The
Supreme Court has recently given a number of key judgments relating to contract
law. They cover a range of areas and, in some cases, mark a decisive shift from
the law as previously understood. These judgments will have implications for
many contracts.
This
is our second article which considers the practical implications of these Supreme
Court decisions and their implications for IT and outsourcing contracts. In our
first article, Matter
over Mind? The Impact of Recent Case Law on IT Contracts, we considered
the recent case law on contractual interpretation and noted the Supreme Court’s
emphasis on the clear and natural meaning of the terms even where it produces a
very bad bargain. This article considers the extent to which implied terms
might be used by a party to get around the restrictions that the courts have
put in place around a more flexible approach to interpreting contract terms. It
does so by reference to common scenarios in IT outsourcing contracts.
Implied
Terms
The
law on implied terms has been clarified by Marks
and Spencer plc v BNP Paribas [2015] UKSC 72. BNP (as landlord) granted
sub-underleases to Marks and Spencer in a building. Marks and Spencer served a
break notice half way through a rental period (having already paid for that
period in advance) and sought the return of the apportioned basic rent that was
paid for the period between the effective date of the break notice and the
expiry of the rental period.
There
was no express term providing for the return of an apportioned rent as Marks
and Spencer contended. They instead relied on an implied term to the effect
that BNP ought to pay back a proportion of the basic rent if the tenant exercised
a break clause.
Before
this case, there was some doubt as to whether a term could be implied into a
contract where the court felt that it would accord with the parties’ intention at
the time of contracting but where it was not strictly necessary for the
contract to operate.
The
Supreme Court re-iterated the general reluctance of judges to rewrite the
parties’ contracts and that the implication of terms into a contract is an
intrusive step (at [29]). A term is not to be implied ‘merely because it appears fair or merely because one considers that the
parties would have agreed it if suggested to them’.
For
a term to be implied:
(1)
it must be reasonable and equitable (although
the Supreme Court considered that this would almost always be satisfied where
the other criteria were satisfied);
(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, or it must be so obvious that ‘it goes without saying’;
(3)
it must be capable of clear expression;
(4)
it must not contradict any express term of the
contract; and
(5)
it must be the only contractual solution, or a
contractual solution that the parties would without doubt have preferred from
the possible solutions.
These
criteria are cumulative: they must all be satisfied and not merely one. The
most difficult criterion to satisfy will normally be the second but the court
confirmed that the test of the second criterion is not ‘absolute necessity’ because it is judged by reference to what is required
to give business efficacy to the contract. An alternative way of putting it is
that a term can only be implied if, without the term, the contract would lack
commercial or practical coherence.
The
Supreme Court also addressed the extent to which the test for implied terms
differs from the test to be applied when interpreting the terms of a contract.
This issue arose because in Attorney
General of Belize v Belize Telecom [2009] 1 WLR 1988 Lord Hoffman suggested
that the process of implying terms into a contract was merely part of the
exercise of construction of the contract. In Belize Telecom, Lord Hoffmann found that ‘there is only one question: is that what the instrument, read as a
whole against the relevant background, would reasonably be understood to mean?’.
The Supreme Court clarified that the term still needed to be necessary for
business efficacy or otherwise go without saying this in order to be implied. A
term cannot be implied merely because it would be reasonable to do so.
Otherwise, the risk is that a judge might effectively rewrite contracts based
on their own view of what is reasonable. In light of the above principles it
was found that there was no room to imply the term as asserted by Marks and
Spencer. The clear general understanding that neither the common law nor
statute apportioned rent payable in advance on a time basis meant it would
require a clear need for such a term to be implied to provide business efficacy
to the contract. That the absence of such a term was found by the Supreme Court
on the particular terms of the lease to be ‘curious’
and even ‘capricious’ or ‘anomalous’ did not make the contract
unworkable (Marks and Spencer, at
[[51]). Part of the reason for this is
that it was up to the tenant when to exercise the break clause in the lease and
therefore minimise the impact of paying the rent in advance.
Both
Marks and Spencer and Arnold v Britton [2015] UKSC 36 (more
fully considered in our first article) follow a similar trend – adherence
to the natural and ordinary meaning of the terms of the contract, a tacit
assumption that the parties meant what they said in the contract and,
therefore, a reluctance to depart from those terms in a material way unless the
circumstances really do require it in something approaching a clear way. It
strikes us that the courts will be very much alive to defeat opportunistic
attempts by parties to rewrite contracts in light of less favourable commercial
circumstances.
Practical
example
Example
1: Amendment Agreement
In
our
previous article, we considered a contract between BigCorp and
ServiceSolutions which entitled BigCorp to terminate in the event of three
consecutive months’ in which there were breaches of the Key Perfomance
Indicators (KPIs), where ServiceSolution’s performance fell behind and, after a
few months of breaches, the parties tried to settle the issue by entering into an
Amendment which stated it was ‘in full
and final settlement of all legal rights accrued by each party against the
other party falling within the Dispute’. After entering into the Amendment,
the KPI breach continued the next month. BigCorp threatened to terminate the
contract based on three months’ consecutive breaches, two before the Amendment
and one after. In our last article, we considered the interpretation of the
contract and concluded that the Amendment did not prevent BigCorp from relying
on the earlier months’ breaches to terminate. This was on the basis that the
legal right to terminate is unlikely to have ‘accrued’ for the purposes of the
Amendment, meaning that the underlying issue giving rise to the right to
terminate was not settled.
