Supreme Court clarifies law on implied terms: "business efficacy" test remains

The Supreme Court has clarified the law on implied terms: in order for a term to be implied it must be necessary for business efficacy or alternatively be so obvious as to go without saying. In practice, it will be a rare case where one of those conditions is satisfied but not the other.

The court confirmed, in the light of the widespread misinterpretation of Lord Hoffman's judgment in Attorney General of Belize and others v Belize Telecom Ltd, that that judgment did not dilute the traditional tests. 

Although the facts relate to a property transaction, the case has wider implications across all commercial contracts. 

Background

The appeal arose following the exercise of a break clause in a lease between Marks and Spencer (the tenant) and BNP Paribas (the landlord).  The lease had been granted for a term expiring in February 2018 and the rent was payable in advance on the usual quarter days.  The tenant exercised its right under the break clause to determine the lease in January 2012, after it had already paid the full quarter's rent in advance in December 2011.

The issue was whether the tenant could recover the apportioned rent in respect of the period from January to March 2012.  This turned on the interpretation of the lease and required the court to consider the principles relating to when a term is to be implied into a contract.

At first instance, the court held that the tenant was entitled to a rebate of the future rent. The Court of Appeal reversed that decision. The question went up to the Supreme Court, which unanimously dismissed the appeal.

The judgment: discussion of relevant tests

There was no provision in the lease that expressly obliged the landlord to pay the apportioned sum to the tenant. The question was therefore whether such an obligation should be implied.

Lord Neuberger, giving the lead judgment, noted that two tests are commonly used when determining whether a term should be implied into a contract: 

• Under the "business efficacy" test the proposed term will be implied if it is necessary to give business efficacy to the contract (The Moorcock (1889) 14 PD 64).
• Under the "officious bystander" test the proposed term will be implied if it is so obvious that, if an officious bystander suggested to the parties that they include it in the contract, 'they would testily suppress him with a common 'oh of course' " (Shirlaw v Southern Foundries (1926) Ltd [1939] 2 KB 206).  In other words, the proposed term must be so obvious that it goes without saying. 

The modern authority is Attorney General of Belize v Belize Telecom Ltd [2009] 1 WLR 1988. In that case Lord Hoffman suggested that the process of implying terms into a contact was simply part of the exercise of construing the contract, saying "There is only one question: is that what the instrument, read as a whole against the relevant background, would reasonably be understood to mean?" 

The Supreme Court held that this formulation in Belize has been misinterpreted as suggesting that reasonableness is itself a sufficient ground for implying a term and suggested that the right course is for Lord Hoffmann's speech in Belize to be treated as a "characteristically inspired discussion rather than authoritative guidance on the law of implied terms."  The court confirmed that Belize did not dilute the traditional business efficacy and officious bystander tests and to the extent subsequent judgments suggested that it had, that approach was mistaken. 

Lord Neuberger confirmed that the pre-Belize authorities "represented a clear, consistent and principled approach". He referred in particular to BP Refinery (Westernport) Pty Ltd v Shire of Hastings (1977) 52 ALJR 20 and Philips Electronique Grand Public SA v British Sky Broadcasting Ltd [1995] EMLR 472. 

In BP Refinery the court said that 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.

In Philips, the conditions in BP Refinery were described as a summary whose simplicity could be misleading.  The court stated it is difficult to infer with confidence what the parties to a lengthy and carefully drafted contract must have intended.  An omission may be the result of the parties' oversight or their deliberate decision.  It is tempting, but wrong, for a court, with the benefit of hindsight, to imply a term which reflects the merits of the situation as they then appear.  The term to be implied must be either the only contractual solution or the one which would, without doubt, have been preferred. 

In the present case, Lord Neuberger made the following comments in addition to the conditions set out above: 

• If reference is made to the question of what the parties would have agreed, the question is not concerned with the hypothetical answer of the actual parties, but with that of notional reasonable people in the position of the parties at the time they were contracting.
• A term should not be implied into a detailed commercial contract merely because it appears fair or one considers that the parties would have agreed it if it had been suggested to them: those are necessary but not sufficient grounds for implying a term.
• The "business necessity" and "obviousness" tests can be alternatives, but in practice it would be a rare case where one was made out but not the other.
• "Business necessity" involves a value judgment: it does not require absolute necessity. In Lord Sumption's words, a term should only be implied if, without the term, the contract would lack "commercial or practical coherence". 

On the facts, the court found that the conditions for implying a term into the lease were not satisfied, in particular because the implied term would have sat uneasily with the fact that the parties had agreed a very comprehensive (70 page) lease and the fact that there was clear caselaw establishing that rent payable and paid in advance can be retained by the landlord. As such, very clear express words would have been needed in order to find in the tenant's favour. 

The court also went on to consider whether it was correct that the processes of contractual interpretation and implication of terms are part of the same exercise.  Lord Neuberger stated that they are separate and that therefore in most, and possibly all, disputes about whether a term should be implied, it is only after the process of construing the express words is complete that the issue of an implied term falls to be considered. 

Comment

The case brings clarity to this area of the law after the uncertainty following the decision in Belize and confirms that the traditional "business efficacy" and "officious bystander" tests are alive and well. 

The decision reinforces that the courts will be slow to imply terms into a professionally drafted commercial agreement even where, as in this case, the court acknowledged the "real force" in the tenant's argument that allowing the landlord to retain the entire rent payment would be unfairly prejudicial to the tenant and a windfall for the landlord. 

The issue as to whether the implications of terms was part of or something separate from the proper interpretation of a contract was referred to by Lord Carnwath as "an interesting debating point", but of little practical significance.  That may be the case, although following Lord Neuberger's approach the process of interpretation would take place before the question of implied terms is considered, which would suggest a clearer distinction does exist.