INTERPRETATION OF THE IMPLIED TERMS OF THE CONTRACT WITH RESPECT TO ARBITRATION MATTERS
Every contract contains both parties’ rights and duties, the violation of which may result in legal action against the party at fault. In order to avoid future disputes, the rights and duties are generally expressly stated in the contract. However, the existence of some contract terms is so obvious that even if they are not expressly stated, courts of law will hold them to be implied. This is referred to as the “Business Efficacy Test”.
The idea of business efficacy is typically used to interpret a clause in a contract or agreement so as to produce the outcome or effect that the parties, acting as wise businessmen, intended. Effectiveness in business refers to the capacity to achieve desired outcomes. To understand the jurisprudence behind the interpretation of the implied terms and applicability of Business efficacy test it is necessary to bring out the observation of the Hon’ble Supreme Court in the case of Satya Jain V/s Anis Ahmed Rushdie,[1] , wherein the Hon’ble Court observed the classic test of business efficacy as propounded in the The Moorcock Case,[2] wherein it was held that;
“… In business transactions such as this, what the law desires to effect by the implication is to give such business efficacy to the transaction as must have been intended at all events by both parties who are businessmen; not to impose on one side all the perils of the transaction, or to emancipate one side from all the chances of failure, but to make each party promise in law as much, at all events, as it must have been in the contemplation of both parties that he should be responsible for in respect of those perils or chances…”
… The business efficacy test, therefore, should be applied only in cases where the term that is sought to be read as implied is such which could have been clearly intended by the parties at the time of making of the agreement…”
Further, The Supreme Court detailed the legal framework surrounding implied contract terms in Nabha Power v. Punjab State Power Corporation[3] and upheld the five-prong (penta) test to be used in this situation. This test was established in B.P. Refinery (Westernport) Proprietary Limited vs. The President Councilors and Ratepayers of the Shire of Hastings (1994) 180 CLR 266, which required the following conditions to be satisfied: (1) reasonable and equitable; (2) necessary to give the contract business efficacy; (3) it goes without saying, i.e., The Officious Bystander Test; (4) capable of clear expression; and (5) must not contradict any express. Further Attorney General of Belize and Ors. vs. Belize Telecom Ltd. and Anr.[4] and Investors Compensation Scheme Ltd. vs. West Bromwich Building Society[5] both make reference to the identical penta-principles. It goes without saying that if the terms are expressly stated, the use of these principles would not be intended to replace this Court’s own interpretation of the presumptive understanding of commercial terms by the parties. Therefore, it is important to understand and interpret the multi-clause contract between the parties in a way that ensures that any interpretation of one provision does not conflict with another.
To summarize, for the effective implementation of the Penta Test as affirmed above the following requisites must be satisfied;
- reasonable and equitable;
- necessary to give business efficacy to the contract;
- it goes without saying, i.e., The Officious Bystander Test;
- capable of clear expression; and
- must not contradict any express term of the contract.
The most recent observation and clarification with respect to the abovementioned principle was observed in the case of Food Corporation Of India vs M/S Adani Agri Logistics Ltd, O.M.P[6]., wherein Hon’ble Justice Vibhu Bakhru observed that;
“This Court is unable to accept that the Arbitral Tribunal could by applying the business efficacy test to alter the express contract between the parties.”
Thereby, clarifying that the Business efficacy test is only applicable to the implied terms of a contract and cannot be used to change the express terms of a Contract.
Further when it comes to the interpretation of contract the Hon’ble Supreme Court in the case of Bharat Aluminium Company V/s Kaiser Aluminium Technical Services INC[7], has already observed that the contract’s terms must be understood in the manner that the parties desired and intended. Apart from the plain or grammatical meaning of the expressions and the use of the expressions at the proper places in the agreement, how the parties worked out the agreement is one of the indicators to decipher the intention in that context, particularly in arbitration agreements where party autonomy is the ground norm.
Conclusion
Contract interpretation is critical in arbitration, and any guidance on the principles to be applied in the aforementioned scenarios was limited to foreign principles. The reluctance of an arbitral Tribunal based in India to apply such principles is understandable, and thus it is enormously satisfying when an issue of contract interpretation in a power purchase agreement in a Thermal Power Plant was appealed all the way to the Supreme Court, and the Supreme Court recognized and relied on the principles of contractual interpretation in common law jurisdiction to provide domestic arbitrations with some affirmation in using such principles. Therefore, the principles established in Nabha Power v. Punjab State Power Corporation (Supra) will serve as the guiding principles for contract interpretation.
[1] (2013) 8 SCC 131
[2] (1889) LR 14 PD 64 (CA),
[3] (2018) 11 SCC 508
[4] [2009] UKPC 10
[5] [1997] UKHL 28
[6] (COMM) 82/2022, Delhi High Court
[7] Civil Appeal No. 7019/2005, Supreme Court of India
WRITTEN BY – PRAKHAR SHUKLA, ASSOCIATE LEGAL COUNSEL, SUO LAW
