Contract Law Week 4 21/02/22

Contract Law
Section 4: Contract Performance and interpretation
A. Doctrine of privity of contract
} Who can enforce a legal contract? The parties to it.
} Two limbs of privity rule: (1) burden side and (2) benefit side
} Burden side is not problematic – contracting parties cannot agree to place the
burden of a contractual obligation on a non-party to the contract.
} There are exceptions to this:
} Agency
} Law of property

Why do we have the privity doctrine?

} Allied to doctrine of consideration – third party has not taken part in an exchange or
bargain, they are a gratuitious promisee.
} Allows for certainty – promisor knows who will sue if they breach agreement.
} Connected to idea that contracts are promises, that is, binding obligations
undertaken to another person – the person to whom you undertake the obligation is
not necessarily the person who benefits from the obligation.

Problems with the privity doctrine

} Causes injustice and allows defendant to get away with breaching a contract: person
who can sue has suffered no loss; person who has suffered loss cannot sue because
of privity rule.
} Causes commercial inconvenience (‘parties’ to the contract are not necessarily the
ones who perform it).
} Defeats intentions of contracting parties (as in Tweddle v Atkinson)
} Judicial attempts to work around the rule resulted in a complex and uncertain law

B. Legislative reform of privity: Contracts (Rights of Third Parties) Act 1999

} Enacted after a comprehensive Law Commission Report (1996) into operation of
privity rule.
} Third parties may rely on the Act to sue under two conditions:
} Contract expressly permits it - S. 1(1)(a) (Tweddle v Atkinson);
} Contract purportedly confers a benefit on third party unless the parties did not
intend it to be enforceable by third party - S. 1(1)(b). (Nisshin Shipping v. Cleaves;
Beswick v Beswick)
Contract (Rights of Third Parties) Act 1999
} S. 1(1)(b) is subject to s.1(2) whereby it will not apply ‘if on a proper construction of
the contract, it appears that the parties did not intend the term to be enforceable by
the third party’.
} The third party need not be specifically named to benefit from the above sections (s.
1(3)) – the third party can be identified in the contract by name, as a member of a
class or as answering a particular description.
 } Chudley v Clydesdale Bank (2019) Court of Appeal – investors who lost money due to
breach of Clydesdale-Arck contract were identifiable as beneficiaries of the contract
(as ‘Paradise Beach’ investors) and could sue Clydesdale Bank.
} Crystallisation of third party right
} S.2 provides that unless the contract provides otherwise, the parties to the contract
may not rescind the contract, or vary it so as to extinguish or alter the third party’s
rights, without his or her consent if the third party has either:
} Communicated to the promisor their assent to the relevant term;
} Relied on the term and the promisor knows of the reliance, or
} Relied on the term and the promisor can reasonably be expected to have foreseen
that reliance
} Third party’s rights to remedies are the same as contracting parties - s. 1(5) – but
they are also subject to any defences available to promisor - s.3(2)).
} Section 1(6) – third party can claim protection of an exclusion clause in the main
contract (cf Eurymedon)
} Section 4 – contracting parties/promisee can also sue to enforce the agreement, but
not for the same loss as third party
} NOTE that the operation of the Act may be excluded by the contract terms
} Common law can still develop exceptions – section 7
} What’s happened to consideration? Doctrine relaxed so third party claim not
defeated by lack of consideration.

C. Common law exceptions to privity rule

} Remedies of promisee
} (i) specific performance (Beswick)
} (ii) promisee recovering on behalf of third parties if contemplated that third party
may suffer a loss (e.g., holiday cases; building transfers).
} Issue: who has a right to compensation recovered?
} Common law – agency, assignment, collateral contracts.
} Law of Tort, especially the tort of negligence and recovery of economic loss

Summary
} The privity rule tells us who is eligible to enforce a contract: only the parties to the
contract
} A party is someone to whom a promise is made and who provides consideration for
it
} Because the rule can cause manifest injustice and inconvenience, a comprehensive
statutory exception to it was introduced by the Law Commission: The Contract
(Rights of Third Parties) Act 1999.
} The judicially-developed exceptions still remain, and the rule itself has not been
abolished.

