Implying Terms into a Commercial Contract - Does the Restrictive and Traditional Test Still Apply?

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On 2 December 2015 the Supreme Court issued a decision in Marks and Spencer plc v BNP Paribas Securities Services Trust Company (Jersey) Ltd [2015] UKSC 72 which restated the legal test to be applied when deciding whether or not terms should be implied into a commercial contract. Although this case concerned the implication of a term into a commercial property lease agreement, the principles which are stated have a much wider application and will be of relevance to shipping and trade contracts and to all commercial agreements generally.

Background Facts

The dispute concerned a commercial lease entered into between the defendant landlord of the property and the claimant tenant. The expiry date for the lease was 2 February 2018 and rent was payable in advance in equal quarterly instalments. In July 2011 the claimant exercised its contractual right to break the lease with the result that it would expire on 24 January 2012. Shortly before the 25 December 2011 the claimant paid the rent due in respect of the quarter from that date to the 25 March 2012.

The key issue to be determined was whether the claimant was entitled to be refunded the rent paid in advance for the period from 24 January 2012 (when the lease expired) to 25 March 2012 (the date up to which advance rent had been paid).

There was no express term in the lease which dealt with the return of rent paid in advance covering the period 24 January to 25 March. Therefore, in order for the claimant to succeed it had to establish that there was an implied term.

At first instance, the Court decided that the claimant was entitled to a refund but on appeal the Court of Appeal overturned this decision. The claim was then appealed by the claimant to the Supreme Court.

Traditional Test for Implied Terms

The conditions (which may overlap) to be satisfied for a term to be implied into a contract were set out by Lord Simon in the Privy Council case BP Refinery (Westernport) Pty Ltd v President Councillors and Ratepayers of the Shire of Hastings (1977) 52 ALJT 20 and are as follows:

1. The term must be reasonable and equitable;
2. It must be necessary to give business efficacy to a contract, no term will be implied if the contract is effective without it;
3. It must be so obvious that “it goes without saying”;
4. It must be capable of clear expression; and
5. It must not contradict any express term of the contract.

The Supreme Court Decision

Lord Neuberger, who gave the main judgment, dismissed the appeal and held that there was no implied term in the contract. In reaching this decision, he emphasised the importance of respecting the bargain which had been struck by two commercial parties.

In giving his judgment, he reviewed and commented on prior authorities on implied terms. In summary, he made the following observations:

• In Philips Electronique Grand Public SA v British Sky Broadcasting Ltd [1995] EMLR 472 Lord Simon’s principles were set out by Sir Thomas Bingham MR who described it as a test whose “simplicity could be almost misleading”. It was also observed that where a contract is long and detailed, it is difficult to ascertain whether an omission was the result of a deliberate decision or an oversight by the parties. Sir Thomas went on to comment that whilst it is tempting for the court to imply a term which reflects the merits of a situation, as they appear with hindsight, this is not the correct approach. It is not enough to show that had the parties foreseen a situation which had in fact occurred they would have wished to make a contractual provision for it.

• Lord Neuberger observed that this was consistent with the approach taken by Bingham LJ, as he then was, in the earlier case of The APJ Priti [1987] 2 Lloyd’s Rep 37, 42. In this case he rejected an argument that a safe port warranty should be implied into a voyage charter. In reaching this decision, he remarked that the omission of the warranty may have been deliberate because such a term is not necessary for the business efficacy of the charter.

In giving his lead judgment in Marks and Spencer plc v BNP Paribas Securities Services Trust Company, Lord Neuberger observed that the principles for applying terms, and the judicial observations which had been made in relation to these, represented a clear and consistent approach that did not require reformulating. However, he did make six helpful comments in relation to the second of Lord Simon’s conditions; the “necessity” test, and how this is to be applied:

i. Firstly, he noted that Lord Steyn had observed in Equitable Life Assurance Society v Hyman [2002] 1 AC 408, 459, that the implication of a term was “not critically dependent on proof of an actual intention of the parties.” It does not need to be shown that there was an actual intention; instead the answer should be by reference to a notional reasonable person in the position of the parties when they were negotiating the contract.

ii. A term should not be implied into a detailed commercial contract merely because it appears “fair” or because the parties would have agreed it had it been suggested to them. Whilst these grounds are necessary for implying a term, they are not sufficient.

iii. Thirdly, he noted that it was questionable whether Lord Simon’s first condition, reasonableness and equitableness, will ever add anything. If a term satisfies all of the other principles of Lord Simon’s test, it would be difficult to think of a situation where it would not be reasonable and equitable.

iv. Only one of the “business necessity” and “obviousness” tests needs to be satisfied, although in practice it would be rare for a term to only meet one of these requirements.

v. He commented that if one approaches the question by reference to the officious bystander, it is “vital to formulate the question to be posed by [him] with the utmost care.”

vi. Finally, the test is not one of “absolute necessity”. The reason for this is that necessity is to be judged by “business efficacy” and involves a value judgment. As such Lord Simon’s second condition is that a term can only be implied if “without the term, the contract would lack commercial or practical coherence.”

