Debenhams Retail Plc & Anor v Sun Alliance & London Assurance Company Ltd

A contract must be construed in its commercial context. Where circumstances have changed in a way the parties did not contemplate, the court should apply the purposes and values expressed or implicit in the contract to those circumstances.

Under a turnover-rent clause defining turnover as the gross amount of total sales, VAT formed part of turnover. VAT had replaced purchase tax, whose economic incidence was already reflected in retail prices and turnover when the lease was negotiated. Differences in collection and accounting treatment did not justify excluding VAT from the gross sales amount.

The tenants operated a department store under a long lease providing for a fixed basic rent and an additional rent calculated as a percentage of turnover. Turnover was defined as the gross amount of total sales, including services from trade.

The lease terms were negotiated in 1965, when purchase tax existed but VAT did not. After paying turnover rent on VAT-inclusive figures for many years, the tenants sought a declaration that VAT should be excluded. Etherton J granted that declaration. The landlords appealed.

The central issue was whether VAT formed part of the gross amount of total sales when calculating the additional rent.

1. Appeal allowed unanimously. VAT was to be included in turnover when calculating the additional rent. The declaration made below was replaced with a declaration to that effect.

2. Per Jacob LJ, the words defining turnover did not have a single, unambiguous meaning. They had to be construed in their commercial context. The relevant context was that purchase tax existed when the lease was negotiated and materially affected the ultimate prices paid by consumers. Although levied at the wholesale stage, it was an embedded cost reflected in retail selling prices and therefore in turnover.

3. The parties could not reasonably have regarded VAT, which replaced purchase tax and similarly affected final consumer prices, as excluded from the gross amount of total sales. The change in the point and method of tax collection did not alter the relevant commercial substance.

4. The judge had placed excessive weight on turnover rent as a means of sharing trading risk. Turnover was only an indirect measure of success because it was also affected by matters such as inflation and the performance of the wider shopping centre. The risk-sharing analysis therefore did not favour excluding VAT.

5. Accounting conventions were secondary to the commercial substance of the transaction. The omission of VAT from a retailer's financial accounts did not determine its treatment under the lease. Nor did the ordinary practice of stating business turnover net of VAT control the meaning of this particular agreement.

6. Per Mance LJ, the contract had to be applied to factual circumstances which the parties had not anticipated. The court should promote the purposes and values expressed or implicit in the contractual wording and apply them consistently to the changed circumstances. Treating VAT as a substitute for purchase tax avoided giving the tenants an uncovenanted reduction in the turnover figure despite substantially unchanged consumer expenditure and receipts.

7. Lynn v Nathanson [1931] 2 DLR 457 and Yates v Yates [1913] 33 NZLR 281 were materially different and provided no assistance. Judge LJ agreed with both judgments.

1. Court of Appeal (Civil Division): The landlords' appeal was allowed unanimously. The court substituted a declaration that VAT was included in turnover for the purpose of calculating the turnover rent.

2. High Court, Chancery Division: Etherton J declared that VAT was excluded from turnover under the lease.