Contract Law Section 4: Contract performance and

interpretation
Intro
 } Doubt or ambiguity over what the terms mean.
} E.g., The Karen Oltmann [1976] 2 Lloyd’s Rep 708.
} Hirers of a ship had an option to return it “after 12 months’ trading”
} (i) at any time after 12 months?
} (ii) on exact expiry of 12 months?
} Implied terms (next set of lectures) are concerned with filling gaps
Why do courts have to interpret contracts?
} Terms as written may not achieve purposes that parties intended, or drafter may
make mistakes (e.g., Mannai Investments).
} Terms may not keep pace with changes in circumstances of the parties, particularly
when performance extends over a long time.
} Interpretation disputes very easy to generate (e.g., Covid-19 and insurance policies
covering ‘business interruption’).

Introductory points about contract interpretation

} Contract interpretation is a matter for the courts (a question of law) not the parties
} The same interpretation method is applied to all contracts of whatever type
} Precedents (previous cases) are of limited value
} Not all relevant evidence of what the contract means will be admissible – the main
exclusion here is ‘prior negotiations’ – these are not taken as a guide to what the
contract means because too subjective and unhelpful
} Chartbrook v Persimmon: Lord Hoffmann reasserted rule that prior negotiations
were not to be used when interpreting a contract
} Main debate is between formalists (emphasising plain meaning) v
contextualists/realists (emphasising background, purposes and commercial sense
over literal word meaning)

Traditional approach: literal method

1. Upholds objective intentions of the parties and freedom of contract
2. Easier for third party to understand agreement
3. Quicker, easier dispute resolution: greater certainty & predictability
} But:
1. Possible absurdity in result
2. No answer to genuine cases of ambiguity
3. Overlooks that all meaning is contextual.

Rise of contextualism or ‘commercial construction’

} Investors Compensation Scheme
[1998] 1 All ER 98: Lord Hoffmann’s statement:
Interpretation is the ascertainment of the meaning which the document [or utterance]
would convey to a reasonable person having all the background knowledge which would
reasonably have been available to the parties in the situation in which they were at the time
of the contract

2. ... Subject to the requirement that it should have been available to the parties and to
the exception [of prior negotiaions] [background] includes absolutely anything which
 would have affected the way in which the language of the document would have
been understood by a reasonable man (emphasis added).

BCCI v Ali: ‘I meant anything which a reasonable man would regard as relevant. I was
merely saying that there is no conceptual limit to what can be regarded as background.’

} Lord Hoffmann – no such thing as plain meaning - all meaning is accessed by

reference to context and experience.
} “semantic…analysis…must be made to yield to business common sense” Lord Diplock
in The Antaios [1985] AC 191
} Courts can ‘correct’ mistakes in the documents – sometimes
} Mannai Investments v Eagle Star Insurance – commercial lease could be terminated
provided tenant gave notice that expired on ‘third anniversary of lease
commencement date’.
} Lease commenced 13 January 1992.

Correcting mistakes: Mannai Investments v Eagle Star

} House of Lords split 3:2
} Lord Goff (minority): ‘the simple fact is that the tenant has failed to use the right key
which alone is capable of turning the lock’.
} Certainty in formalism - the parties know where they stand and the contractual
arrangement agreed between the parties is upheld (paper deal more important than
real deal).

Menai Investments v Eagle Star

} Majority reasoning: It would be obvious to a reasonable landlord that the tenant had
made a mistake.
} Words should be interpreted in a way that a reasonable commercial party would
construe them.
} The reasonable commercial person is hostile to ‘technical interpretations and undue
emphasis on the niceties of language’ (Lord Steyn).

Rainy Sky v Kookmin Bank

} Courts should apply plain meaning, but …
} Lord Clarke (SC): ‘if there are two possible constructions, the court is entitled to
prefer the construction that is consistent with business common sense and to reject
the other’ [20]-[23], [30].
} Patten LJ (CA): ‘Unless the most natural meaning of the words produces a result
which is so extreme as to suggest that it was unintended, the Court has no
alternative but to give effect to its terms’ [2010] EWCA Civ 582 [51].
Arnold v Britton
} 1980 – service charge of £90 pa
} 2015 – service charge of £2500 pa
} 2072 – service charge would be £550,000 pa
} http://ukscblog.com/new-judgment-arnold-v-britton-ors-2015-uksc-36/
} Decision in line with commercial expectations, but this not a commercial contract
} Courts concerned to ensure no escape from a bad bargain
 } Discourages opportunism around ‘ambiguity’ and encourages clear drafting
} Decision confirmed in Wood v Capita (2017) SC
} Problems with formalism – unexpected events

