Yet another legal ruling highlights the importance of avoiding loopholes and gaps when negotiating business contracts
If you’re a business negotiating a commercial contract you need to be sure it commits the other side to doing everything you want them to, exactly as you want them to – because, if there’s a loophole or gap in the agreement that the other side exploits, the courts will be very reluctant to imply a term into the contract to bail you out.
So it’s important to try to anticipate all the things that could go wrong and specifically address what will happen if they do, in clear, unambiguous language, to avoid having to later argue in court that the terms you think should apply, but which aren't actually in the contract, should be implied.
For example, once it’s been signed, the courts won’t imply a term into a business contract just because something has happened that you didn’t think of at the time, and you want to amend the contract to cover it. Or because you agreed something with the other side but it was never actually written into the contract.
Instead, you have to prove to the court that either the term you are arguing should be included in the contract:
- is actually necessary, to give the contract ‘business efficacy’ – the agreement simply won’t work without it. (Or, to put it another way, if the contract still works without the term you are arguing for, the courts won’t imply it into the contract); or
- is so obvious that it goes without saying that it should be implied into the contract.
The term you are arguing for also has to be reasonable and equitable, capable of clear expression, and must not contradict any express term of the contract, before it will be implied.
While the business efficacy and ‘so obvious it goes without saying’ tests are alternatives – only one needs to be satisfied for a term to be implied – the court noted that it would be a rare case where one was present without the other.
In a recent dispute a contract for the sale of a private company’s shares (the ‘sale contract’) said a seller was entitled to an addiitonal payment for the shares in the future if the company’s tax liabilities after the sale turned out to be lower than had been anticipated in the company’s accounts.
In order to establish whether they were, the sale contract said:
- The seller could require the new owner of the shares to ask the auditors to produce a report (to be paid for by the seller) saying whether the liabilities had turned out lower or not.
- If the report said the accounts had overstated the tax liability compared to the tax that was actually payable, the seller could become entitled to a further payment.
- Both the buyer and the seller had the right to ask the auditor to review its decision in future, to take any new circumstances into account.
The seller exercised its right to ask for an auditor’s report, and the buyer duly obtained one. But when the seller asked for a copy, the buyer said it was only going to show the seller the ‘background’ and ‘executive summary’ sections, saying that there was nothing in the SSA that said it had to show the seller the whole report.
The seller admitted that the contract didn’t expressly require the buyer to show it the complete report, but argued that a term requiring disclosure of the whole report should be implied into the sale contract because, without the full report, it could not know if it was entitled to exercise its right to ask the auditor to review its decision. It had never occurred to it to specifically say in the contract that the buyer had to show it the whole report because it was so obvious it had to, and the relevant terms in the contract wouldn’t work unless it did.
The court in this case agreed with the seller, saying that both of the above tests were satisfied, and the term argued for by the seller should be implied.
First, the court found that the sale contract clearly envisaged that both parties should have the right to ask the auditor to review its report later if there was a change in the circumstances that the auditor had based its report on. It said that ‘in order to engage effectively in that process the party needs to know the basis of the original [report] so as to be able to assess what circumstances were taken into account…’.
Since neither party could know this without seeing the whole report, it ruled that the relevant part of the sale contract could only work properly if that was the case. The seller had therefore satisfied the requirement of showing that the term to be implied was necessary to give business efficacy to the sale contract.
Second, it said that the two parties had opposing interests so it would be unusual if one was to have access to the report, but not the other – especially given that the party being denied access had paid for it. The more unusual an arrangement appeared if a particular term wasn’t implied, the more likely that the ‘so obvious’ test would be satisfied. In this case, it found that test was satisfied too.
While the seller’s argument that a term should be implied into the sale contract was successful in this case, remember that it’s still pretty unusual for the courts to imply terms into a business contract, so businesses negotiating contracts should ensure they are comprehensive, and clearly and unambiguously expressed, to avoid disputes about what they mean, or whether additional terms should be implied into them. Even this case, which seems obvious, ended up in a full-blown court case.
This highlights how important it can be to get an experienced legal adviser to draft important contracts.
In contentious business, a solicitor may not calculate fees or other charges as a percentage or proportion of any award or settlement.