Supreme Court restates the law on implied terms

In a recent case, Marks and Spencer plc v BNP Paribas Securities Services Trust Company (Jersey) Ltd and another [2015] UKSC 72, the Supreme Court has clarified the law relating to implied terms in contracts.

The case, which may be read here, concerned a tenant’s break clause in a lease and the effect of exercising the right to break on the rent payable. We recently reported on the property aspects of this case here; this update considers its implications for the law on implied terms more generally.

The lease – Marks and Spencer and BNP Paribas

Marks and Spencer (the tenant) leased four floors in The Point, an office building at Paddington Basin in London, from BNP Paribas (the landlord). Each of the floors was demised under a separate lease, granted on 25 January 2006. The leases were in similar terms, providing that the rent for the floor was £919,800 per annum, reviewable on certain review dates and payable quarterly in advance on the usual quarter days. The tenant had the option of breaking the lease on 24 January 2012 by giving six months’ notice, provided a break premium of £919,800 was paid to the landlord on or before the break date and there were no arrears of rent. If the tenant did not exercise its right to break, then the landlord would deduct £150,000 from the next quarter’s rent.

The tenant served a break notice on 7 July 2011, paid a full quarter’s rent on 25 December 2011, and paid the break premium on 18 January 2012. The lease accordingly determined on 24 January 2012.

The tenant sought repayment from the landlord of the rent paid in respect of the period from 24 January to 25 March. There was no express term in the lease providing for apportionment of the rent in this way. The tenant therefore contended that such a term should be implied, on the grounds that it was reasonable and equitable for the landlord to reimburse the tenant for rent paid for a period in which the tenant had no use of the property.

The tenant was successful in the High Court, and the landlord appealed to the Court of Appeal, which reversed the High Court’s decision. The tenant appealed to the Supreme Court, which took the opportunity to review the law relating to implied terms generally.

Implied terms – the traditional tests and BP Refinery

The traditional requirements to be met before a term can be implied into a contract are the test of business efficacy, or necessity, and the officious bystander test. A term may only be implied if it is necessary to give business efficacy to the contract, and if it is so obvious that it goes without saying.  As MacKinnon LJ remarked in Shirlaw v Southern Foundries (1926) Ltd [1939] 2 KB 206, "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!’."

In BP Refinery (Westernport) Pty Ltd v President, Councillors and Ratepayers of the Shire of Hastings (1977) 52 ALJR 20, Lord Simon of Glaisdale, giving the judgment of the Privy Council, proposed five conditions which should be satisfied for a term to be implied in a contract: "(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."

Implied terms – Belize Telecom

In Attorney General of Belize v Belize Telecom Ltd [2009] 1 WLR 1988, another Privy Council case, Lord Hoffmann appeared to take a rather different approach. He said that the list of five conditions set down in BP Refinery "is best regarded, not as a series of independent tests which must each be surmounted, but rather as a collection of different ways in which judges have tried to express the central idea that the proposed implied term must spell out what the contract actually means, or in which they have explained why they did not think that it did so".

For Lord Hoffmann, the implication of a term is an exercise in the construction of the contract as a whole: "[it] is not an addition to the instrument. It only spells out what the instrument means". He added: "There is only one question: is that what the instrument, read as whole against the relevant background, would reasonably be understood to mean?" These dicta have been widely interpreted as diluting the requirements to be satisfied before a term will be implied.

Implied terms – the law clarified

In Marks and Spencer, Lord Neuberger, with whom Lord Sumption and Lord Hodge agreed, has confirmed that Lord Hoffmann’s remarks in Belize Telecom did not change the law. The traditional tests "represent a clear, consistent and principled approach", which should still be followed.

The notion that a term will be implied if a reasonable reader would understand it to be implied is acceptable only if "(i) the reasonable reader is treated as reading the contract at the time it was made and (ii) he would consider the term to be so obvious as to go without saying or to be necessary for business efficacy". Lord Hoffmann’s formulation should not be interpreted as suggesting that reasonableness is a sufficient ground for the implication of a term.

