Implied terms are commonly divided into terms implied in fact and terms implied in law. What are they and when will they arise?

Terms implied in fact

The original test for when the courts would imply a term in fact into a contract was laid down in 1889 in The Moorcock (where it was argued, and accepted, that there was a term implied in a contract for mooring a ship at the jetty under which the defendant owners of the jetty guaranteed that they had taken reasonable steps to see that the depth of the water around the jetty was such that it was safe for the claimant shipowners to moor their ship at the jetty). This was the business efficacy test: ‘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 business men’ (per Bowen LJ). So under the business efficacy test the courts will imply a term in fact into a contract where it was necessary to do so to make the contract work in the way that was intended by the parties to the contract.

A different test was suggested by MacKinnon LJ in the 1939 case of Shirlaw v Southern Foundries (1926) Ltd (where it was argued, and accepted, that there was an implied term in a contract appointing a managing director of a company for ten years that the company would not remove the director from his position for the period of his appointment, and it would not alter its articles of association so as to enable the director to be removed). This was the officious bystander test: ‘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!”’

There are problems with both these tests. Consider:

Dodgy: A Finance company sells an investment product to Mug knowing that the product is worthless and that Mug will probably lose a lot of money on the deal. However, selling the product to Mug (and thousands like him) will help Finance avoid the consequences of some terrible investment decisions that it made in the past. Mug has now lost a lot of money as a result of owning this investment product and wishes to sue Finance, arguing that there was an implied term in the contract of sale that Finance would warn the claimant if it knew that the product it was selling him was worthless.

Secretary: Randy appoints Beauty to work for him as a secretary. Randy has always fancied Beauty; in fact, that is the main reason why Beauty got the job. Two days after starting work, Randy tells Beauty he can’t stop thinking about her and would like them both to go away for a naughty weekend in Blackpool. Beauty does not welcome Randy’s advances and wants to argue that there is an implied term in her contract with Randy that Randy will not ask her out or in any way indicate that he is sexually attracted to her.

Neither of these terms need to be implied into the contracts in Dodgy and Secretary respectively in ordert to make the contracts work. Implying a term that Finance will warn Mug if it knows the product it is selling him is worthless will actually negate the contract, as Mug will not contract with Finance if he is given such a warning. And Beauty does not really need Randy to shut up about how much he fancies her to get on with her job of working for him as a secretary. So neither of these terms could be implied under the business efficacy test. And if we apply the officious bystander test, it is obvious that had an officious bystander asked Mug and Finance, ‘Is Finance undertaking to warn Mug if it knows this product is worthless?’ then Mug would probably have said ‘Of course!’ but Finance would have said ‘No, we’re not – it’s for Mug to decide whether or not to buy this product.’ And if an officious bystander had asked Randy and Beauty, ‘Is Randy undertaking not to sexually harass Beauty?’ then Beauty would probably have said, ‘Of course!’ but Randy would have said, ‘I think that’s a bit extreme – if I want to tell Beauty how beautiful she is, I think I should be allowed to do that.’

Maybe we should rest content with that, and say that Mug and Beauty will lose their cases, insofar as they are based on the implication of a term in fact into their contracts with Finance and Randy respectively. However, Mug and Beauty may still have two arguments left to them when arguing that there was an implied term in fact in their contracts:

(1) The Belize argument

In Attorney General of Belize v Belize Telecom Ltd (2009) (where it was argued, and accepted, that there was an implied term in a company’s articles of association that a director who had been appointed under a special procedure that could only be invoked by a shareholder holding a ‘golden’ share in the company and over 37.5% of ‘C’ shares in the company should step down if the shareholder who had appointed him subsequently sold some of its ‘C’ shares so that it no longer held 37.5% of the ‘C’ shares in the company), Lord Hoffmann suggested that both the ‘business efficacy’ and ‘officious bystander’ tests for implying a term in fact into a contract should be superseded by a new test under which a term will be implied into a contract if such a term ‘would spell out in express words what the [contract], read against the relevant background, would reasonably be understood to mean’ (at [21]).

As John McCaughran (‘Implied terms: the journey of the man on the Clapham omnibus’ (2011) 70 CLJ 607, at 614) has acutely pointed out, this test for implying a term in fact into a contract involves applying a reverse ‘officious bystander’ test – instead of the officious bystander asking the parties what they have meant to agree, the parties ask the bystander ‘You know the business background against which we are dealing – what do you think we have agreed in entering into this contract?’ Taking the power to determine the terms of the contract out of the hands of the parties and into the hands of a reasonable bystander might make it easier for Mug and Beauty to win their cases.

