A judge can only imply a contractual term if it is a reasonable and contextual reflection of what the parties must have intended.

Two recent appellate decisions show how this test is applied in practice. Most recently, the Court of Appeal for Ontario in Energy Fundamentals Group Inc v Veresen Inc, 2015 ONCA 514 upheld an application judge’s decision to imply a term governing one party’s disclosure obligations. In Moulton Contracting Ltd v British Columbia, 2015 BCCA 89, released earlier this year, the BC Court of Appeal overturned a trial judge’s finding that the province had breached an implied term in a timber sale agreement.

Despite these different results on the facts, both courts took a similarly balanced legal approach, one that generally preserves freedom of contract, but still leaves room for judicial intervention if necessary. In doing so, they confirmed that the latest Supreme Court of Canada cases on contract interpretation, Sattva Capital Corp v Creston Moly Corp, 2014 SCC 53 and Bhasin v Hrynew, 2014 SCC 71 (which established the new cause of action for breach of the duty of honest contractual performance) have not changed the test for implying terms.

The test

The courts in both Energy Fundamentals and Moulton Contracting followed the “presumed intention” test from Supreme Court cases like M.J.B. Enterprises Ltd v Defence Construction (1951) Ltd, [1999] 1 SCR 619 at para 27. As Justice Levine summarized in Moulton Contracting:

[55]            The key element is that the implied term is more than just reasonable; it is necessary to make the contract as the parties intended. That is, without the term, the contract, as intended by the parties, would not be effective.

A term can be implied to “fill a gap” and to give “business efficacy” to the agreement, but not to change the substantive meaning of the bargain (see e.g. Energy Fundamentals at paras 30- 35).

Applying Sattva

Both courts of appeal referenced Sattva on the proper standard of review in contractual interpretation appeals. We know from Sattva that most issues of contractual interpretation are questions of mixed fact and law, meaning a court of appeal has to defer to the lower court’s conclusion unless it made a palpable and overriding error of fact. But if the court of appeal finds an extricable issue of law, that can be reviewed for correctness and replaced with the court of appeal’s own conclusion if the trial judge erred (Energy Fundamentals at para 29; Moulton Contracting at para 77). The level of appellate deference, then, depends on the proper characterization of the question.

The terms

It was important for the application judge, and the Court of Appeal, in Energy Fundamentals that the parties’ contract, a letter agreement, “was not intended to comprehensively define the relationship between the parties” (para 37). The application judge implied a term that Veresen had to disclose certain price and value information to EFG so that EFG could make a fully informed decision on whether to exercise an option right in the agreement, related to EFG’s potential investment in Veresen’s natural gas project (para 15). Justice Pardu found no reason to intervene:

[39]      The application judge’s conclusions that the option was illusory unless a right to disclosure was implied, and that an implied term of disclosure was necessary to give business efficacy to the agreement[,] are not tainted by reviewable error.

Contrast this conclusion to the Court of Appeal’s decision in Moulton Contracting, where the implied term also related to disclosure of a sort. There, the trial judge had implied a term into the timber sale licences (“TSLs”) issued to Moulton providing “that the Province was not aware of any First Nations expressing dissatisfaction with the consultation undertaken by the Province, save as disclosed to Moulton” (para 5). This translated into an ongoing duty of disclosure on the Province’s part. The trial judge did this “on his own,” as Moulton had not pleaded or argued its case from that angle (para 40).

The trial judge then found a breach of the term he created and implied, because the Province had not informed Moulton that a member of the Fort Nelson First Nation had expressed dissatisfaction about the TSLs and threatened to “stop the logging.” This blockade ended up impeding Moulton’s access to the area it planned to log, and Moulton suffered losses as a result. The trial judge awarded Moulton $1,750,000 in damages, reflecting “Moulton’s lost opportunities to enter into alternative logging contracts” (para 3).

When the Province appealed, Moulton had a problem: the trial judge’s implied term was actually inconsistent with several explicit terms in the TSLs, and with other findings he made (para 60). The trial judge had refused to imply a term providing that the Province guaranteed barrier-free access to the logging land, and he upheld the explicit term exempting the Province from liability if access was blocked by a third party (paras 31-35). The implied “dissatisfaction term” was incompatible with these findings, and with the presumed intention of the parties (para 59). Because the trial judge did not apply the proper legal test, there was reason for appellate reversal.

Comparing the two cases, it is probably not a coincidence that the implied term upheld in Energy Fundamentals involved the sharing of information, rather than a basis for paying close to $2 million in damages as the trial judge’s implied term would have done in Moulton.

Applying Bhasin

While Justice Cromwell did not say anything revolutionary in Bhasin about implying terms, this statement about good faith may have caused some confusion:

The implication of terms plays a functionally similar role in common law contract law to the doctrine of good faith in civil law jurisdictions by filling in gaps in the written agreement of the parties: Chitty on Contracts, at para. 1-051. [Bhasin at para 44]

Moulton tried to use this comment to bolster its argument on the implied dissatisfaction term (para 65) – even though Bhasin says that good faith does not ground its own cause of action, but rather acts as an “organizing principle” in contract law. The Court of Appeal rejected Moulton’s submission, finding that it was mixing up the implication of terms for reasons of law (e.g. in employment and insurance contracts – see para 64) with implied terms based on the presumed intention of the parties (paras 67-68). Neither had Moulton proved the separate Bhasin cause of action: “No issues of honest contractual performance…arise in this appeal” (para 76).

The application judge in Energy Fundamentals had also referred to Bhasin and good faith, but he had applied the correct test for implying terms so the “references to good faith [did] not undermine his earlier factual conclusions as to necessity and business efficacy” (para 47).

In conclusion

Whether the court should imply a term into a contract depends on the parties’ actual and presumed-to-be-actual intentions. These two appellate decisions offer a good reminder of that basic point, which has not changed with the arrival of Sattva and Bhasin on the contract law scene. Energy Fundamentals confirms that it’s appropriate to imply a term where necessary to breathe life into the contract and make the rights therein more than “illusory.” And after Moulton, it goes without saying that the court cannot imply a term that is actually inconsistent with other explicit provisions of the agreement.