Supreme Court clarifies test for implying terms into a contract

In a judgment handed down yesterday morning, the Supreme Court has clarified the law on when the court can imply a term that the parties have not expressly included in their contract, endorsing the traditional approach that the term either must be so obvious as to go without saying or must be necessary to give business efficacy to the contract: Marks and Spencer plc v BNP Paribas Securities Services Trust Company (Jersey) Limited and another [2015] UKSC 72.

The decision considers the Privy Council decision in Attorney General of Belize v Belize Telecom [2009] 1 WLR 1988, which had generally been accepted as the leading modern case on the implication of terms. In that case, Lord Hoffmann suggested that the process of implying terms was part of the exercise of contractual construction, so that the only question was whether a reasonable reader of the contract, with the relevant background knowledge, would understand it to be implied. That decision led to a great deal of academic debate as to whether it had changed the law, so that reasonableness could now be seen as a sufficient ground for implying a term.

In the present decision, the Supreme Court is unanimous in emphasising that Belize Telecom should not be taken as having watered down the traditional, highly restrictive approach to the implication of terms. The upshot of the decision is that reasonableness in itself is not sufficient; the tests of obviousness or business efficacy must be met. There is however some disagreement between the Supreme Court Justices as to how Belize Telecom should be treated going forward. Natasha Johnson, a partner in our dispute resolution team, considers the decision below.

Background / decision

The context for the Supreme Court's judgment was a dispute between M&S and its landlord as to whether M&S could reclaim the proportion of quarterly rent it had paid in advance which related to the period after its lease came to an end following service of a break notice. There was no express provision entitling M&S to a refund, so the question was whether a term should be implied.

The High Court held that a term should be implied which entitled M&S to recover, the Court of Appeal overturned that decision, and the Supreme Court has now unanimously dismissed the appeal against the Court of Appeal's decision. For more analysis on the commercial real estate (landlord and tenant) aspects of the case please click here for our real estate dispute resolution e-bulletin. The below addresses in more detail the Supreme Court's more general comments relating to implied terms.

Implied terms

The majority of the Supreme Court (Lord Neuberger, with whom Lord Sumption and Lord Hodge agreed) started with the classic statements in the 19th century and early 20th century cases as to the requirements which have to be satisfied before the court can imply a term into a commercial contract, which were summarised as follows in the Privy Council case of BP Refinery (Westernport) Pty Ltd v President, Councillors and Ratepayors of the Shire of Hastings (1977) 52 ALJR 20:

"[F]or 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."

Lord Neuberger said these observations represent a clear, consistent and principled approach and it could be dangerous to reformulate the principles. However, he added six comments:

1. The implication of a term was "not critically dependent on proof of an actual intention of the parties" when negotiating the contract.
2. A term should not be implied into a detailed commercial contract merely because it appears fair or because the court considers that the parties would have agreed it if it had been suggested to them.
3. A requirement that a term is reasonable and equitable will not usually, if ever, add anything – if a term satisfies the other requirements, it is likely that it will be reasonable and equitable.
4. Business efficacy and obviousness can be alternatives in that only one of them needs to be satisfied, although in practice it would be rare for only one of these requirements to be satisfied.
5. If approaching the implication of a term by reference to the officious bystander requirement, it is "vital to formulate the question to be posed by [him] with the utmost care".
6. Necessity for business efficacy involves a value judgment. The test is not one of "absolute necessity". A more helpful way of putting the requirement may be that a term can only be implied if, without the term, the contract would lack commercial or practical coherence.

Lord Neuberger also referred to the Privy Council decision in Belize Telecom, and Lord Hoffmann's suggestion that a term will be implied if a reasonable reader of the contract, with the relevant background knowledge, would understand the contract to include the implied term. Lord Neuberger described this notion as "quite acceptable", provided that:

• the reasonable reader is treated as reading the contract at the time it was made - ie the question of whether a term is implied must be judged at the date the contract is made; and 
• the reasonable reader would consider the term to be so obvious as to go without saying or to be necessary for business efficacy - ie Lord Hoffmann's formulation must not be interpreted as suggesting that reasonableness is a sufficient ground for implying a term.

With regard to Lord Hoffmann's suggestion that the process of implying a term is part of the exercise of construction, Lord Neuberger accepted that both exercises involve determining the scope and meaning of the contract. However, he considered that Lord Hoffmann's analysis could obscure the fact that they are different processes governed by different rules.

Overall Lord Neuberger concluded that, since Lord Hoffmann's observations in Belize Telecom are open to more than one interpretation and some of those interpretations are wrong in law, the right course is to say that those observations should be "treated as characteristically inspired discussion rather than authoritative guidance on the law of implied terms".

Lord Carnwath, giving a separate judgment, said he would have been content to take Belize Telecom as his starting point rather than the older cases referred to by Lord Neuberger. In Lord Carnwath's view, Belize Telecom should be treated as authoritative, and the traditional tests (of obviousness and business efficacy) should be seen as different ways of expressing the central idea that the proposed term must spell out what the reasonable reader would understand the contract to mean.

In any event, all of the Supreme Court Justices agreed that Belize Telecom should not be taken to have watered down the traditional, highly restrictive approach to the implication of terms. In particular, it should not be taken as suggesting that it is sufficient to imply a term that it would be reasonable to do so.