Doctrine of Business Efficacy: The Law of Contract

The principle of business efficacy is normally invoked to read a term in an agreement or contract so as to achieve the result or the consequence intended by the parties acting as prudent businessmen. Business efficacy means the power to produce intended results.

In the matter of: Satya Jain V/s Anis Ahmed Rushdie, (2013) 8 SCC 131, after observing that the classic test of business efficacy was proposed by Bowen, L.J. in The Moorcock, (1889) LR 14 PD 64 (CA), it was held that:

“… This test requires that a term can only be implied if it is necessary to give business efficacy to the contract to avoid such a failure of consideration that the parties cannot as reasonable businessmen have intended. But only the most limited term should then be implied- the bare minimum to achieve this goal. If the contract makes business sense without the term, the courts will not imply the same. The following passage from the opinion of Bowen, L.J. in The Moorcock, (1889) LR 14 PD 64 (CA), sums up the position:

“… 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…”

Key Aspects: 

1.     An Unexpressed Term in an Agreement:

In the matter of: United India Insurance Co. Ltd. V/s Manubhai Dharmasinhbhai Gajera, (2008) 10 SCC 404, it was observed that:

“… An unexpressed term can be implied if and only if the court finds that the parties must have intended that term to form part of their contract: it is not enough for the court to find that such a term would have been adopted by the parties as reasonable men if it had been suggested to them: it must have been a term that went without saying, a term necessary to give business efficacy to the contract, a term which, although tacit, formed part of the contract which the parties made for themselves…”

2.     The Officious Bystander Test:

In the matter of: Shirlaw V/s Southern Foundaries (1926) Ltd., (1939) 2 K.B. 206: (1939) 2 All ER 113 (CA), it was observed that, prima facie that which in any contract is left to be implied and need not be expressed is something so obvious that it goes without saying; so that, if, while the parties were making their bargain, an officious bystander, were to suggest some express provision for it in their agreement, they would testily suppress him with a common “Oh, of course!”.  

3.     Joint Intent of Parties V/s Intent of the Reasonable Person:

In the matter of Rajasthan State Industrial Development and Investment Corporation & Anr. V/s Diamond & Gem Development Corporation Ltd. & Anr., (2013) 5 SCC 470, it was observed that the court of law generally assumes that parties to the contract are reasonable persons who seek to achieve reasonable results, fairness and efficiency; in a contract between the joint intent of the parties and the intent of the reasonable person, joint intent trumps, and the Judge should interpret the contract accordingly.

4.     Interpretation of Contract:

In the matter of: Bharat Aluminium Company V/s Kaiser Aluminium Technical Services INC, (2016) 4 SCC 126, it was observed that:

“… In the matter of interpretation, the court has to make different approaches depending upon the instrument falling for interpretation. Legislative drafting is made by experts and is subjected to scrutiny at different stages before it takes final shape of an Act, Rule or Regulation. There is another category of drafting by lawmen or document writers who are professionally qualified and experienced in the field like drafting deeds, treaties, settlements in court, etc. And then there is the third category of documents made by laymen who have no knowledge of law or expertise in the field. The legal quality or perfection of the document is comparatively low in the third category, high in second and higher in first. No doubt, in the process of interpretation in the first category, the courts do make an attempt to gather the purpose of the legislation, its context and text. In the second category also, the text as well as the purpose is certainly important, and in the third category of the documents like wills, it is simply intention alone of the executor that is relevant. In the case before us, being a contract executed between the two parties, the court cannot adopt an approach for interpreting a statute. The terms of the contract will have to be understood in the way the parties wanted and intended them to be. In that context, particularly in agreements of arbitration, where party autonomy is the ground norm, how the parties worked out the agreement, is one of the indicators to decipher the intention, apart from the plain or grammatical meaning of the expressions and the use of the expressions at the proper places in the agreement…”

5.     Implied terms are not to be readily inferred:

In the matter of: Attorney General of Belize V/s Belize Telecom Ltd., (2009) 1 WLR 1988 (PC), it was observed that:

“… The question of implication arises when the instrument does not expressly provide for what is to happen when some event occurs. The most usual inference in such a case is that nothing is to happen. If the parties had intended something to happen, the instrument would have said so. Otherwise, the express provisions of the instrument are to continue to operate undisturbed. If the event has caused loss to one or other of the parties, the loss lies where it falls…”

6.     Principle of Reddendo Singula Singulis:

a.     Where a complex sentence has more than one subject, and more than one object, it may be the right construction to render each to each, by reading the provision distributively and applying each object to its appropriate subject. A similar principle applies to verbs and their subjects, and to other parts of speech.

b.     For example, the sentence, “I devise and bequeath all my real and personal property to X”, will be construed reddendo singula singulis by applying ‘devise’ to ‘real’ property and ‘bequeath’ to ‘personal’ property.

