For anyone who thought that the courts would be more willing to imply terms into contracts following the Privy Council’s decision in Attorney General of Belize & ors v Belize Telecom Ltd & anor  and the Supreme Court’s decision in Rainy Sky SA v Kookmin Bank , the judgment in Procter & Gamble Company & ors v Svenska Cellulosa Aktiebolaget SCA & anor  offers a timely reminder of the courts’ innate unwillingness to interfere in parties’ freedom to contract on whatever terms they wish.
The courts will imply terms into contracts where it can be established that such a term was or would have been intended by the parties but was not in fact expressed. This category of implied terms (there are others) is often divided into those terms that are necessary in order to give business efficacy to a contract and those terms that are an obvious inference from the contract in question. With respect to the latter category, the test to be applied (often referred to as the ‘officious bystander test’) is that, in the hypothetical event that a third party were to ask the parties whether or not a certain term was intended to apply to the contract in question they would both categorically answer in the affirmative.
The Privy Council’s decision in Belize, delivered by Lord Hoffmann, suggested that there was in fact only one test: what is the contract, read as a whole, reasonably understood to mean? In applying this one test, the court appears to have been moving away from and arguably relaxing the rules of the officious bystander test and taking the view of the reasonable bystander.1
The Supreme Court in Rainy Sky, which also favoured contractual interpretation as being ‘one unitary exercise’, overturned the Court of Appeal’s judgment and determined that the most natural meaning of words used in a contract were not necessarily to be taken as expressing the intention of the parties but instead the court is able:
‘… to prefer the construction which is consistent with business common sense and to reject the other’.
PROCTER & GAMBLE COMPANY V SVENSKA CELLULOSA AKTIEBOLAGET
The claimants (P&G) were in the process of selling their tissue towel business to the defendants (SCA). The subject of these proceedings was a contract that was supplemental to the main asset sale and purchase agreement (the contract). The contract provided for the sale by P&G of certain products prior to the transfer in ownership of a particular manufacturing process to SCA under the main agreement.
The contract provided for the products to be supplied at fixed prices, which were set out in a schedule and specified that all payments were to be made by SCA to P&G in sterling. The schedule stated that the prices had been derived from a document attached to the schedule setting out plant budgets and costs associated with the production of the products (the costs schedule). All costs in this document were stated in euros, even though some of the costs would be incurred in other currencies. At the foot of the costs schedule there was a note stating: ‘£/euro exchange rate 1.49164’. The fixed prices (calculated from the figures set out in the costs schedule) were set out in a second document attached to the schedule (the pricing schedule). These prices were also stated in euros, however, there was no reference to an exchange rate in the pricing schedule.
SCA contended that the contract provided for the fixed prices set out in the pricing schedule in euros to be converted to sterling at a fixed rate of conversion of 1.49164 £/euros in accordance with the costs schedule. P&G asserted that the contract contained no such provision and that, where no rate of conversion is provided for, the appropriate rate of exchange to be used is the rate applicable at the date of payment.
SCA argued that the exchange rate was expressly provided for by way of the note at the foot of the costs schedule or, if that rate of conversion was not an express term, it was implicit from the contract read as a whole that the parties intended that the rate of conversion be that set out in the costs schedule.
SCA presented a third alternative in the form of a claim for rectification, which was unsuccessful on the grounds that SCA was unable to demonstrate the requisite objective intention of the parties.
Hildyard J expressed the task of contractual interpretation as one of grappling with ‘the familiar but elusive questions that arise as to whether in construing words their literal meaning or some more purposive interpretation is to be adopted’. He noted that the authorities to which he had been taken illustrated the swing of the pendulum between the two approaches and suggested that deciding this case would require him to find a synthesis between the authorities.
Having quoted the familiar ‘factual matrix’ of Sir Thomas Bingham MR (as was) and his explanation that ‘construction is a composite exercise, neither uncompromisingly literal nor unswervingly purposive’2, the judge turned to the most recent judgment of the Supreme Court on the issue of implied terms, Rainy Sky. Here the court held that, where the language used by the parties has more than one potential meaning, the court need not necessarily favour the most natural meaning of the words, but is entitled ‘to prefer the construction which is consistent with business common sense and to reject the other’. The judge then returned to the classic statement of the objective as being:
‘the ascertainment of the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract’.3
The judge concluded that the note on the costs schedule could not amount to an express term as to the exchange rate to be applied for the following reasons:
- it was clear from the face of the costs schedule that it was included to provide information regarding costings rather than to make any substantive provision regulating the performance of the parties; and
- given the care that went into the drafting of the contract and the calibre of the legal teams involved, it was unlikely that such an important term would have been dealt with in such a ‘casual, confusing and elliptical way’.
Having established that there was no express term as to the exchange rate to be applied, the judge turned to whether such a term could be deemed to be included by way of inference, implication or interpolation. In his approach to this question, the judge distinguished between these terms, which are often viewed as interchangeable: inference is a process of spelling out in words a provision which it is to be inferred from particular express terms that they used, the parties must have meant to include; whereas implication (or interpolation) is the process of writing in a provision in order to give effect to the obvious objective intention of the parties as evinced by the instrument read as a whole.
In this context, he explained, where the court is not really being asked to consider competing interpretations of the meaning of particular words used, the fact that the note in question had not been found to constitute an express term, effectively meant that that note cannot be deemed to constitute a term by way of inference either. So the court was left with the question of whether or not such a term should be implied by the reading of the contract as a whole.
In his consideration of whether or not a term should be implied, the judge noted the authorities’ emphasis that what the court is trying to get to is what the instrument would reasonably be understood to mean against the relevant background and, although recent authorities (such as Rainy Sky) would appear to suggest that the court may adopt a construction which is consistent with common sense and to reject a construction which it considers not be so, the court must nevertheless proceed cautiously and not seek to improve the instrument to accord with its view of what would have been commercially sensible or fair. Quoting Lord Hoffman in Belize4:
‘[The court] cannot introduce terms to make it fairer or more reasonable. It is concerned only to discover what the instrument means.’
Hildyard J held that in this instance there was no basis for implying a term that the exchange rate applied should be fixed at the rate set out in the costs schedule, or indeed any rate, for the following reasons:
- there was no difficulty in the working of the contract without such a term being implied; indeed it was common ground that, if it was held that there was no term fixing the exchange rate, the exchange rate would be the market rate on the day of payment;
- this was not a case (as in In re Sigma Finance Corporation (in administrative receivership) ) where the relevant clause had to be interpreted in a completely different context to the one it had been envisaged it would have its application; and
- such a term would be central to the allocation of risk between the parties and therefore extra caution should be taken by the court in considering whether it should be implied.
There have been a number of cases over the last few years where the courts have shown themselves to be willing to imply terms into legal instruments. However, as Hilyard J’s judgment in this case underlines, there remains a natural and longstanding disinclination to interfere with the fundamental freedom of parties to contract. This approach is entirely appropriate in the context where, as Hildyard J himself pointed out:
‘it is almost inevitable that a court has an imperfect grasp of all the commercial consequences; and… denies itself the knowledge of the pre-contractual negotiations that may offer the explanation for the result it happens to query.’
Parties should not be encouraged to look to the courts to correct deficiencies in drafting and they should expect to get fairly short shrift where they want to improve upon their position when the contract in question has been the subject of legal advice and negotiation, where the term that a party is seeking to have implied is central to the parties rights, obligations or risk, or where the situation in which the parties find themselves is wholly foreseeable.