THE recent case of Grove Investments Ltd vs Cape Building Products Ltd has created interest in the legal community. This is because it asks a profound question: what role do courts have when interpreting contracts?
Large commercial contracts in particular, no matter how carefully drafted, are likely to contain clauses which are ‘open to interpretation’. Where large amounts of money turn on either interpretation, a court is likely to be asked – ‘What does this mean?’ The court can look at the words and decide what they mean by adopting a literal approach, but this is not always possible, as the ambiguity might always remain. Case law has established that courts ought to interpret ambiguous contractual provisions ‘in accordance with commercial common sense’ (to quote from the case). Court judgements are littered with references to ‘common sense’, but as Voltaire said: “Common sense is not so common.”
Grove Investments concerned the interpretation of a clause in a tenancy agreement, and specifically the quantification of dilapidations (items requiring upgrading or renewal) at the end of the lease. Key wording was this – ‘The tenants bind themselves ... to repair any damage done by the removal of fittings belonging to them and to pay to the landlords the total value of the Schedule of Dilapidations prepared by the landlords in respect of the tenants’ obligations... declaring that the landlords shall be free to expend all moneys recovered as dilapidations as they think fit.’ (emphasis added)
The court was presented with two possible interpretations of the clause. Read one way, the landlord could demand money even if it had no intention of making good the dilapidations – a windfall in other words. Read another way, the landlord could only recover its actual losses. No windfall.
On an initial reading of the clause, I suspect that most people would regard the ‘windfall’ interpretation as the more obvious interpretation. The Court of Session judges, however, disagreed. They took the view that an indication of ‘common sense’ is to consider what the law would have been if the clause didn’t exist, ie the common law position. As the decision stated: “If a particular construction of a contractual term achieves a result that is radically different from the rules of the common law, this is a factor that may in some circumstances indicate that that construction is commercially unreasonable.”
Discussing the ‘windfall interpretation’, the court said that it could lead to a recovery by the landlord ‘that was arbitrary and disproportionate, not related to any loss sustained. That in itself appears contrary to commercial common sense. In this connection, we note that, wherever possible, a contract should be construed in such a way as to avoid results that are arbitrary or disproportionate, whether by benefit or burden.’ I would suggest that the vast majority of people would regard the court’s approach as a very sensible one. Of course the court’s role is to apply common sense and fairness to contracts, isn’t it? So why is the case generating such discussion?
In my opinion, it’s because of the tension which often exists in contracts between what words say and whether or not those words are (from an objective perspective) fair. Whilst the judges were very careful to point out that the court’s role is not to rewrite a bad bargain for one of the parties, it is intriguing to contemplate what factors the courts had in mind when applying ‘commercial common sense’. In isolation, it does no doubt seem unfair and disproportionate for a landlord to receive, say, £100,000 for defects if it has no intention of attending to them. Looking at the lease as a whole, however, would it still be unfair if the tenant was well aware of this risk but was prepared to enter into the lease anyway because it still made commercial sense for them to do so?
Lawyers are pondering how far-reaching this decision might be. In construction contracts, for example, it is common for the parties to agree a liquidated damages clause. What happens if the building owner does not, as it turns out, suffer any loss as a result of delay? Is this unfair or disproportionate? Or is this simply a bad bargain?
At the heart of Grove vs Cape is the principle of fairness, badged as ‘common sense’. I suspect litigators are going to have a lot of fun arguing what this seemingly innocuous phrase actually means.
• Alistair Dean is a partner and Solicitor Advocate with ADLP Solicitors, www.adlp.co.uk