Afternote:

1.     Commercial documents are sometimes expressed in language which does not, on its face, bear a clear meaning; the effort of court must be always to give meaning, if possible. [Hillas & Co. V/s Arcos Ltd., 1932 All ER Rep 494 (HL)]. In the matter of: Adamastos Shipping Co. Ltd. V/s Anglo-Saxon Petroleum Co. Ltd., 1959 AC 133: (1958) 2 WLR 688 (HL), the clause in the commercial document stated “This bill of lading”, whereas the document to which it referred was a charter-party; in the facts of the case, the House of Lords stated that effort should always be made to construe commercial agreements broadly and one must not be astute to find defects in them, or reject them as meaningless.

2.     The Penta-Test:

For invoking the business efficacy test and carving out an implied condition, not expressly found in the language of the contract, the following five conditions will have to be satisfied:

i.               Reasonable and equitable;

ii.             Necessary to give business efficacy to the contract;

iii.            It goes without saying i.e. the Officious Bystander Test;

iv.            Capable of clear expression; and,

v.              Must not contradict any express term of the contract. 

3.     The explicit terms of a contract are always the final word with regard to the intention of the parties. The multi-clause contract inter-se the parties has to be understood and interpreted in a manner that any view, on a particular clause of the contract, should not do violence to another part of the contract.

4.     In the matter of: Nabha Power Ltd. (NPL) V/s Punjab State Power Corporation Ltd. (PSPCL) & Anr, Civil Appeal No. 179/ 2016, Supreme Court of India, Date of Decision: 05.10.2017, Coram: R.F. Nariman & Sanjay Kishan Kaul, JJ., it was observed that:

a.     In the matter of: Reigate V/s Union Manufacturing Co. (Ramsbottom) Ltd., (1918) 1 K.B. 592, it was observed that:

“… These principles, however, have been clearly established: The first thing is to see what the parties have expressed in the contract; and then an implied term is not to be added because the Court thinks it would have been reasonable to have inserted it in the contract. A term can only be implied if it is necessary in the business sense to give efficacy to the contract; that is, if it is such a term that it can confidently be said that if at the time the contract was being negotiated someone had said to the parties, “What will happen in such a case”, they would both have replied, “Of course, so and so will happen; we did not trouble to say that; it is too clear.” Unless the Court comes to some such conclusion as that, it ought not to imply a term which the parties themselves have not expressed. …”

b.     In the matter of: Trollope & Colls Ltd. V/s North West Metropolitan Regional Hospital Board, (1973) 1 WLR 601 (609), it was observed that:

“… the court does not make a contract for the parties. The court will not even improve the contract which the parties have made for themselves, however desirable the improvement might be. The court’s function is to interpret and apply the contract which the parties have made for themselves. If the express terms are perfectly clear and free from ambiguity, there is no choice to be made between different possible meanings: the clear terms must be applied even if the court thinks some other terms would have been more suitable. An unexpressed term can be implied if and only if the court finds that the parties must have intended that term to form part of their contract: it is not enough for the court to find that such a term would have been adopted by the parties as reasonable men if it had been suggested to them: it must have been a term that went without saying, a term necessary to give business efficacy to the contract, a term which, though tacit, formed part of the contract which the parties made for themselves…”

c.     In the matter of: Equitable Life Assurance Society V/s Hyman, (2002) 1 AC 408 (459), it was observed that:

“… If a term is to be implied, it could only be a term implied from the language of [the instrument] read in its commercial setting…”

d.     An implied term in a commercial contract is a term that goes without saying, and is necessary to give business efficacy to the contract. The test to determine an implied term in a commercial contract is this: “What the instrument, read as a whole against the relevant background, would reasonably be understood to mean?”

e.     A multi-clause contract inter-se the parties has to be understood and interpreted in a manner that any view, on a particular clause of the contract, should not do violence to another part of the contract.

f.      In Para 72 of the report it was observed that:

“… We may, however, in the end, extend a word of caution. It should certainly not be an endeavor of commercial courts to look to implied terms of contract. In the current day and age, making of contracts is a matter of high technical expertise with legal brains from all sides involved in the process of drafting a contract. It is even preceded by opportunities of seeking clarifications and doubts so that the parties know what they are getting into. Thus, normally a contract should be read as it reads, as per its express terms. The ‘implied terms’ is a concept, which is necessitated only when the Penta-test referred to aforesaid comes into play. There has to be a strict necessity for it. …”

5.     In the matter of: Adani Power (Mundra) Ltd. V/s Gujarat Electricity Regulatory Commission & Ors, Civil Appeal No. 11133/ 2011, Supreme Court of India, Date of Decision: 02.07.2019, the ratio in the matter of Nabha Power Ltd. (NPL) (Supra) was quoted with approval.

*An Imprint of Lex Unified (Shivam Goel, Co-Founder)