This article was first published in the Driver Trett Digest, Issue 12 – September 2016.

Parties to a contract aim to achieve certainty as to the bargain they have reached. However, when unanticipated events unfold it is not uncommon for the parties to differ in their understanding of the agreement between them, and for the courts to be requested to interpret the contract as to its true meaning. Sometimes one party will argue the court should imply a term which has not been expressly agreed in the contract.

This article considers recent judicial developments concerning interpretation and implication, the relationship between the two, and the tests applied by the courts in each case.

Interpretation of contracts

"The professed object of a common law court in interpreting or construing a written contract is to discover the mutual intention of the parties" (Lord Justice Beatson in Globe Motors Inc and others v TRW Lucas Varity Electric Steering Limited and others [2016] EWCA Civ 396).

The court's approach, when interpreting contracts, is to look at the contract as a whole and consider not only the words of the relevant clauses, but also the commercial context. However, in identifying the intention of the parties, the court will apply an objective test of, "what a reasonable person having all the background knowledge which would have been available to the parties, would have understood them to be using the language in the contract to mean" (Lord Hoffman in Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38). The court is interested in establishing the understanding of a 'reasonable person', rather than that of the parties themselves.

By way of example, in his earlier judgment in Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896, Lord Hoffman stated the court, "is concerned only to discover what the instrument means. However, the meaning is not necessarily or always what the authors or parties to the document would have intended. It is the meaning which the instrument would convey to a reasonable person having all the background knowledge which would reasonably be available to the audience to whom the instrument is addressed." It is this objective meaning which is conventionally called 'the intention of the parties'.

In Arnold v Britton [2015] UKSC 35, Lord Neuberger identified six considerations of general applicability when interpreting a contract which are:

  • The natural and ordinary meaning of the clause.
  • Any other relevant provisions of the contract.
  • The overall purpose of the clause and the contract.
  • The facts and the circumstances known or assumed by the parties at the time that the document was executed.
  • Commercial common sense.
  • But disregarding any subjective evidence of any party's intentions.

It has been argued that the process of implying a term into a contract is no more than a facet of interpreting its true meaning; as it will sometimes be necessary to imply a term into the contract in order to make the contract work as the parties must have intended. However, despite some uncertainty following the judgment of Lord Hoffmann, this time in the Privy Council case of Attorney General of Belize v Belize Telecom Ltd [2009] 1 WLR 1988 (as to which see more below), the processes of interpretation and implication are "different processes governed by different rules" (per Lord Neuberger in Marks and Spencer plc v BNP Paribas [2015] UKSC 72) and it is only once the court has construed the express terms of the contract that it will consider whether to imply a term.

Implied terms

Then, in what circumstances will the court imply a term into a contract? Lord Neuberger addressed this recently in Marks & Spencer plc v BNP Paribas Securities Services Trust Company (Jersey) Ltd & Anor [2015] UKSC 72, essentially refining the earlier test laid down by the courts so that the necessary factors, before implying a term into a contract, can now be summarised as:

  • The term must be necessary to give business efficacy to the contract or it must be so obvious that it goes without saying (it will be rare for one to be present without the other).
  • The term must be capable of clear expression.
  • It must not contradict any express terms of the contract.

Traditionally, the courts' approach to implication of terms into contracts has centred around the application of the business efficacy test. The 1889 case of The Moorcock [1889] 14 PD 64 provided that a term would only be implied into a contract if it was necessary to give business efficacy to the contract.

The officious bystander test, set out in Shirlaw v Southern Foundries (1926) Ltd [1939] 2 KB 206, takes into consideration what the parties would have intended at the outset. A term will be implied if it is so obvious that, if an officious bystander suggested to the parties that the term should be included, "they would testily suppress him with a common 'oh of course'".

As touched on above, recent case law has allowed the Supreme Court to revisit these principles and clarify the position on implication and interpretation, including the distinction between the two.

The Privy Council Case, Attorney General of Belize and others v Belize Telecom Ltd [2009] UKPC 10, has been considered to be widely misunderstood to mean that a term could or should be implied if it is reasonable to do so, and that implying a term is part of the process of interpretation of a contract. It was noted that the court has:

"no power to improve upon the instrument which it is called upon to construe…[And] cannot introduce terms to make it fairer or more reasonable. It is concerned only to discover what the instrument means"

The Privy Council held that, "The question of implication arises when the instrument does not expressly provide for what is to happen when some event occurs." Under these circumstances, the usual approach is that nothing is to happen, as any alternative result would have been provided for in the instrument. However, the court considered a scenario in which any reasonable person, who read the document in question, would consider that the only meaning consistent with the remainder of the document, taking into account the relevant background, would be that something should occur. Only in these circumstances would the court then imply the term. The Privy Council considered that it would be appropriate to imply a term because any reasonable person would consider it necessary.

The requirement of necessity was further confirmed by Mr Justice Edwards Stuart in Manor Asset Ltd v Demolition Services Ltd [2016] EWHC 222 (TCC). In this case the contract had been varied in a way which was inconsistent with other provisions of the contract. The judge reasoned that it must have been the intention of both parties to give effect to the variation, and so the contract was interpreted in a way which enabled the new clause to work. This involved either implying a term or interpreting it in a certain way, which effectively reduced the prescribed period for service of a pay less notice before the final date for payment to nil, which the court did. If the court had not implied this term, the variation would have been inconsistent with the original terms and could not have operated, which could not have been what the parties had intended. Mr Justice Edwards Stuart acknowledged elements of the approach of Lord Hoffman in Belize Telecom, but in the light of the qualifications made by Lord Neuberger in Marks and Spencer. He stated:

"…the overriding point to be borne in mind before implying any term the court must conclude that the implication of that term is necessary in order to give business efficacy to the contract, or to put it another way, it is necessary to imply the term in order to make the contract work as the parties must have intended."

In Marks and Spencer, the Supreme Court stated that whilst interpreting the words which the parties have used and implying words into the contract, both involve determining the scope and meaning of the contract, these are different processes governed by different rules.

The recent case law shows that the courts continue to take a strict approach to the circumstances in which they will imply a term, and the requirement of necessity has not fallen away, even when a broader approach is applied. When interpreting contract terms, the key consideration continues to be the intention of the parties as described by Lord Hoffman in the Investors Compensation Scheme judgment. When implying terms, the courts will respect the parties' freedom of contract to set out their own terms and will only interfere when it is necessary, and not because the words used in the written contract result in a bad bargain for one of the parties. When negotiating contracts it is not safe to assume the law will assist with a common sense interpretation if the agreement is coherent and workable as it stands.