Subjectivity or Objectivity? Supreme Court on Implied Terms in Commercial Contracts

[Manjari Rammohan is a 4th year student at School of Law, Christ University, Bangalore]

This post seeks to critically analyze the October 2017 judgment of the Supreme Court in Nabha Power Limited v. Punjab State Power Corporation Limited  with respect to remedying ambiguous terms in commercial contracts. This case is of vital importance as the Court comprehensively analysed Indian and international jurisprudence regarding implying terms in commercial contracts and upheld a five-pronged test to douse such ambiguities and breathe life into contracts. It will henceforth serve as a beacon of guidance to interpreting all commercial contracts.

Ambiguity in contracts arises when the terms are susceptible to more than one interpretation. Since a contract is primarily the creation of the will of parties, backed by legislation and subject to certain limitations, it has often plagued courts that are required to dissect these contractual terms drafted by the parties where it is capable of being understood in several ways. There are two guiding theories adopted by courts during the interpretation of vague contractual terms: the objective theory and the subjective theory. Simply put, the objective theory eschews taking into account the intention of the parties whilst decoding the ambiguous terms and instead relies solely on the plain or literal meaning of the terms. It can be summarized as:

Contracting parties must be made to know that it is their written words that constitute their contract, not their intentions that they try to express in the words. They, not the court, have chosen the words; and they, not the court, have made the contract. Its legal operation must be in accordance with the meaning that the words convey to the court, not the meaning that they intend to convey.[1]

On the other hand, the subjective theory extols using the intention of the parties as a guiding factor to decipher contractual terms. It is centered around the concept of consensus ad idem, or the meeting of minds, without which there is no contract formation.[2] Under this rule, the courts heavily rely on parol evidence or pre-negotiation deliberations of the parties while determining the intention of the parties.

Keeping the above in mind, the factual matrix of the Nabha Power Limited (“NPL”) case can be summarized as follows. The Punjab State Electricity Board (“PSEB”) called for a competitive bid in order to select a developer for a power station in Punjab. L&T Power Development Ltd. (“L&T”) secured the contract pursuant to the bid and subsequently acquired 100 per cent shareholding in NPL. NPL then entered into a 25-year Power Purchase Agreement (“Agreement”) with Punjab State Power Corporation Limited (“PSPCL”) – the successor entity of PSEB under which NPL was to supply coal to PSPCL. Disputes arose with regard to the interpretation of the Formula Clause in Clause 1.2.3 of the Agreement which reads as follows:

FCOALis the weighted average actual cost to the Seller of purchasing, transporting and unloading the coal most recently supplied to and at the Project before the beginning of month “m”.

It was the contention of NPL that the term “cost” included the cost of washing, transportation and handling, as well as crushing the coal. This was pursuant to a pre-bid clarification, where PSPCL stated that the successful bidder was to “arrange” for the washing of the coal. NPL argued that the costs included all charges borne by them till transportation at the project site. They invoked the principle of reddendo singular singulis to refer to the actual cost of transporting the coal to the project and the actual cost of unloading at the project site. On the other hand, PSPCL contended that the term “washing” was not expressly mentioned in the contract and if the parties intended for it to be included in the costs, there would have been a separate stipulation of the same. They also pleaded that until the claims fell under the three heads of the contract, i.e., purchase, transport and unloading, the same cannot be included in the costs of discharge. In a tussle between whether the actual cost or purchase cost of the coal was to be charged, PSPCL contended that the washing of the coal was not part of the purchase cost and could have been done in a washery or by outsourcing to a third party. It was not to include any expenditure paid by the plaintiff other than the purchase price paid, which was to supply coal from the Korba/Rajgarh field.

The crux of the issue before the Court was whether the cost of washing the coal could be implied into the contract while determining final costs to be paid to NPL. The Court analyzed several cases[3] on the concept of implied terms and upheld the five-pronged test before terms are read into contracts:

(1) It must be reasonable and equitable to imply terms;

(2) It must be necessary to give business efficacy to the contract, so that no term will be implied if the contract is effective without it;

(3) It must be so obvious that “it goes without saying”;

(4) It must be capable of clear expression;

(5) It must not contradict any express term of the contract.

The Court concluded that the pre-bid clarification made it abundantly clear that NPL had to “arrange” for the washing of coal, but did not imply that NPL alone was to be charged for the washing of coal. While dealing specifically with the principle of ‘business efficacy’, it was held that the contractual terms were to be interpreted in a manner as would be normally understood in the business sense, or in other words, an objective standard of the same. The Court also held that washed coal was a sine qua non to determine the quality of coal at the project site and thus inclusive of all costs till that point as no other coal but washed coal could be used in the project. It was further held that the Formula Clause contains only three elements – transportation, handling and storage – and only those terms incidental to them could form part of the formula. While analyzing this penta-principled test, the Court also held that the express terms of the contract would take precedence in the event there is a contradiction with the plausible implied terms. Interestingly, the Court also paid necessary heed to the presumed intention of the parties and retained that as a peripheral test holding that the implication of terms by courts should not be contrary to the presumed intent of the parties.

On a juxtaposition between subjective and objective theories of dealing with ambiguities, it can be observed that the Court, when faced with the task of implying terms into the contract based on the abovementioned test, is more likely to tilt towards an objective stance of the same rather than a complete intention-based guide. This means that literal or plain meaning rule is given more weightage to determine the implication of terms in the contract, rather than parol evidence and other manifest intentions of the parties. Accordingly, the term “Coal” was held by necessary implication to mean “washed coal” as only such coal would bolster the efficiency of the business operations as a lay businessman would understand.

However, the Court took a middle stance and combined both theories, holding that although objectivity is the primary element to formulate implied terms, such terms should not be contrary to the presumed intentions of parties. While implication of terms in commercial contracts does merit the objective theory, courts must tread carefully to not distort or substitute the business acumen of experts who have drafted the contract. This is where subjective theory of dealing with ambiguities must be given due weightage to reassure negotiating parties that their terms and conditions would be upheld by the court. Thus, the Court in this case struck a reasonable balance between the two theories, giving cardinal importance to objective interpretation but using the subjective theory of presumed intention of parties as a guard to which contrary terms cannot be presumed.

– Manjari Rammohan

[1] Arthur L. Corbin, The Interpretation of Words and the Parol Evidence Rule, Cornell Law Quarterly, 1965, 50:161.

[2] Peter M. Tiersma, A Message in a Bottle: Text, Autonomy, and Statutory Interpretation, Tulane Law Review, 76:2, 431-82.

[3] Liverpool City Council v. Irwin, (1976) Q.B. 319, Attorney General of Belize & ors. v. Belize Telecom Ltd. & An, (2009) 1 WLR 1988, Satya Jain (Dead) Through LRs. And Ors. v. Anis Ahmed Rushdie (Dead) Through LRs. And Ors, (2013) 8 SCC 131.

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