However, Hoffmann’s test for implying a term in fact into a contract can be criticised on a number of grounds. (i) He uses the exact same test for interpreting the terms of a contract (see his decision in Investors Compensation Scheme Ltd v West Bromwich Building Society (1997)) as he does for implying terms into a contract, but as Bingham MR pointed out in Phillips Electronique Grand Public SA v British Sky Broadcasting (1995), the two things are very different exercises – implying a term in a contract that the parties did not expressly say they wanted to be part of the contract is a lot more of an intrusion on the parties’ freedom of contract than trying to determine what the parties meant by a term that they did expressly say that they wanted to be part of the contract. (ii) Hoffmann’s test makes it too easy for the courts to impose on the parties to a contract terms that they did not want to be part of the contract, on the basis that a reasonable person with a similar business background to the parties would have thought that that term was part of the contract. (iii) Hoffmann’s test is also very vague and creates a great deal of commercial uncertainty for parties entering into contracts, as they would find it hard to predict what terms a court employing Hoffmann’s test might end up implying into the contract.

Perhaps significantly, the caselaw since the Belize case has not expressed much enthusiasm for Hoffmann’s test, with (1) the CA in Mediterranean Salvage & Towage v Seamar Trading & Commerce Inc (2009) endorsing the ‘business efficacy’ test, (2) the CA in Groveholt Ltd v Alan Hughes (2010) endorsing the ‘officious bystander’ test, and (3) a majority of the UKSC effectively disowning the test in Marks & Spencer plc v BNP Paribas Securities Services (2015) (at paras [22]-[31], per Lord Neuberger, with Lord Carnwath supporting the Hoffmann test in his judgment) in favour of implying a term when the ‘business efficacy’ test or the ‘officious bystander’ test indicates such a term should be implied (para [21], per Lord Neuberger). (See elsewhere on this website for a detailed casenote on the Marks & Spencer case.) So it is doubtful whether we should seek to rely on Hoffmann’s test in Mug and Beauty’s cases.

(2) The officious bystander argument revisited

Both Mug and Beauty might be able to argue that the ‘officious bystander’ test is satisfied in their cases. Both would rely on the fact that had an officious bystander asked whether Finance was promising to warn Mug if it knew that it was selling him a worthless product, or whether Randy was guaranteeing that he would not sexually harass Beauty, while Finance and Randy might say now that they would not have gone along with the officious bystander’s suggestion, at the time the contract was entered into things would have been very different. The officious bystander’s question would have put Finance and Randy in a very difficult position: they would either have had to confess that, no, they wanted the option of selling Mug or worthless product or sexually harassing Beauty and endanger the deal, or they would have had to act as though they were decent people and say to the officious bystander, ‘Of course we would never sell Mug a product that we knew to be worthless’ or ‘Of course I would never dream of making sexual advances to Beauty.’ Faced with this choice, they probably would have done the latter and suppressed the officious bystander with a testy, though grudging, ‘Oh, of course!’. Given this, Mug and Beauty might be able to argue that the officious bystander test is satisfied in their cases, or at least that Finance and Randy should not be allowed now to argue that the officious bystander test is not satisfied, given that at the time they would have probably been embarrassed (for fear of looking like a really dodgy person) or forced (for fear of endangering the deal) into giving a positive response to the officious bystander’s question.

I think argument (2) would probably work (see, in particular, para [21] of Lord Neuberger’s judgment in the Marks & Spencer case: ‘If one [asks] what the parties would have agreed, one is not strictly concerned with the hypothetical answer of the actual parties, but with that of notional reasonable people in the position of the parties at the time at which they were contracting’), and indicates that the officious bystander test, if sensitively applied, copes well with difficult cases such as Dodgy and Secretary. But less can be said in favour of the business efficacy test – if it would rule out an implied term in cases like Dodgy and Secretary on the ground that the terms were not needed to make the contract work, when such terms would be implied on the officious bystander test, then that seems to indicate that officious bystander test provides a more comprehensive test for implying a term in fact into a contract than the business efficacy test does.