The Financial Conduct Authority v Arch Insurance (UK) Ltd and others [2021] UKSC 1
} Test case concerning interpretation of ‘business interruption’ clauses in insurance
policies in light of covid pandemic and national lockdown
} Clause: ‘We [insurer] shall indemnify you [business] in respect of interruption or
interference with the business … following any occurrence of a notifiable disease
within a radius of 25 miles of the Premises’
} Lords Hamblen, Leggatt and Reed: ‘As a matter of plain language, the clause covers
only cases of illness resulting from COVID-19 that occur within the 25-mile radius
specified in the clause’ [71]
} ‘the disease clause … is properly interpreted as providing cover for business
interruption caused by any cases of illness resulting from COVID-19 that occur within
a radius of 25 miles of the premises from which the business is carried on. The clause
does not cover interruption caused by cases of illness resulting from COVID-19 that
occur outside that area’ [74]
} No need for business to show a causal connection between the covid outbreak
within 25 miles, and their own business closure.

The Financial Conduct Authority v Arch Insurance (UK) Ltd and others [2021] UKSC 1
} Lords Briggs and Hodge relied on the context and purposes of the clause, rather than
language.
} Lord Briggs at [322]: emphasised the importance of the ‘reasonable reader’ rather
than an ‘insurance lawyer’ - ‘To my mind, that person would ask: do clauses with the
radius limitations provide cover for the adverse business consequences of a national
reaction to a national pandemic disease?’
} Reasonable reader would not embark on a detailed linguistic analysis.

Contract Law
Section 4: Contract performance and interpretation
Implied terms: general issues
} Writing a complete contract is:
(a) Impossible (parties lack perfect foresight)
(b) Expensive (‘transaction costs’)
} Justification for implication:
1. Making contract work (implied terms in fact)
2. Policy (terms implied in law)
3. Allocating risk for event ex post (i.e., after the event)
4. Extension of the process of interpretation

How can terms be implied

} By courts – ‘in fact’ and ‘in law’
 } By [trade] custom - must be ‘certain, notorious and reasonable’: Smith v Wilson
(1832)
} By statute:
E.g., Sale of Goods Act 1979, section 14(2):
‘Where the seller sells goods in the course of a business, there is an implied term that the
goods supplied under the contract are of satisfactory quality’.

Consumer Rights Act 2015

9. Goods to be of satisfactory quality
} (1) Every contract [between a trader and consumer] to supply goods is to be treated
as including a term that the quality of the goods is satisfactory.
} Advantages of the implied terms approach in this context

Implied terms in fact

} Limitations on courts implying terms in fact or by custom:
1. Not whole contracts (e.g., Baird v M & S)
2. Implication must be consistent with express terms
3. Implied term must be clear – that is the term must be formulated with sufficient
precision
4. Implication must be necessary, not just reasonable

Terms implied in fact: the ‘business efficacy’ test

} ‘Individualised’ term necessary to make the contract work.
} The Moorcock: implication of terms arises from ‘the presumed intention of the
parties with the object of giving to the transaction such efficacy as both parties must
have intended that at all events it should have.’ Per Bowen LJ.

Terms implied in fact: the ‘officious bystander’ test

} Sharla v Southern Foundries:
‘that which in any contract is left to be implied…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 of it in their agreement, they would testily suppress him
with a common, ‘Oh, of course!’’ Per MacKinnon LJ.
} Paragon Finance v Nash
} Held: term would be implied that the discretion to vary interest rates would not be
exercised ‘dishonestly, for an improper purpose, capriciously or arbitrarily, or in a
way that no reasonable lender, acting reasonably, would do’.
} ‘...such an implied term is necessary in order to give effect to the reasonable
expectations of the parties.’ Per Dyson LJ.

Bournemouth and Boscombe FC v Manchester United FC (CA)

} BBFC sold a player to MUFC for £200,000. £175,000 paid immediately, remaining
£25,000 was to be paid when the player had scored 20 goals for MUFC.
} Player scored 5 goals for MUFC in 13 matches between October and December 1972.
} Player sold to another club in February 1973 having scored only 1 more goal in 7
matches.
 } No express term in contract to deal with situation where the player was sold before
scoring 20 goals.

