Contracts: an outline of implied terms

A contract will generally contain express terms that have been agreed between the parties (either in writing or orally, or both), together with any additional terms that have not been expressly agreed between the parties but which are found by the Court to be part of the contract. These are known as 'implied terms'.

To avoid potential disputes and achieve certainty, the parties should ensure that their respective rights and obligations are, so far as possible, expressly set out in the contract. 

If issues do arise between the parties regarding the operation of a particular contract, it is not enough to consider the express terms of the contract.  Careful consideration must also be given to any implied terms.  A recent Court of Appeal decision highlights the importance of this, as outlined below.

When terms may be implied into a contract

The power of the Courts to imply terms into contracts is relatively limited.  There are a finite number of circumstances in which the Courts may do this. These are:

• To give effect to the parties' intentions
• Due to a previous course of dealings between the parties
• As a result of custom and practice
• Where required by statute (such as the Sale of Goods Act 1979)
• Under the common law for particular types of contract (e.g. employment contracts and landlord and tenant contracts)

To give effect to the parties' intentions

This generally arises where there is a gap in the contract drafting, such that the contract does not reflect the parties' intentions at the time it was entered into. This is, in our experience, the most common area for disputes over implied terms.

The Court will consider the position objectively and seek to determine what a reasonable person would have understood the parties' intentions to be, given the background knowledge reasonably available to them at the time they entered into the contract.

There have been a significant number of cases in which the Court considered the correct test to apply. These cases have resulted in the test being formulated in a number of ways, including:

• The 'business efficacy' test: a term may be implied into a contract if it is necessary to do so in order to give the contract business efficacy
• The 'officious bystander' test: a term may be implied into a contract if it is so obvious that it goes without saying, so that if an officious bystander suggested it to the parties, they would both say “Oh, of course!”
• The 'necessity' test: a term may be implied into a contract where it is necessary to do so in order to make the contract work. The Court will not imply a term into a contract simply because it considers that it would have been reasonable for the parties to have done so. This is now the preferred test and is most commonly used by the Court

The recent Court of Appeal case of Marks and Spencer plc v BNP Paribas Securities Services Trust Company (Jersey) Limited and another [2014] EWCA Civ 603 is an example of the application of the necessity test. This case concerned a lease between the parties which was terminated early by the tenant, Marks & Spencer, under a break clause. Marks & Spencer argued that a term should be implied into the lease entitling it to a refund from the landlord of that part of the advance rent, car parking and insurance charges which related to the period after the break date when the lease had terminated.

The Court of Appeal found against Marks & Spencer on this point. It said that a term should only be implied into a contract where it is necessary to do so in order to achieve the objective intentions of the parties. On the facts of this case, the lease, read as a whole against the relevant background, would not reasonably be understood to require such a term, which meant the test was not satisfied. 

Marks & Spencer has been granted permission to appeal to the Supreme Court, so this position may be re-evaluated and useful guidance on the applicability of the necessity test may be given.

Previous course of dealings

A term may also be implied into a contract where the parties have consistently conducted business on specific terms in their previous dealings. The party seeking to rely on the implied term must show that there is no express term to the contrary in the current contract and that the parties' reasonable expectation was that the term would apply to this transaction.

It is not enough to show simply that the parties have previously traded with each other. The Court must be satisfied that such trading was regular (perhaps as much as several transactions a month for several years) and consistently on the same terms. 

An example of this might be where a contract for the supply of goods or services does not expressly state when payment is required. Where the parties have, in the past, regularly and consistently traded on the basis that payment would be made on delivery, a Court might be willing to imply this term into the current contract.

Custom and practice

In certain circumstances, a term may be implied into a contract in accordance with the custom and practice of the market in which the contracting parties are operating. The rationale for this is that the Court is prepared to give effect to what both contracting parties know is part of their bargain, even if this is not expressly stated in the contract.

This is a high hurdle for the party seeking to have the term implied to overcome.  The Courts have said that the custom and practice must be notorious, certain, reasonable and not contrary to law.  It must be something more than a mere trade practice. 

Required by statute

Certain terms may be implied into contracts by statute. 

A common example of this is the various terms implied by the Sale of Goods Act 1979 into contracts for the sale of goods. These implied terms include that the goods are free from undisclosed charges or encumbrances and that the goods will be of satisfactory quality.

Under the common law

The Courts may also imply terms into contracts where the term is a necessary characteristic of a particular type of contract. An example of this is an implied term in arbitration agreements that the arbitration is confidential.

Excluding implied terms

The fact that terms may be implied into contracts in a limited number of circumstances can mean that it is difficult for contracting parties to know with any certainty the actual terms of their agreement. This can result in disputes arising.

At the contract drafting stage, parties often try to expressly exclude implied terms by including in the contract an 'entire agreement' clause. This is a contractual provision which aims to prevent liability for any statements or representations made by the parties other than those expressly set out in the contract.

However, in order to be effective at excluding implied terms, the entire agreement clause must be carefully drafted. An entire agreement clause will not generally be effective at excluding implied terms where it is silent as to their exclusion: very clear words must be used in order to do so. 

Not all implied terms can be excluded by an entire agreement clause. For example, certain of the terms implied by the Sale of Goods Act 1979 cannot be excluded at all and others can only be excluded or limited to the extent that it is reasonable to do so. 

Summary

Contracting parties should be aware that the express terms set out in their contract may not be an exhaustive statement of their respective rights and obligations. If one or more of the circumstances above applies, and no effective exclusion has been incorporated, it may be that additional terms will be implied into the contract. 

To avoid the uncertainty that this can create, parties should obtain legal advice at the contract drafting stage to ensure that their commercial intentions are reflected by the express terms of the contract so far as it is possible to do so. Clear and careful expression of the intentions of the parties can help to avoid complicated questions of implied terms and contractual interpretation, and disputes over these, arising later on.

However, if a dispute does arise, specialist dispute resolution lawyers should be engaged as early as possible.

For advice or guidance, please contact me on +44 (0)1392 685284 or email [email protected]