UK Court of Appeal rules in favour of developer on interpretation of restrictive covenant

A recent Court of Appeal decision in Cheung & Anor v Mackenzie overturns a High Court ruling which prevented a developer from carrying out its redevelopment plans.

The decision is the latest in the flurry of restrictive covenant cases. It emphasises the importance of careful consideration of the wording of restrictive covenants and offers an insight into the approach courts will take when considering interpretation.

Background

Cheung, the first respondent, was the owner of 444 Selsdon Road. The second respondent was a developer who had entered into an option agreement to purchase number 444 and had planning permission to develop nine flats on the land. Mackenzie, the appellant, was owner of 432 Selsdon Road.

Both properties were formerly owned by the Whitgift Educational Foundation and formed part of a larger estate. In 1947, number 432 was sold out of the estate, and number 444 was then sold in the same year. A conveyance from the 1947 sale contained a restrictive covenant that prevented building "except one detached dwelling house" which seemed to prevent the respondents' planned development.

The conveyance also contained a provision reserving to the governors – who replaced the Whitgift Foundation as owners – "the right to deal with any of the plots situated upon this estate … independently of these stipulations 'and also' to allow a departure from them in any one or more cases".

The governors agreed with Cheung, for a payment, to modify the covenant to permit the development. Mackenzie objected and issued a claim for an injunction asserting that the development would be in breach of the restrictive covenant and it could not be modified. The respondents defended this claim asserting that in accordance with the reservation it had agreed a form of a deed of modification with the Whitgift Foundation and that this, once executed, would modify the restrictive covenant.

High Court rules against modification

The judge held that the governors were not intending to create a building scheme or a system of mutually enforceable covenants over or in respect of the estate. The intention of the reservation was that the governors had the flexibility to impose different restrictions in their future dealings on the estate.

The ruling was in favour of Mackenzie, as it was, therefore, held that the reservation meant the governors had the freedom to choose which covenants to impose on future sales; but importantly, they could not release a covenant already applied to an existing plot.

Contractual interpretation

Two leading Supreme Court cases were applied by the judge in both the High Court and the Court of Appeal when considering contractual interpretation of the reservation.

In Arnold v Britton, it was decided that, as the parties will have agreed the terms of their contract, the court should apply the words used and refrain from rewriting contracts to reflect the court's view of "commercial common sense".

In Capita v Wood, the judge said that the court may give weight to the construction which is more consistent with business common sense, but the court must:

• consider the quality of drafting of the clause;
• be alive to the possibility that one side may have agreed to something which with hindsight did not serve his interest; and
• not lose sight of the possibility that a provision may be a negotiated compromise or that the negotiators were not able to agree more precise terms.

Court of Appeal decides modification permissible

The respondents' principal submission was that the governors had two separate and distinct rights. The focus was the use of the words "and also". They argued this meant that there was a right in relation to future dealings and a separate right in relation to the land being conveyed.

The "commercial common sense" argument was also deployed on behalf of the respondents. The argument was that if the defendants' interpretation was correct, the owners of the property would only have to seek consent from one single party (the governors) to obtain a release, as opposed to negotiation with all landowners who have the benefit of the covenant. In addition, it allowed the governors to retain control of the development.

The judge found that the use of "to reserve" and "to allow" were separate and distinct – the first part of the provision relates to subsequent dealings and the second part is a separate obligation allowing departures from other stipulations, such as those entered into by the conveyance itself. The judge also agreed with the "commercial common sense" argument put forward by the respondents, stating that the governors retaining the sole ability to release the restrictive covenant in exchange for the payment of a release fee, is a common way for landlords to make money.

It was held the words would have been understood by "a reasonable reader having the background knowledge available to the parties". The court therefore gave a declaration that modification of the restrictive covenant was permissible. Consequently, if the deed of modification was completed, the development would not be in breach of the restrictive covenant.

Osborne Clarke comment

This case demonstrates that the commercial common sense factor is a key tool for interpreting contractual provisions, but this tool must be used in the context of the natural and ordinary meaning of the wording used in the agreement between the parties.

Given that a covenant can hinder or prevent development entirely, and the interpretation of a covenant can rest on the interpretation of a few seemingly minor words, it is essential that developers take specialist advice on any release provisions, whether a covenant is enforceable and whether it can be modified or discharged.