Rules for Interpretation of Contracts: Implied Terms of Contract
Conditions for using ‘Implied Terms’ for Interpretation
Lord Simon in BP Refinery (Westernport) Pty Ltd vs. The Shire of Hastings [1978] 52 AJLR 20 held that- “…for a term to be implied, the following conditions (which may overlap) must be satisfied:
- it must be reasonable and equitable;
- 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;
- it must be so obvious that it ‘goes without saying’;
- it must be capable of clear expression;
- it must not contradict any express term of the contract.”
What are the sources from which a term is implied into the contract? What are the possible reasons for doing so?
In most of the contracts, the primary obligations of the parties are incorporated in express terms. However, there may be circumstances in which, extra terms and meanings may be implied into the agreement. Such terms may be implied from a wide spectrum of sources, including, inter alia, legislation of general application in commerce such as, consumer protection, tenancy, sale of goods, specific legislation applicable to a particular type of transaction such as those found between subcontractors in construction law, international conventions and common law principles created through decisions of various Courts through the passage of time.
Sources of Implied Terms
[1] Terms implied by the Court
To explain this, let us take the example of a contract for sale of goods, wherein terms are implied that- (a) the seller has the right to sell the goods; (b) that the purchaser will enjoy quiet possession of the goods; (c) purchaser the possession of the goods without interference from a third party or the supplier; (d) that the goods are free from any charge or encumbrances and will remain so when the property is passed, etc. Similarly, in the event that a proprietor purchases a registered trade mark with a business, it is an implied term of that contract that the purchaser will not be subject to claims of ownership by predecessors in title to the vendor of the trade mark.
Similarly in Secy. Irrigation Deptt. Govt., of Orissa v. G.C. Roy, [1991] 3 SCR 417, it was observed-
“Where the agreement between the parties does not prohibit grant of interest and where a party claims interest and that dispute (along with the claim for principal amount or independently) is referred to the arbitrator, he shall have the power to award interest pendente lite. This is for the reason that in such a case it must be presumed that interest was an implied term of the agreement between the parties and therefore when the parties refer all their disputes – or refer the dispute as to interest as such – to the arbitrator, he shall have the power to award interest.”
However, the Court in this case also cautioned that there cannot be a blanket application of such rule and any matter must be decided in the light of all the facts and circumstances of the case, keeping the ends of justice in view.
There are no hard and fast rules for using such implied terms for interpretation, however, these unwritten rules are based on equity and well established principles of law set as precedents and obiter dicta through the time.
[2] Terms Implied by Statute/Relationship between the Parties
In certain legal relationships and contracts, the law seeks to impose a model or standardized set of terms as a form of regulation. Such terms arise from the relationship between the parties is often implied by the instrument of law. One of the most notable cases on this issue is Liverpool City Council v. Irwin, [1977] AC 239. In this case, Liverpool city council owned a block of flats in which the defendant was a tenant. The common parts of the flats, the lifts, stair cases, rubbish chutes, etc., had fallen into disrepair. A rent strike was implemented by many of the tenants including the defendant. The council sought to evict the defendant for non payment of rent and she counter claimed for breach of an obligation to repair. However, the tenancy agreement did not mention any obligation to repair. In fact, the tenancy agreement only imposed obligations on the tenant with no mention of the obligations of the landlord. The defendant asked the court to imply a term that the council had an obligation to repair the common parts of the block of flats. Here, the Court did imply such term. Such implied term arose as a legal incident in contracts of a defined type between landlord and tenant that the landlord was to take reasonable care to maintain the common parts. However, it was found that there was no breach of such duty. In a very recent judgment of the Apex Court decided on March 5, 2014, Sushil Ansal vs. State (through CBI), (2014) 6 SCC 173 it was observed:
“At common law there is an implied term in the contract between the occupier and the visitor that the occupier’s premises shall be reasonably safe. The occupier’s duty must be held to have been breached if any injury is caused to a contractual visitor by any defect in the premises apart from a latent defect.”
[3] Intention of the Parties/Terms Implied as Fact
The Courts are generally inclined towards implying a term into a contract in order to give effect to the obvious intentions of the parties. It may often be the case that certain issues may inadvertently be overlooked or the parties might fail to express their intentions clearly. In these circumstances, the Courts generally import a term in the interests of ‘business efficacy’ so that the contract makes commercial sense.