Given
the above, the next question is whether ServiceSolutions could be assisted by
an implied term that the contract is ‘reset’ so that neither party could rely
on pre-settlement breaches to terminate.
This
implied term would get around the unfairness of BigCorp relying on
pre-settlement breaches giving rise to strict breaches after the settlement
because the legal rights had not technically accrued at the time of the
Amendment. The implied term would widen the ambit of the issues that were
previously caught by the Amendment.
Would
the courts accept this implied term? While it seems harsh, given the result in Marks and Spencer, it seems unlikely
that such a term would be implied. While the Amendment may appear unfair,
unbalanced or surprising in allowing BigCorp to terminate in these circumstances,
this is not enough. The Amendment is workable without the implied term and so
it does not appear to be necessary to give business efficacy to the contract. Simply
because it is the most fair or reasonable outcome will not mean that such a
term can be implied into the contract.
Example 2: Dispute Resolution
Let’s now assume that BigCorp and ServiceSolutions enter
into a dispute resolution process because of the above disputes on termination.
The contract provides a tiered dispute resolution clause, which requires the
parties to escalate the dispute to CEO level and, if this fails to resolve the
dispute, for the dispute to be decided in a temporarily binding manner by a dispute
board.
The contract contains a mechanism to appoint a single expert
as the dispute board. If the parties do not agree on the expert they can apply
to the President of the SCL who will then choose the expert. However, the
contracts do not specify how the parties are to approach the expert’s terms and
conditions or provide a mechanism requiring the parties to use reasonable
endeavours to agree them or to accept reasonable terms.
ServiceSolutions considers that it has a weak case on some
of the points and have a strategic objective to delay the matter being resolved
against it as far as possible. They therefore refuse to negotiate or agree the
expert’s terms in order to delay his or her appointment.
In this scenario, can BigCorp argue that there is an implied
term that the parties could not object to terms of engagement which were
reasonable and consistent with the rights and obligations of the parties?
A similar question was considered in Cream Holdings Ltd v Davenport [2011] EWCA Civ 1287 and the Court
of Appeal held that implying such a term was both an obvious and necessary
means of giving effect to the contract. Looking back at the requirements set
out in Marks and Spencer it appears
to the authors that the implied term still would fall on the right side of the line.
Without the implied term the contractual provision for expert determination
would not work and this part of the contract would not be effective without it.
The parties contracted for an expert determination process, freely chose it and
are being prevented from entering into that process only by tactics. It must be
obvious that where those terms of appointment are reasonable and
uncontroversial the parties would have expected to have proceeded with the
appointment, that being the process that was chosen. However, the position may
be different where there is a genuine issue with the appointment (such as a
disagreement on whether the expert should be permitted to curtail
liability).
Example 3: Over-deployment of a Software Licence
Extending our factual scenario further, as part of its IT
system, BigCorp uses software licensed from a major software developer (‘MajorDev’).
The licence terms state:
‘Subject to complying with the terms of this Licence Agreement, the
Customer is permitted simultaneously to use 1,000 copies of the Software’
and
‘in the event that the Customer breaches the terms of this Licence
Agreement, the Customer is required to indemnify the Licensor for its breaches
and/or to pay for the cost of any Licences at the Licensor’s list price at the
time of the breach.’
Following an audit, MajorDev discovers that BigCorp actually
had 1,500 simultaneous users. The terms of the licence quoted above are permissive
(it ‘permit[s]’ BigCorp to use 1,000
copies simultaneously rather than prohibiting it from using more), so there is
no express breach of the licence by exceeding the number of simultaneous users.
Can MajorDev rely on an implied term that BigCorp must not
exceed 1,000 users?
This scenario is closer to the margins than Example 1. On
one level, it might reasonably be said that permission to use 1,000 copies
implies that there is an obligation to not use more than that number. However,
would such an obligation be ‘so obvious’ that it goes without saying? Following
the judgment in Marks and Spencer, it
seems likely that the answer to this question is no. While it is likely that
the parties would have intended their relationship in respect of use of the
software to be governed by the contract rather than a mix of contractual and
non-contractual obligations, the term is not necessary to give business
efficacy to the transaction. The licence can be viewed simply as granting
permission to BigCorp to use the software without being sued for IPR
infringement. Interpreted in this way, there is no need for a contractual
remedy for BigCorp exceeding 1,000 simultaneous users: BigCorp will be liable
for copyright infringement if the 1,000 user limit is breached. The contract is
therefore workable on its express terms without the need for a term to be
implied.
Alex Shattock is a senior associate solicitor at Norton Rose Fulbright.
Gideon Shirazi is a barrister at 4 Pump Court.