Terms implied in law

It follows from the above that terms implied in fact into a contract are designed to give effect to the intentions of the parties – or what the parties reasonably indicated that they intended – in entering into the contract. Terms implied in law are quite different. Terms implied in law act as default rules for particular, well-established types of contractual relationship, such as those that exist between a business seller of goods and a purchaser of those goods, an employer and an employee, an insurance company and someone purchasing insurance from that company, a shipowner and an owner of goods placed aboard the ship, a builder and a client, a landlord and a tenant, and so on and so on. A default rule is a rule that will apply to a particular relationship unless the parties to that relationship indicate that they don’t want it to apply. Default rules are a huge aid to efficiency in contracting: they allow the parties to a well-established type of contractual relationship to contract with each other safe in the knowledge that a large number of terms will automatically be implied into the contract to safeguard their respective interests and that all they need to focus on in their negotiations are a few terms which need to be fiddled with to fit the circumstances of their case. (In the same way, the fact that when you open a new document on your computer, the fact that document is preformatted according to certain default rules for page size, font, margins, line spacing and so on, means they you can get on with writing what you want to write much more quickly: you don’t specify every aspect of what your document should look like – you can just focus on adjusting particular default rules that you don’t want to apply.)

Once we understand the status of terms implied in law as default rules, two things follow:

(1) We can make sense of the emphasis that the House of Lords placed in Liverpool City Council v Irwin (1977) on the courts’ only implying a term by law into a contract when it is necessary to do so. ‘Necessary’ here does not mean the same as ‘necessary to give business efficacy’ to the contract. If it did, then the House of Lords’ decision in Irwin would have effectively abolished terms implied in law. But it did not: the term that the House of Lords ended up implying in Irwin into the contract in that case between the landlord (the city council) and its tenants occupying a block of flats known as ‘the Piggeries’ was a term requiring the landlord to take reasonable steps to keep the common parts of the let premises in good repair. (In this case, that would have been the lifts and the stairs.) The House of Lords did not need to imply that term into the contract between the landlord and the council tenants in order to make the contract work properly – so ‘necessary’ in Irwin could not have meant ‘necessary to give business efficacy’ to the contract. What the House of Lords actually meant (see, on this, Jane Stapleton, ‘Duty of care and economic loss: a wider agenda’ (1991) 107 LQR 249, 290-1) by ‘necessary’ in this context was ‘The suggested term has to be such that we think it would be reasonable to imply this into any contract of the general type with which this case is concerned, so that from now on that term would become (unless the parties indicated otherwise) a necessary incident of a contract of that type.’ So before the House of Lords could imply a term by law into the landlord-tenant contract in Irwin, requiring the landlord in that case to take reasonable care of the common parts of the let premises, the House of Lords had to be convinced that it would be reasonable to imply such a term into any landlord-tenant contract no matter who the landlord might be and who the tenant might be. And plainly it was reasonable: when you are letting premises to a large number of people, it seems obvious that the responsibility for looking after the common parts of the premises should fall on the landlord and it would be very difficult for the tenants to co-ordinate efforts themselves to keep those common parts in good repair.

(2) When you are doing a problem question which turns on whether you can imply a term into a particular contract, and you have found that no such term can be implied in fact into the contract, it would be unwise to confidently assert that the courts will imply such a term in law into the contract unless you have statute or caselaw to support that assertion. If you do not, and it is a novel question whether the courts would imply a term in law of the type you are considering into this kind of contract, you cannot have any confidence that the courts will imply such a term into a contract, given the huge number of factors the courts would have to take into account in determining whether it would be reasonable to imply such a term into all contracts of that type. (For an account of these considerations see Peden, ‘Policy concerns behind implications of terms in law’ (2001) 117 LQR 459.) So when you are considering whether the courts will find that a term was implied by law into a particular type of contract, stick closely to the existing caselaw and statute law on this issue. And when it comes to the existing law, the two most important terms that will be implied by law into a contract (unless the parties indicate that they do not want the term to be implied – and even then their freedom to avoid that term may be limited by the Unfair Contract Terms Act 1977) that you have to know about and carry around with you in your mental knapsack are: (i) the terms implied into a contract between a business seller of goods and someone buying those goods that the goods will be of satisfactory quality and reasonably fit for the purpose for which the buyer let the seller know he wanted the goods (under s 14 of the Sale of Goods Act 1979); and (ii) the term implied into a contract for the supply of services, supplied in the course of business, that those services will be performed with a reasonable degree of care and skill (under s 13 of the Sale and Supply of Goods and Services Act 1982). Implied term (ii) is particularly useful as it applies in a wide range of circumstances – builder-client contracts; hotel-guest contracts, cinema-customer contracts, restaurant-diner contracts, and so on and so on.