Shell v Lostock Garage

} Relevant tests for implication not satisfied.
} L claimed implied term breached by Shell: ‘Shell, as supplier, would not abnormally
discriminate against him’.
} Held: term was reasonable, but unnecessary to make contract work, nor could it be
formulated with sufficient precision.
} Shell would not have agreed to such a term (not to discriminate against D) if they
had been asked at the outset of the agreement.
} CA refused to grant an injunction.

Interpretation and implication

} AG of Belize [2009] Privy Council
} Lord Hoffmann: Different tests for implication in fact are just ways of expressing the
same question: ‘what the instrument, read as a whole against the relevant
background, would reasonably be understood to mean’.
} Marks and Spencer (tenant) v. BNP Paribas (landlord) UKSC
} Lease agreement where rent payable in advance
} M&S terminated early, which was permitted under the terms
} M&S sought refund of rent paid in advance. BNP refused – no express term in the
contract. M&S argued a term should be implied (in fact) entitling them to a refund,
as that was fair and reasonable
} Lord Neuberger reiterated the traditional tests for implied terms over Lord
Hoffmann’s interpretation-based approach in AG of Belize.
} No rent payable back to M&S – the suggested implied term did not pass the
‘officious bystander’ test.

Interpretation and implication of terms

} Wells v Devani [2019] UKSC 4
} Oral arrangement between house-seller and estate agent that the agent’s fees for
finding a purchaser were ‘2% + VAT’, but no indication of when this was payable and
on what.
} Seller claimed agreement for commission was too uncertain to be enforced.
} CA agreed – court could not create a contract for the parties if essential terms
(circumstances when commission payable) were missing.
} SC overruled – ‘it would naturally be understood that payment would become due
on completion and made from the proceeds of sale … that is the only sensible
interpretation of what they said to each other in the course of their … conversation’
[19].
} No need to imply a term to reach this result, although that was also an acceptable
route to the same outcome (on business efficacy grounds).
} Context of estate agency important here?

Terms implied in law

 } Terms implied in law are applicable to all contracts of a particular type (cf., terms
implied in fact)
} Justification is policy based - they are terms that ought to be included, irrespective of
the intentions of the parties, usually based on the category of relationship between
parties, e.g., landlord and tenant; employer and employee (Malik and Mahmud v
BCCI).

Terms implied in law: Liverpool CC v Irwin

} Facts: Liverpool CC owned a tower block of flats. The tenancy agreement did not
specify the landlord’s obligations.
} Common areas of the tower block were vandalised, lifts broke down, rubbish chutes
became blocked, stairways were unlit.
} Lease said nothing about landlord’s obligations to repair common areas of an
apartment building.
} Held: (HL) implied term necessary: landlord had an obligation to take reasonable
care of the premises.
} Term implied (in law) into all leases, but parties can exclude its operation

Relational contracts
} Implied term that the parties will act in good faith in a ‘relational contract’.
} Yam Seng v ITC (2013); Bates v Post Office (2019)
} What is a relational contract?
} Long-term; obligations cannot be formulated in advance; performance
depends on mutual co-operation of the parties
} What does good faith require?
} Observe reasonable commercial standards of fair dealing; faithfulness to
agreed purpose of the contract – not to frustrate it; act consistently with
justified expectations of the other party and considering the other’s
legitimate interests.
} Note that this is a controversial development, as it goes against long-standing
position that there is no duty of good faith in English contract law and the
individualist ‘ethic’ of contracts (as in, e.g., Walford v Miles)

Summary/assessment of implied terms

} Implied terms are those to which parties have not expressly agreed, but are supplied
by the law either on policy grounds (terms implied in law) or because they are
necessary to make contract work (terms implied in fact).
} Test for implying terms in fact has been stated in different ways:
1. Business efficacy test
2. Officious bystander test
3. Reasonable expectations of the parties test
} Do courts have too much freedom to interfere in bargains and impose obligations on
the parties that they did not freely accept during bargaining process?
} Commercial parties expected to bargain for express terms to deal with
contingencies, or loss will lie where it falls, unless contract is a ‘relational’ one.