The contours of principle of 'business efficacy' in interpreting commercial contracts


Principle of 'business efficacy'  is well-recognized tool for interpreting a commercial contract inter se the parties. Documenting terms of a commercial contract may not always be perfect enough to capture and provide for all contingencies. During the performance of such contracts, often the parties face situations not explicitly dealt by the written contract. In such event the principle of ‘business efficacy’ is invoked to read an implied term in the contract so as to achieve the consequence intended by the parties, acting as prudent businessmen.

Conditions for applying ‘business efficacy’

The principle has now well established confines for its applicability. Per Supreme Court of India[1], parties indulging in commerce act in a commercial sense. On a review of precedents the court noticed that an implied condition can be read into the contract by invoking ‘business efficacy’ by satisfying the ‘five condition test’ viz.:

(1) it is reasonable and equitable;
(2) it is also necessary (and not merely reasonable) to give business efficacy to the contract;
(3) it is obvious and goes without saying;
(4) it is capable of clear expression; and
(5) it does contradict any express term of the contract.

Evolution of the Principle in United Kingdom

The decision of the Court of Appeal in the Moorcock’s case[2] is a leading case on test for implying terms into commercial contracts. In said case, dealing with a contract for the use of the jetty to a ship, for discharge of its cargo, regarding the implied warranty on the part of the owners of the jetty, the court held:

“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 business men; not impose on one side all the perils of the transaction, or to emancipate one side from the all 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.”

In a later decision in Reigate v. Union Manufacturing Co. (Ramsbottom) Ltd.[3], the principle was clarified to point out that term to be implied by recourse to business efficacy, must not contradict any express term of the contract and further the same must go without saying. It was held thus:

“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 so me one 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….”

The aforesaid principle found reiteration in Shirlaw v. Southern Foundries Ltd.[4] but with a note of caution, in the following words:

“I recognize that the right or duty of a Court to find the existence of an implied term or implied terms in a written contract is a matter to be exercised with care; and a Court is too often invited to do so upon vague and uncertain grounds. Too often also such an invitation is backed by the citation of a sentence or two from the judgment of Bowen LJ. in The Moorcock (1899) 2 KB 206. …For my part, I think that there is a test that may be at least as useful as such generalities. If I may quote from an essay which I wrote some years ago, I then said: “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!’”At least it is true, I think, that, if a term were never implied by a judge unless it could pass that test, he could not be held to be wrong.”

The House of Lords in Liverpool City Council v. Irwin,[5] clarified that the touchstone for interpreting commercial documents, cannot be ‘mere reasonableness’ but ‘necessity”

Indian Scenario

Principle of ‘business efficacy’ has been recognized and applied for long in India. For instance, Supreme Court of India in Dhanrajamal Gobindram v. Shamji Kalidas and Co.[6] acknowledged:

“Commercial documents are sometimes expressed in language which does not, on its face, bear a clear meaning. The effort of Courts is to give a meaning, if possible.”

Again in Khardah Co. Ltd. v. Raymon & Co. (India) Private, Ltd.[7], on interpretation of a contract it was observed as follows:

“We agree that when a contract has been reduced to writing we must look only to that writing for ascertaining the terms of the agreement between the parties but it does not follow from this that it is only what is set out expressly and in so many words in the document that can constitute a term of the contract between the parties. If on a reading of the document as a whole, it can fairly be deduced from the words actually used therein that the parties had agreed on a particular term, there is nothing in law which prevents them from setting up that term. The terms of a contract can be expressed or implied from what has been expressed. It is in the ultimate analysis a question of construction of the contract. And again it is well established that in construing a contract it would be legitimate to take into account surrounding circumstances...”

In  Union of India v. D.N Revri & Co.[8] the Supreme Court held:

“It must be remembered that a contract is a commercial document between the parties and it must be interpreted in such a manner as to give efficacy to the contract rather than to invalidate it. It would not be right while interpreting a contract, entered into between two lay parties, to apply strict rules of construction which are ordinarily applicable to a conveyance and other formal documents. The meaning of such a contract must be gathered by adopting a common sense approach and it must not be allowed to be thwarted by a narrow, pedantic and legalistic interpretation…..”

The Supreme Court in United India Insurance Co. Ltd. v. Manubhai Dharmasinhbhai Gajera[9]  considered the circumstances when reading an unexpressed term in an agreement would be justified on the basis that such a term was always and obviously intended by and between the parties thereto. It observed:

“‘An expressed 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.”

In Satya Jain (Dead) Through LRs. v. Anis Ahmed Rushdie (Dead) Through LRs.[10] the Supreme Court elucidated the test of business efficacy  as under:

“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 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…..”

The substance

The evolution and application of the principle of ‘business efficacy’ in various judicial pronouncements shows that it fills up gaps in a commercial contracts so as to achieve the intended obvious efficacy of the transaction. It by no means can substitute contrary terms agreed explicitly.

[1] Nabha Power Limited (NPL) v. Punjab State Power Corporation Limited (PSPCL) 2017 SCC OnLine SC 1239
[2] (1889) 14 PD 64
[3] [1918] 1 K.B. 592
[4] [1939] 2 KB 206
[5] [1977] AC 239
[6]  AIR1961SC1285
[7] MANU/SC/0428/1962
[8] AIR1976SC2257
[9] (2008) 10 SCC 404
[10] AIR2013SC434


Smita Singh 
on 09 August 2018
Published in Civil Law
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