In India, the application of the above principle, more popularly known as ‘Officious Bystander Test‘ has been very restricted. One of the oldest cases on this principle was Delhi Cloth and General Mills Co. Ltd. vs. K.L. Kapur, AIR 1958 P&H 93, wherein it was held that- “Implication of term in contract can be made only where it is necessary in order to give efficacy to transaction which is intended by both parties.” The High Court of Punjab in this case also referred to the historic English case of The Moorcock (1889) 14 PD 64 and summarized the judgment in the following words-
“The defendants were wharfingers who had agreed, in consideration of charges for landing and stowing the cargo, to allow the plaintiff, a shipowner, to discharge his vessel at their jetty. The jetty extended into the Thames, and, as both parties realized, the vessel must ground at low water. While she was unloading, the tide ebbed and she settled on a ridge of hard ground beneath the mud. The plaintiff sued for the resultant damage.’
The defendants had not guaranteed the safety of the anchorage, nor was the bed of the river adjoining the jetty vested in them, but in the Thames Conservators. But the Court of Appeal implied an undertaking by the defendants that the river bottom was, so far as reasonable care could provide, in such a condition as not to endanger the vessel. Bowen L. J., explained the nature of the implication:
‘I believe if one were to take all the cases, and there are many, of implied warranties or covenants in law, it will be found that in all of them the law is raising an implication from the presumed intention of the parties, with the object of giving to the transaction such efficacy as both parties must have intended that at all events it should have. In business transactions such as this, what the law desires to effect by the implication is to give such business efficacy to the transaction as must have been intended at all events by both parties who are businessmen…. The question is what inference is to be drawn where the parties are dealing with each other on the assumption that the negotiations are to have some fruit, and where they say nothing about the burden of this unseen peril, leaving the law to raise such inferences as are reasonable from the very nature of the transaction.”
The principle as laid down in The Moorcock Case, finds its analogy in another principle that each party implicitly agrees to do all that is necessary for the proper and effectual performance of the contract. Most importantly, drawing the boundary lines for application of such rule, the Punjab High Court in this case observed that-
“The Courts, however, have recognized the danger of undue elasticity, and have circumscribed its limits. Based upon the presumed intention of the parties, it may not contradict or vary the express terms of the agreement. Nor can it be used simply to render the contract rather more attractive in the eyes of reasonable men.
It is for the parties, not for the judges, to determine the nature of their liabilities. The doctrine can be invoked only if an obligation, clearly intended as such, must fail to take effect unless obvious oversight is remedied; and, even so, the judges will supply the minimum necessary to save the contract from shipwreck.”
At paragraph 27 of the judgment, Justice Kapur noted-
“The existence of judicial power to remedy an omission arises “not under the pressure of external circumstances, but in order to repair an intrinsic failure, of expression” and whenever there is an omission due to inadvertence or clumsiness of draftsmanship, the Courts, it has been held, may remedy this omission. This judicial power was asserted and justified in (1889) 14 PD 64. Bowen, L.J. stated the law at page 68 to be: “…..
In business transactions such as this, what the law desires to effect by the implication is to give such business efficacy to the transaction as must have been intended at all events by both parties who are businessmen * * * The question is what inference is to be drawn where the parties are dealing with each other on the assumption that the negotiations are to have some fruit, and where they say nothing about the burden of this unseen peril, leaving the law to raise such inferences as are reasonable from the very nature of the transaction.”
Other significant English cases cited in this case were, Mackay v. Dick (1881) ACJ 251, Hamlyn and Co. v. Wood’ and Co. (1891) 2 QB 488, Reigate v. Union Manufacturing Co (Ramsbottom) Ltd. [1918] 1 KB 592, Shirlaw v Southern Foundries [1939] 2 KB 206, Hivac Ltd. v. Park Royal Scientific Instruments, Ltd. (1946) 1 All ER 350, K. C. Sethia v. Partabmull Rameshwar (1950) 1 All ER 51.
In yet another old case from India, Pragdas Mathuradas vs. Jeewanlal, AIR 1948 P.C. 217 (J), the defendant had contracted to supply the plaintiff ‘Penang’ quality tin and it was already known in Calcutta that war with Japan had broken out. The plaintiff sued the defendant for damages for the breach of contract when the defendant-firm refused to supply the goods owing to the unforeseen circumstances. The Privy Council, in this case, held that the contract did not imply the condition that the Penang tin already ordered by the sellers should arrive in Calcutta, and the words “for forward delivery” were given their ordinary meaning “for delivery in the future”. Lord Morton of Henryton in this case cited the observations of Scrutton L.J. in Re Comptoir Commercial Anverpois and Power Son & Co. (1920) 1 KB 868 to quote-
“The Court * * * ought not to imply a term merely because it would be a reasonable term to include if the parties had thought about the matter, or be cause one party, if he had thought about the matter, would not have made the contract unless the term was included; it must be such a necessary term that both parties must have intended that it should be a term of the contract, and have only not expressed it because its necessity was so obvious that it was taken for granted.”
