Scottish court's favouring of 'common commercial sense' in dilapidations dispute could be seen as contradictory, says expert

Out-Law News | 16 May 2014 | 11:56 am | 3 min. read

Disputes over the interpretation of contractual provisions should be resolved in favour of the meaning that "accords best with commercial common sense", Scotland's highest appeal court has ruled.

In its judgment, the Inner House of the Court of Session said that dilapidation provisions in a commercial lease only required a tenant to reimburse its landlord for true damages on the termination of the lease and not the additional cost of carrying out any repair work, whether or not that repair work was actually carried out. Lord Drummond Young said that it could not be presumed that the parties had contracted out of the landlord's common law right to damages reflecting actual loss without "definite indications to that effect".

However, litigation expert Heidi Archibald of Pinsent Masons, the law firm behind Out-Law.com, said that in this case the wording of the repairing obligation in the lease was "clearly phrased". "In circumstances where the landlord probably thought that it had in place a provision which entitled it to recover the total cost of repairs, whether or not the repairs were done, the decision will seem harsh," she said.

"It is implicit from the decision that the court was keen to avoid the landlord recovering a significant windfall – one wonders whether the result would have been different if the claim had been for a lower sum," she said. "Given the amount at stake – the claim was for over £10 million – it is not surprising that the tenant continued to fight after two defeats in the lower courts."

"The decision is likely to strengthen a tenant's resolve in dilapidations disputes: in order to succeed, landlords will need to demonstrate that they have in fact suffered, or are genuinely going to suffer a loss," she said.

Cape Building Products Ltd entered into the original lease of a unit on an industrial estate in Glasgow in August 1986. The lease expired on 15 May 2011. Under the terms of the lease, on expiry Cape was required to "repair any damage done by the removal of the 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". The landlord was "free to expend all moneys recovered as dilapidations as they think fit", according to the lease.

The landlord, Grove Investments Ltd, argued that this term required Cape to pay the total amount set out in the schedule. Cape argued that the term only required them to pay the loss actually suffered by the landlord as set out in the common law, and not the value of the various cost estimates set out in the schedule. Both lower courts found in favour of the landlord, ruling that the terms of the lease must have been intended to alter the common law position.

Ruling on the interpretation of commercial contracts generally, Lord Drummond Young said that previous case law required the court to "adopt the meaning that best accords with commercial common sense" in cases where a contractual provision was capable of more than one meaning. Although the court could not "correct a bad bargain" and had to "respect the substance of the transaction that the parties [had] actually entered into", judges would "usually be in a good position to decide what is commercial sensible", he said.

In addition, he said that the "legal context" of a contract had to be considered "as well as the factual context".

"The relevance of the common law goes beyond that, however, because in the field of contract its rules represent the considered attempts of judges, over many years, to strike a fair balance between the interests of contractual parties," he said. "Usually, therefore, the common law will achieve a result in accordance with commercial common sense. For this reason, when a contract is interpreted, the common law can often serve as a benchmark against which considerations of fairness can be measured."

"If a particular construction of a contractual term achieves a result that is radically different from the rules of the common law, that is a factor that may in some circumstances indicate that the construction is commercially unreasonable. Such a factor is unlikely to be of great importance in construing the main terms of a contract, dealing with the parties' substantive rights and obligations, since these will almost invariably be the subject of specific negotiation. With many of the subsidiary terms, however, such as a term providing for a payment that does not form part of the main consideration, the consequences of the wording used may not have been well thought through and there may be no active intention either to abrogate or to follow the common law rule. In a case of that sort the common law may provide considerable assistance in deciding what is commercially sensible," he said.

Litigation expert Heidi Archibald said that in some circumstances, the court's view that it could not "correct a bad bargain" while at the same time looking for the construction that "accords best with commercial common sense" could be contradictory.

"If the court should not protect a party who 'gets it wrong', why should it construe a contract 'in such a way as to avoid arbitrary or unpredictable burdens or impositions, and conversely arbitrary or unpredictable benefits in the nature of windfalls'?" she said. "It justified this by saying that to have done otherwise would 'frustrate one of the most elementary commercial objectives'."