In addition to this, in deciding there was no implied term it was also noted that the lease was a full and carefully considered contract, which had been professionally drafted, and which contained obligations of a similar nature to the implied term proposed by the claimant. Of critical importance to this decision is that there is clear case law that rent payable and paid in advance can be retained by the landlord, save in very exceptional circumstances (eg where the contract could not work or would lead to an absurdity) and, therefore, express words would be needed before it would be right to imply a term to the contrary.

One of the key issues in the case was the correct interpretation of the decision of the Privy Council in Attorney General of Belize v Belize Telecom Ltd [2009] 1 WLR 1998. Various academic authors and commentators had suggested that this case established a more liberal test for the implication of terms into contracts and that it would suffice if the term was reasonable, albeit not absolutely necessary. The claimant sought to take this position in support of its argument. In Belize Telecom, Lord Hoffman suggested that the process of implying terms was part of the exercise of construing the contract and, in making this observation, he said “[t]here is only one question: is that what the instrument, read as a whole against the relevant background, would reasonably be understood to mean?” In clarifying this statement Lord Neuberger said “the notion that a term will be implied if a reasonable reader, knowing all the provisions of the contract and the surrounding circumstances, would understand the term to be implied is acceptable, provided that: (i) the reasonable reader is treated as reading the contract at the time it was entered into; and (ii) he would consider the term to be so obvious that it goes without saying or to be necessary for business efficacy.” He went on to stress that whilst he accepted “(i) construing the words which the parties have used in their contract and (ii) implying terms into the contract, involve determining the scope and meaning of the contract”, Lord Hoffmann’s analysis in Belize Telecom could obscure the fact that construing the words used and implying additional words are different processes governed by different rules.

Following their review of Attorney General of Belize and the later authorities which referred to that case, their Lordships emphatically rejected the more liberal approach to implying terms into contracts and emphasised that nothing which Lord Hoffman had said diluted the test with the result that the restrictive and traditional requirements, as set out above, continued to apply.

Implied Terms in Shipping Contracts

The implication of terms into contracts is a complicated area of law and one which frequently arises in shipping cases. Key examples of this are The Island Archon and The Kitsa. These cases both concerned the scope of the implied indemnity for losses or expenses incurred by an owner in following a charterer’s orders. In the first of these cases it was held that if at the time that the charter is concluded, the occurrence and type of loss or expense to the shipowner flowing from the order as to employment of the vessel were unforeseen, that will be a key factor in determining whether the loss or expense falls within the scope of the implied indemnity. In the second, costs of de-fouling the hull after a long port stay were considered to be foreseeable and forseen at the time of entering into the charter and as such a risk which owners had agreed to accept.

These decisions are consistent with the reasoning in Philips Electronique Grand Public SA v British Sky Broadcasting and also with the principles as highlighted by Lord Neuberger, in particular what a reasonable person would have thought when considering what the parties’ intentions were at the time of entering into the contract.

Comment

This is the first judgment that has been handed down by the Supreme Court which analyses the law on implied terms and has brought much needed clarity to this issue. Following this judgment, it is clear that the test to be applied continues to be stringent and very restrictive. As a result, the application of this test can lead to results which may seem harsh as it will not be sufficient that the term is fair and reasonable or that if it had been suggested to the parties it would have been agreed. Therefore, where there is no express term dealing with a specific situation, even if the outcome is considered by the claimant to be clear or obvious, it may not meet the criteria for implied terms with the possibility of an outcome which could be perceived as uncommercial.

The impact of this is that careful thought must be given when entering into commercial contracts, particularly charterparties where standard terms are often utilised, to ensure that the terms reflect the intended agreement. Whilst it is of course difficult to predict every eventuality and ensure that these are all addressed in a contract, draft wording should be meticulously considered before a contract is entered into, particularly where the rights and obligations are long term.