one of the parties to agree to the term as drafted.³⁷ For a clear mistake to be shown, the literal meaning of the language used should produce a result which is irrational, arbitrary, nonsensical or absurd³⁸;

    2. Even if it is clear that a mistake has been made, the court will not correct the mistake by construction if it is not clear what the parties in fact intended. In such a case, the literal meaning will be applied.

Summary

20. Bringing the above points together, the principles can be summarised as follows³⁹:

1. 1. When interpreting a lease, or any other written contract, the task of the court is to identify the intention of the parties by reference to what a reasonable person, having all the background knowledge which would have been available to the parties, would have understood them to be using the language in the contract to mean;

   2. The court will do so by focussing on the meaning of the relevant words in their documentary, factual and commercial context. That meaning has to be assessed in the light of:

      1. The natural and ordinary meaning of the clause;

      2. Any other relevant provisions of the contract;

      3. The overall purpose of the clause and the contract;

      4. The facts and circumstances known or assumed by the parties at the time that the document was executed;

      5. Commercial common sense;

   3. Evidence of prior negotiations⁴⁰, or of any party’s subjective intentions, is irrelevant;

   4. The relevant circumstances are those at the date the agreement was made, not anything that occurred after that date⁴¹;

   5. Commercial common sense should not be used to undervalue the importance of the actual words used. Save in an usual case, identifying what the parties meant through the eyes of a reasonable reader is most obviously to be gleaned from the language of the provision;

   6. The less clear the words, the more ready the court will be to depart from their natural meaning, but that does not mean that the court should look for drafting infelicities to facilitate a departure from the natural meaning;

   7. 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;

   8. Where a lease is required to be protected by registration, extrinsic documents or circumstances which are not publicly accessible will not be given weight in interpreting the lease;

   9. Where there is a clear mistake in the language used in a lease, and it is clear what correction ought to be made to correct the mistake, the court may do so as part of the process of construction.

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