Two other notable judgments by the Supreme Court on this issue were- Ganga Saran vs. Ram Charan Ram Gopal, 1952 SCR 36 and Satyabrata Ghose v. Mugneeram Bangur and Co., (1954) 24 AWR 123. In the first case, the judges had discussed the question of implied term in a contract to point out that the Courts must look primarily to the law as embodied in Section 32 and 56 of the Indian Contract Act, 1872. On the similar lines, the Supreme Court in the second case, held that to the extent that Indian Contract Act may be dealing with a particular subject, it is exhaustive upon the same and it is not permissible to import the principles of English law over and above the the statutory provisions governing the issue. The limitations of thus rule was further reiterated by the Supreme Court in The Naihati Jute Mills Ltd. vs. Khyaliram Jagannath, [1968] 1 SCR 821, wherein it was held that where there is an express term, the Court cannot find, on construction of the contract, an implied term inconsistent with such express term.
Business Efficacy Test
Lord Hoffman in the famous case Attorney General of Belize vs. Belize Telecom Ltd. [2009] UKPC 10 was very precise and warned against business efficacy taking on a life of its own. He stated-“There is only one question: is that what the instrument, read as a whole against the relevant background, would reasonably be understood to mean, when the issue of implying a term arises?”
The most interesting of Lord Hoffman’s statements was…
“The danger lies, however, in detaching the phrase, “necessary to give business efficacy” from the basic process of construction of the instrument. It is frequently the case that a contract may work perfectly well in the sense that both parties can perform their express obligations, but the consequences would contradict what a reasonable person would understand the contract to mean. Lord Steyn made this point in the Equitable Life case (at p 459) when he said that in that case an implication was necessary “to give effect to the reasonable expectations of the parties.”
Earlier to this case, the boundaries of importing such implied terms into the contract had already been drawn in Trollope & Colls Ltd vs. North West Metropolitan Regional Hospital Board [1973] 1 WLR 601, 609 in the following clear terms:
“[T]he court does not make a contract for the parties. The court will not even improve the contract which the parties have made for themselves, however desirable the improvement might be. The court’s function is to interpret and apply the contract which the parties have made for themselves. If the express terms are perfectly clear and free from ambiguity, there is no choice to be made between different possible meanings: the clear terms must be applied even if the court thinks some other terms would have been more suitable. An unexpressed term can be implied if and only if the court finds that the parties must have intended that term to form part of their contract: it is not enough for the court to find that such a term would have been adopted by the parties as reasonable men if it had been suggested to them: it must have been a term that went without saying, a term necessary to give business efficacy to the contract, a term which, though tacit, formed part of the contract which the parties made for themselves.”
Similarly in Equitable Life Assurance Society vs. Hyman [2002] 1 AC 408, 459, Lord Steyn observed that- “if a term is to be implied, it could only be a term implied from the language of [the instrument] read in its commercial setting.”
In India, the Apex Court in United India Insurance Company Limited vs. Manubhai Dharamasinhbhai Gajera and Ors. (2008) 10 SCC 404 considered the circumstances when reading an unexpressed term in an agreement would be justified on the basis that such a term was always and obviously intended by and between the parties thereto. The Supreme Court in the present case cited two landmark English cases discussed earlier, viz. Shirlaw v. Southern Foundries (1926) Ltd. (1939) 2 All ER 113 (CA), and Trollope and Colls Ltd. Case (supra) to observe-
“Prima facie that which in any contract is left to be implied and need not to be expressed is something so obvious that it goes without saying; so that, if, while the parties were making their bargain, an officious bystander, were to suggest some express provision for it in their agreement, they would testily suppress him with a common Oh, of course!
Shirlaw v. Southern Foundries (1926) Ltd.(1939) 2 All ER 113(CA) “
—-
An expressed term can be implied if and only if the court finds that the parties must have intended that term to form part of their contract: it is not enough for the court to find that such a term would have been adopted by the parties as reasonable men if it had been suggested to them: it must have been a term that went without saying, a term necessary to give business efficacy to the contract, a term which, although tacit, formed part of the contract which the parties made for themselves.
