Return of the officious bystander: Supreme Court takes stricter approach to implied terms

Summary

In Marks and Spencer plc v BNP Paribas Securities Services Trust Company (Jersey) Ltd and anr the Supreme Court restated the traditional test for the implication of terms in contracts and clarified that a term will be implied only if the contract would be commercially unworkable or absurd without it.

The Supreme Court’s decision reflects a recent shift by the English courts to a stricter and more literal approach to contracts. This was seen in the Supreme Court’s decision in Arnold v Britton last year, concerning the interpretation of contracts. It appears that parties will now find it more difficult to escape bad bargains through creative interpretations or implied terms.

In light of this decision and the recent attitude of the English courts:

• in negotiating and drafting contracts, parties should consider all the possible practical scenarios arising out of the proposed transaction and decide whether drafting is needed to deal with these (rather than attempting to rely on any implied terms later on)
• if contemplating any claim against a contractual counterparty which is based on an implied term, parties should be wary of the Supreme Court’s decision and consider the strengths of their claim, and
• conversely, if faced with a claim which is based on an implied term, parties should consider whether they can raise a more robust defence based on this decision.

The implied term

In this case, Marks and Spencer (M&S) was the tenant under a lease from the defendant landlord. Under the lease agreement, the tenant was obliged to pay rent to the landlord in quarterly instalments in advance. The rent comprised various components but was made up principally of the basic rent.

The tenant exercised its break clause rights under the lease in July 2011 to bring the lease to an end on 24 January 2012. A condition of the break clause taking effect was that the tenant should not have any rent outstanding on the break date and, accordingly, the tenant made its quarterly rent payment in December 2011, which covered the period until 25 March 2012.

After the lease was terminated on 24 January 2012, the tenant sought to recover the portion of the rent covering the period from 24 January 2012 to 25 March 2012 (given that it was not using the premises during that time) on the basis of an implied term obliging the landlord to repay an apportionable amount of the rent in these circumstances.

The tenant accepted that the lease did not expressly oblige the landlord to repay an apportionable amount of the rent following termination of the lease. Accordingly, the tenant argued that a term should be implied into the lease that the landlord were obliged to repay a portion of the quarterly rent paid in advance in respect of the period after the break date.

In the High Court, Morgan J held that the tenant was permitted to recover the apportioned rent. However, this decision was overturned in the Court of Appeal which found in favour of the landlord.

The tenant subsequently appealed that decision to the Supreme Court.

Supreme Court Decision

The five Supreme Court justices unanimously dismissed the tenant’s appeal and thus refused to imply a term obliging the landlord to repay an apportionable amount of the rent to the tenant following the break date.

Lord Neuberger gave the leading judgment. He started by considering some of the previous authorities dealing with implied terms and made six comments (which we expect will be referred to in later cases dealing with implied terms) (paragraph 19). Lord Neuberger also distinguished between so-called terms “implied in law” (which are implied into every contract of a certain type) and terms “implied in fact” (which may be implied into any contract if they satisfy the relevant test) (paragraph 15). This case involved the latter category of implied terms (although Lord Neuberger did not use these same labels). Of note, Lord Neuberger said:

"A term should not be implied into a detailed commercial contract merely because it appears fair or merely because one considers that the parties would have agreed it if it had been suggested to them (those are necessary but not sufficient grounds for implying a term).

"There does not have to be “absolute necessity” for a term to be implied but there should be “business necessity” (such that the contract would lack commercial or practical coherence without the term) or “obviousness” (such that, if an officious bystander would have suggested the implied term to the parties at the time of contracting, they would have both unquestionably agreed to include it as an express term)."

Lord Neuberger expressed some sympathy with the tenant’s argument that it should be entitled to recover an apportionable amount of the rent on the basis that: (A) rent was paid in order to reflect the use and enjoyment of the premises, which had not occurred after the break date, and (B) rent was stated under the lease agreement to be payable yearly and “proportionately”.

However, Lord Neuberger noted that:

• the Lease was a detailed document, drafted by expert solicitors and entered into between experienced parties (paragraph 38)
• the parties had carefully considered the effects of the break clause through various other provisions of the lease and it would thus be “inappropriate for the court to step in and fill in what is no more than an arguable lacuna” (paragraph 40), and
• after considering various sources, “neither common law nor statute apportions rent in advance on a time basis” (paragraph 46).

In conclusion, Lord Neuberger accepted that the result of not implying a term would be “somewhat curious” and “anomalous”. However, it did not make the contract unworkable or commercially absurd (paragraph 51). In other words, the tenant had entered into a bad bargain and could not be saved by an implied term, even if the result could be said to be commercially unreasonable.

The tricky impact of the Belize case

Lord Hoffmann’s formulation of the test for the implication of terms in the Belize case has been interpreted as watering down the traditional test. Lord Hoffmann suggested that: (A) reasonableness may be a sufficient ground for implying a term, and (B) the process of implying terms is a part of the overall exercise of construing a contract.

In a welcome clarification to the impact of the Belize case, Lord Neuberger said that the case had not changed the law on implied terms and, to the extent that Lord Hoffmann was suggesting it: (A) a term cannot be implied into a contract merely because it is reasonable, and (B) the process of implying a term into a contract is distinct from the exercise of interpreting a contract (paragraphs 22 to 31).

Lord Neuberger even went so far as to say that Lord Hoffmann’s comments in Belize should “henceforth be treated as a characteristically inspired discussion rather than authoritative guidance on the law of implied terms” (paragraph 31).

Lord Sumption and Lord Hodge agreed with the judgment of Lord Neuberger without comment. Lord Carnwarth and Lord Clarke made some brief comments, largely trying to make sense of Lord Hoffman’s comments in the Belize case as regards the distinction between the implication of terms and the construction of a contract. These brief comments may be referred to in later cases but are somewhat academic and, importantly, are unlikely to affect the main thrust of the Supreme Court’s decision to restate the stricter test for the implication of terms, as indicated by Lord Neuberger.