The Court of Appeal for Ontario recently released its decision in Energy Fundamentals Group Inc. v Veresen Inc.1 This decision revisited and reaffirmed the circumstances in which a court will imply a term into a contract.
Background facts and arguments
Energy Fundamentals Group (EFG) provided financial services to the appellant pursuant to a letter agreement. The letter agreement was not comprehensive, but provided EFG the option to acquire up to a 20% interest in a liquid natural gas project contingent on successful financing.
The relationship deteriorated when the appellant asserted that the option had expired as a result of fundamental changes to the project and, further, refused to provide EFG with documents to verify the option price or its likely economic value.
The application judge’s decision
The application judge declared that the option was still valid and ordered the appellant to provide sufficient information to enable EFG to calculate the option price and determine the value of a 20% equity stake in the project.
Referring to the leading Supreme Court of Canada case on the implication of terms, the application judge found that terms may be implied where necessary to give business efficacy to a contract, or where terms are considered too obvious to require express inclusion.
Accordingly, the application judge concluded that disclosure of the financial documents in this case was “a necessary incident to the existence of the option right itself.” The parties must have intended a right to disclosure, as any other interpretation would frustrate the business purpose of the agreement. He concluded that without disclosure of the valuation information, “The option right is really no right at all” and no reasonable person would have embarked on an exercise of an option without disclosure.
The appellant declined to appeal the finding that the option had not expired, and, instead, focused solely on the implied term of disclosure, arguing it would never have agreed to undefined disclosure terms, and submitted that terms requiring value and price disclosure should not be implied. The appellant contended that a court cannot imply a term mandating “sufficient disclosure,” as such a term is too indefinite and uncertain as to the scope of disclosure.
The respondent argued that the option would be illusory without the right to the requested disclosure and submitted that a court can imply terms to a contract where necessary for the agreement to have such commercial efficacy as the parties intended.
The Court of Appeal reaffirmed established principles of contractual interpretation, holding that the application judge correctly articulated the test for determining whether to imply terms to a contract and dismissed the appeal.
The court found that the correct standard to apply in determining whether to imply terms into a contract involves questions of mixed law and fact. Ultimately, a contractual term may be implied “on the basis of the presumed intentions of the parties where necessary to give business efficacy to the contract or where it meets the officious bystander test.”
The business efficacy test considers how the law can give such effect to the transaction as must have been intended by both parties. Assessed on the standard of a reasonable person "who had knowledge of the relevant background," it asks what construction would frustrate the parties’ apparent business purpose.
The officious bystander test is used to determine if an unstated condition was originally implied at the time of contract formation. It suggests that a term can be implied where it is prima facie something both parties would have undoubtedly included as part of their agreement, at the time they were making their bargain.
The court ruled that both the business efficacy test and the officious bystander test focus on the intentions of the actual parties, but “reasonableness” is an inescapable part of determining whether to imply a contractual term. A court should assess the reasonableness of the proposed term to be implied in the specific context, but also rely on the general reasonableness of the term. Finally, the court recognized the implication of a contractual term does not require a finding that a party actually thought about a term or expressly agreed to it. Often terms are implied to fill gaps to which the parties did not turn their minds.
This case is a helpful reminder that courts will imply a term into a contract where such a term represents and gives effect to the parties’ intention in order to provide the contract with the effectiveness and purpose that the parties intended. In essence, courts will imply terms where necessary to give business efficacy to a contract, having regard to the parties, the contractual context and guided by what is reasonable in the circumstances.
The authors wish to thank Gillian Moore, summer law student, for her help in preparing this legal update.