Lord Neuberger also emphasized that construing the express words of a contract is a different exercise from implying words which are ex hypothesi not there to be construed. He concluded that, since some interpretations given to Lord Hoffmann’s observations in Belize Telecom are wrong in law, "those observations should henceforth be treated as a characteristically inspired discussion rather than authoritative guidance on the law of implied terms".

Implied terms – further guidance

Lord Neuberger added six comments on the five conditions proposed in BP Refinery:

(i) Reasonableness is to be judged objectively – in considering what the parties would have agreed, "one is not strictly concerned with the hypothetical answer of the actual parties, but with that of notional reasonable people in the position of the parties at the time at which they were contracting".

(ii) Fairness and acceptability to the parties are not enough – the fact that a term appears fair or that one considers that the parties would have agreed to it if it had been suggested are necessary but not sufficient grounds for implying it.

(iii) The requirement for reasonableness and equitableness will usually add nothing to the other tests – "if a term satisfies the other requirements, it is hard to think that it would not be reasonable and equitable". 

(iv) The business efficacy and officious bystander tests are not cumulative – they can be alternatives in that only one needs to be satisfied, "though it would be a rare case where only one of those two requirements would be met". The tests in BP Refinery are otherwise to be regarded as cumulative, however.

(v) The officious bystander test may not be straightforward – it is important to formulate the question to be posed by the officious bystander "with the utmost care".

(vi) The test of necessity for business efficacy involves a value judgment – it is not a test of absolute necessity, because the necessity is judged by reference to business efficacy. As Lord Sumption suggested in argument, it may be more helpful to say that "a term can only be implied if, without the term, the contract would lack commercial or practical coherence".

Application to the lease – no implied term

Applying these principles to Marks and Spencer’s lease, the Supreme Court declined to imply a term requiring the landlord to reimburse the tenant with a sum representing the proportion of rent attributable to the period after the exercise of the break.

While it would be reasonable and equitable for the landlord to reimburse such a sum, which was a windfall for the landlord, it was not necessary to require such reimbursement to give business efficacy to the contract.

The tenant was not assisted by the general law on apportionability of rent, since rent is not apportionable in time at common law, and section 2 of the Apportionment Act 1870 only provides for the apportionment of rent payable in arrears, not (as here) rent payable in advance. That was generally understood to be the position when the lease – a professionally drafted document of some 70 pages – was negotiated and executed.

There was an anomaly in the lease as drafted. If the tenant had paid the break premium before 25 December, then only the rent for the period from 25 December to 24 January would have been payable, since by the date on which the rent was due all the requirements for exercising the break would have been fulfilled and determination of the lease on 24 January would have been certain. Since the tenant did not in fact pay the break premium until 18 January, however, the early determination of the lease was not certain by 25 December, and so a full quarter’s rent was due on that date. Lord Neuberger described this effect as "capricious", but since it did not amount to an absurdity or make the lease unworkable, there was no justification for implying a term to the contrary.

Comment – a trend in the Supreme Court

This judgment reinforces a trend, evident in two other recent cases decided by the Supreme Court, for the court to respect the words used by the parties to effect the deal they have made.

In Arnold v Britton and others [2015] UKSC 36, the Supreme Court declined to depart from the natural reading of a term in the lease of a holiday chalet providing that the service charge due would increase by 10% per annum, even though the result of applying such an increase was "plainly unattractive, indeed alarming" for the lessee.

In Cavendish Square Holding BV v El Makdessi [2015] UKSC 67, on which we reported here, the Supreme Court upheld provisions in a contract for the sale of shares providing that the buyer would not have to make the interim and final payments due if the seller breached certain restrictive covenants, even though the value of those payments went far beyond a genuine pre-estimate of the buyer’s loss.

Taken together, these cases, in all of which the leading judgment was given by Lord Neuberger, represent a move away from the more creative approach to contractual interpretation, stressing commercial reasonableness, associated with Lord Hoffmann. It is evident that the court is now returning to a more literal approach, placing greater emphasis on the actual words of the contract in question.

The lesson for parties negotiating an agreement is clear: they should take care to ensure that the words used reflect their intentions explicitly, and not seek to rely on the courts to rewrite their contract according to what may be considered to be commercially reasonable.