Implied Terms: is the reasonable observer legally trained? Secretary of State for Defence [2012] EWHC 120 Ch

Background

Contracts may be incomplete for a variety of reasons. Often written terms will not cater for every eventuality and, as a result, the court may be willing to accept that terms can be implied in certain circumstances. The test used when deciding whether to imply a term into a contract is objective. The court will ask what a reasonable observer would consider the contract to mean, given the background knowledge available to the parties when they entered into the contract.

The facts

The tenants in this case held a lease under the Secretary of State, as landlord. The parties agreed that an extra area of land should be added to the lease holding. To affect this, the parties entered into a written Memorandum. The intention of both parties was that the Memorandum would amend the original tenancy. However, as a matter of property law, the unintended effect of the Memorandum was that the original tenancy was surrendered and replaced with a re-grant of a new tenancy which comprised the additional land.

Before the Memorandum had been executed the parties had entered into an arbitration to decide how much rent was payable under the original tenancy – ultimately decided to be £27,700 per annum. Both parties had wrongly assumed that the rent review would fix the rent payable going forward under the new tenancy. However, this assumption was wrong due to the fact that the Memorandum replaced the original tenancy with a separate lease rather than affected a continuation of the old one. In contrast, the Memorandum stated that the agreed rent was £16,333. As a result, the tenants were due to make an unexpected and unintended saving.

The landlord argued that a term should be implied in the Memorandum, so that the rent review would decide the rent payable in the future under the new lease. This was on the basis that the test for implying terms into contracts did not attribute the reasonable person with the same knowledge as the parties, but rather the knowledge available to them. The landlord contended that the true legal position would have been available to the parties, regardless of whether the parties were aware of it.

Meanwhile, the tenants argued that it was not possible for the parties to intend something they knew nothing about.

The decision

The judge noted that when implying terms into a contract, the Court is not trying to establish what the parties subjectively intended. Rather the test is what an objective observer would think. As such, even knowledge which the parties were unaware of could be attributed to them, providing such information was available.

Comment

The difficulty which arises with this case is knowing exactly where the line should be drawn when assessing what knowledge was available to the parties at the time of transacting. For example, the Judge suggested that a complex tax scheme created with advice from an experienced tax QC would not be deemed to be available to the parties, but a principle of the kind applicable in this case would. The Judge added that a reasonable person cannot be assumed to be ignorant of clear and well known legal principles. However, it is hard to see how the legal principle in this case could be said to be 'clear and well known' when neither of the parties (one of which was a Secretary of State) nor their lawyers were seemingly ware of it.

Nonetheless, this case effectively demonstrates that the test for implying terms into contracts is tested objectively, rather than subjectively, and highlights the difference between the two.