Implying terms into contracts
In this fourth article in the series, Stephen Brown and Sappho Dias, barristers at 4-5 Gray's Inn Square, consider the implication of terms into a contract.
Historically, the circumstances in which terms can be implied have been described in a number of different ways. These were summarised in the case of BP Refinery (Westernport) Pty Ltd v the President, Councillors and Ratepayers of Shire of Hastings (1977) 52 ALJR 20 at 26 where Lord Simon said:
"Their Lordships do not think it necessary to review exhaustively the authorities on the implication of a term in a contract which the parties have not thought fit to express. In their view, for a term to be implied, the following conditions (which may overlap) must be satisfied: (1) it must be reasonable and equitable; (2) it must be necessary to give business efficacy to the contract, so that 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; (5) it must not contradict any express term of the contract."
However, the apparent simplicity of this approach could almost be misleading and Lord Simon made the following additional points.
Unlike the ordinary process of construction, implication was:
"an altogether more ambitious undertaking: the interpolation of terms to deal with matters for which, ex hypothesi, the parties themselves have made no provision. It is because the implication of terms is so potentially intrusive that the law imposes strict constraints on the exercise of this extraordinary power."
He added further caution by saying that:
"It is much more difficult to infer with confidence what the parties must have intended when they have entered into a lengthy and carefully-drafted contract but have omitted to make provision for the matter in issue."
He also warned that the question of implying a term usually arises after a crisis has arisen. The court therefore:
"comes to the task of implication with the benefit of hindsight, and it is tempting for the court then to fashion a term which will reflect the merits of the situation as they then appear. Tempting, but wrong."
The test for implying terms was further clarified in AG v Belize Telecom. The implication of a term is part of the exercise of construing a contract. The court, as with construction of an express term, is seeking to give effect to the objective intention of the parties. Hoffmann in Belize said:
"The need for an implied term not infrequently arises when the draftsman of a complicated instrument has omitted to make express provision for some event because he has not fully thought through the contingencies which might arise, even though it is obvious after careful consideration of the express terms and the background that only one answer would be consistent with the rest of the instrument."
In Belize, classes of shareholders were given the right to appoint directors. However, the articles were silent on what happened to a director if the shareholder appointing him subsequently lost that right, for instance, because it ceased to hold the requisite number of shares. The court concluded that it was the intention of the parties that the representation on the Board would reflect the share ownership and therefore implied a term of the articles that, if a shareholder subsequently ceased to qualify for the right to appoint a director, the director appointed by that shareholder would resign.
Lord Hoffman’s judgment in Belize contains lengthy and helpful consideration of the nature of implication. He says:
"The court has no power to improve upon the instrument which it is called upon to construe, whether it be a contract, a statute or articles of association. It cannot introduce terms to make it fairer or more reasonable. It is concerned only to discover what the instrument means.
"The question of implication arises when the instrument does not expressly provide for what is to happen when some event occurs. The most usual inference in such a case is that nothing is to happen. If the parties had intended something to happen, the instrument would have said so. Otherwise, the express provisions of the instrument are to continue to operate undisturbed. If the event has caused loss to one or other of the parties, the loss lies where it falls."
A term will be implied if this is,"the only meaning consistent with the other provisions of the instrument" on the basis that this is what the instrument "must mean". But "the implication of the term is not an addition to the instrument. It only spells out what the instrument means".
He states that the word "necessary" used in the conventional formulations in relation to business efficacy highlights that "it is not enough for a court to consider that the implied term expresses what it would have been reasonable for the parties to agree to. It must be satisfied that it is what the contract actually means". It does not mean "necessary in order to make the contract work", it means "necessary to give effect to the objective intention of the parties".
More recently, in the case of Procter & Gamble v SCA, Hildyard J observed that there is perhaps a difference between inference and implication. He said that "inference" was "spelling out in words a provision which it was to be inferred from the particular express terms the parties must have meant to include". So for instance, if A agrees to pay B Euro prices but that those prices can be paid in Sterling, the inference must be that A will pay B sufficient Sterling on the day so as to equal the Euro price. One can see from the express wording what the parties intended to happen even though they have not spelt it out. It was not an unforeseen event. Hildyard J contrasted that with implication, or interpolation, of a term where the parties had not foreseen the event and a term has to be written in to correct a clear mistake and to make the contract workable.
The traditional reformulations as summarised in BP Refinery (go without saying, necessary to give business efficacy) must now be considered in conjunction with the more recent formulations of the test in relation to implied terms. They are different ways of reformulating the essential question of whether the proposed implied term would, "spell out in express words what the instrument, read against the relevant background, would reasonably be understood to mean".
As in the case of express terms, the Court will seek to give effect to the objective intention of the parties to the agreement. It is not the Court’s job to improve the agreement or do a deal which the parties did not do. An implied term is therefore an extension of the construction exercise beyond the express terms. The exercise of implying terms falls to be carried out by the Court where there are no specific words to construe and the Court needs either to infer or imply a term to give effect to the parties’ objective intention.
In our next and final article we consider how the Court approaches rectification and conclude with some drafting tips derived from the principles considered in this series.
Stephen Brown and Sappho Dias are barristers at 4-5 Gray's Inn Square.
Also in this series:
