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Contractual interpretation / implied terms

Published on 12 April 2018

How will the Court approach interpretation of related agreements and implying terms for "business purposes"?

The background

Kemutec Powder Technologies Ltd (KPTL) ran into financial difficulties and entered administration.  Process Components Limited (PCL) and Kason Kek-Gardner Ltd (KGL), both companies formed by former directors of KPTL, entered into asset sale agreements with KPTL for parts of the business and certain intellectual property rights. 

PCL and KGL subsequently entered into a licence agreement under which KGL licensed PCL to use IP formerly belonging to KPTL.  The licence included a termination clause for any material breach of the parties' obligations under the agreement.  When PCL was later acquired, it disclosed a copy of the licence to the purchaser.  KGL terminated the agreement on the basis that a confidentiality clause had been breached through this disclosure. 

The issues included interpretation of contractual provisions, what IP had KGL acquired, and was PCL estopped from asserting certain rights.  There were also issues regarding implied terms and termination of the licence between KGL and PCL. 

PCL argued that both sale agreements should be read together and, in the light of the overall administration, it made 'commercial common sense' that PCL would have received the IP relevant to the parts of KPTL's business that it had purchased.  PCL also argued that a term should be implied in the licence to permit it to disclose the contents of the licence 'for necessary business purposes'. 

The decision

The Court of Appeal clarified several points on contractual interpretation, as follows:

  • the parties' conduct after concluding an agreement could not be used to affect the interpretation of that agreement.As such, PCL's sale agreement, concluded 10 days after KGL's, could not be used to interpret the initial agreement;
  • the 'admissible background' to be considered in contractual interpretation is limited to facts known or reasonably available to both or all parties and it is not right to take into account facts known by only one party;
  • relying on 'commercial common sense' and the background of the agreements devalued the importance of the language of the contractual provisions in question;
  • an implied term will not be implied into a detailed commercial contract unless it is necessary to give the contract 'business efficacy' or it was so obvious it went without saying.The Court rejected PCL's proposed test that a term could be implied as it was reasonable for 'necessary business purposes', as an implied term must be necessary for the business efficacy of the contract rather than a wider business purpose of a party.

When interpreting the agreement under these principles, PCL had not acquired the IP in the divisions of KPTL it had bought.  There was also no implied term in the licence upon which PCL could rely and so the licence was validly terminated. 

Why is this important?

The Court of Appeal decision is a useful summary of existing principles of contractual interpretation.  It confirms that, for background knowledge to be admissible in the interpretation of contractual provisions, such knowledge must be known to all parties.  Background and commercial common sense should not be used to devalue the actual language of the contractual provisions being considered. 

Any practical tips?

As always, the wording of the agreement should properly capture the deal.  If there are commercial considerations/background that should be taken into account, include this within the recitals. 

Also remember that terms will only be implied in limited circumstances – eg they must be necessary to give business efficacy to the agreement, not because they are of wider assistance to the business.