Trollope and Colls Ltd. v. North West Metropolitan Regl. Hospital Board (1973) 2 All ER 260 (HL)”
One more recent Supreme Court case which considered the applicability of ‘Business Efficacy Test’ in India was Satya Jain (D) Thr. L.Rs. and Ors. vs. Anis Ahmed Rushdie (D) Thr. L.Rs. and Ors., (2013) 8 SCC 131. In this case, the High Court had earlier resorted to the principle of ‘business efficacy’ to read certain implied term into the agreement. The Hon’ble Supreme Court in this case observed that-
“The principle of business efficacy is normally invoked to read a term in an agreement or contract so as to achieve the result or the consequence intended by the parties acting as prudent businessmen. Business efficacy means the power to produce intended results. The classic test of business efficacy was proposed by Lord Justice Bowen in The Moorcock (1889) 14 PD 64. This test requires that a term can only be implied if it is necessary to give business efficacy to the contract to avoid such a failure of consideration that the parties cannot as reasonable businessmen have intended. But only the most limited term should then be implied – the bare minimum to achieve this goal. If the contract makes business sense without the term, the courts will not imply the same.”
The Supreme Court, thus concluded by saying that the – “business efficacy test, therefore, should be applied only in cases where the term that is sought to be read as implied is such which could have been clearly intended by the parties at the time of making of the agreement” and accordingly held that resort to the principle of business efficacy by the High Court to read the implied terms in the agreement was not warranted in the given facts and circumstances.
[4] Terms Implied into Specific Contracts
Terms may be implied into a contract depending on the nature of the contract. For instance, in a contract of employment, an employee has a duty of good faith towards his/her employer.
[5] Terms of General Application
A contractual responsibility may be implied upon a promise on the part of each party to a contract to do all that is necessary to secure the performance of the contract, except where such an implication would fetter the future legislative discretion of one party. Examples may be:
- Where the consideration is controlled by a third party, none of the parties to the contract would attempt to obtain an unfair advantage over the other.
- A contracting party in breach may be under a duty to inform the other party of his breach.
- A contract of service may be terminated after reasonable notice where there is no express provision in the contract for termination.
Similarly, Courts have declined to imply duties and obligations where it was alleged that the price quoted for building work was exclusive of value added tax, despite the existence in the building trade of a custom to that effect.
[6] Terms Implied by Custom/Business Practice
It is possible that the terms of a contract may have been negotiated against the backdrop of the prevailing customs of a particular locality or trade. In such a case, the parties automatically assume that their contract will be subject to such customs and sometime omit to incorporate such apparently obvious or implied terms specifically into the contract.
In commercial transactions, custom and usage is admissible as evidence to imply terms. There is a presumption that in such transactions, the parties did not mean to express in writing the whole of the contract by which they intended to be bound, but meant to contract with reference to those usages and prevailing customs. In such a scenario, the need for implying a term into a contract also depends upon on the size and intricacy (minute details) of the contract. Greater the details, the less likely it is that the contract would be considered to have implied such terms based on customs and business practice. However, in the absence of evidence of a contrary intention, a Court may be inclined to order that a local custom or usage forms part of the contract where the terms is notorious, certain, legal and reasonable. If it can be shown that the custom or usage is common place for the particular type of contract, it will be regarded as part of that contract in precisely the same manner as if the parties had expressly agreed to it.
The custom or usage will only be imported into a contract where there is nothing in its express or necessarily implied terms to prevent its inclusion and is not inconsistent with the tenor of the contract. However, it is well established that a custom or usage may be imported whether or not the parties knew of it. Furthermore, it may be possible to import the term on the basis of the earlier course of dealings between the parties, for instance: an implied promise to pay compound interest on a debt; the incorporation of terms printed on the back of ‘sold notes’; the obligations of the parties to a commission agency, etc..
One good example of such implied terms can be the English case of Hutton v. Warren, [1886] EWHC J61, wherein Hutton had taken out the certain property of Warren on lease. Hutton, as tenant, was given a six months’ prior notice to quit. However, the landlord of Hutton insisted that he can continue to cultivate the land during the notice period in keeping with the prevailing custom. The term of the lease expired even before the harvesting began. The lease agreement was silent about how to deal with such a contingency. The Court in this case held that even though there was no express provision in the lease agreement to that effect, it was reasonable to assume that the local custom of the area was an implied term of the contract. Therefore, the plaintiff was held to be rightfully entitled to reasonable reimbursement for seed and labour expended on the piece of land.
[7] International obligations
There may be a situation when a particular international treaty may be applicable on certain type of contracts. In such a situation, unless the terms of such applicable international treaty is lawfully contracted out, such terms of the treaty may be implied into the contact.
Author: Adv. Vivek Verma
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