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Principles of Business Efficacy and Contra Proferentem and their application in interpretation of co

In the modern world, with every passing year, the volume of commercial transactions keeps increasing. The advent of technology and the ever-increasing means of communication have played a huge role in bridging the gap and increasing the business transactions between people.

However, in addition to the increase in the number of transactions, the stake involved in each transaction is also on a rise, thereby making business transactions in present scenario a very conscientious affair.

Prudent business persons have been known to protect their business interests by laying out, in clear and concise words, the terms and conditions in the form of a contract which is enforceable by law. It is a common practice to incorporate all foreseeable contingencies and their consequences into the contract to firmly establish the intention of the contracting parties and to avoid all kinds of ambiguity.

However, despite the best efforts of the parties, situations arise wherein a given term is capable of having multiple interpretations and when interpretation of such a term can substantially affects the rights of contracting parties, it brings about a deadlock between the parties. To disentangle the deadlock, courts often apply certain rules and principles which are discussed in detail in this article.

a) Business Efficacy

The Principle of Business Efficacy is now being widely invoked in India and it primarily means the power to produce the intended results in the absence of clear definitions in the contract. It is the prerogative of the contracting parties that the consequence intended by them while entering into the contract is achieved even though the terms of the contract might be ambiguous. To do so, the court can apply the principle of ‘Business Efficacy’ and read an implied term so as to ensure that the interpretation is in line with the intention of the contracting parties.

English Case Laws

In the leading English case law of The Moorcock, it has been held by the court of appeal that: 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 the other English case laws of Shirlaw v. Southern Foundries (1926) L.D and Reigate vs. Union Manufacturing Co. (Ramsbottom) Ltd, the courts, in addition to reiterating the above principle, further propounded the test of ‘Officious Bystander’ which needs to be satisfied while applying the above principle.

In the words of MacKinnon, L.J, the officious bystander is explained as follows:
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

Indian Case Laws

Surrounding circumstance to be considered while determining intention of parties
In India, the Supreme Court in Transmission Corporation of Andhra Pradesh Ltd. v. GMR Vemagiri Power Generation Ltd. (2018) 3 SCC 716 has held that:
The terms of a contract can be express 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 contact it would be legitimate to take into account surrounding circumstances. In the event of any ambiguity arising, the terms of the contract will have to be interpreted by taking into consideration all surrounding facts and circumstances, including correspondence exchanged, to arrive at the real intendment of the parties, and not what one of the parties may contend subsequently to have been the intendment or to say as included afterwards.

Five Point Test
In another case, Nabha Power Limited (NPL) V. Punjab State Power Corporation Limited (PSPCL) 2017 SCC Online SC 1239, the Supreme Court, while cautioning against its overzealous application by the courts, has held that the principle of business efficacy should be applied only when the five-condition test as laid out by the Lords of the Judicial Committee of the Privy Council of Australia in B.P. Refinery (Westernport) Proprietary Limited vs. The President Councillors and Ratepayers of the Shire of Hastings is satisfied.

The five-conditions which are required to satisfied are as follows:
i) Implied term must be reasonable and equitable
ii) Implied term must be necessary to give business efficacy to the contract
iii) Implied term must be so obvious that it goes without saying.
iv) Implied term must be capable of clear expression
v) Implied term must not contradict any express term of the contract.

If contract is capable of interpretation on its plain meaning, implied term cannot be read into

In Gedala Satchidananda Murthy v. Commr., Deptt. of Endowments, (2007) 5 SCC 677, the Supreme Court has held that:
A commercial document cannot be interpreted in a manner to arrive at a complete variance with what may originally have been the intendment of the parties. Such a situation can only contemplated when the implied term can be considered necessary to lend efficacy to the terms of the contract. If the contract is capable of interpretation on its plain meaning with regard to the true intention of the parties it will not be prudent to read implied terms on the understanding of a party, or by the court, with regards to business efficacy.

In light of all these judgements, it is pertinent to note that the principle of business efficacy is applicable only when the interpretation of the plain meaning of the contract is incapable of giving expression to the intention of the parties. When the plain meaning of a term or expression in a contract is clear, unambiguous and capable of providing an interpretation with respect to the intention of the parties, it shall not be within the rights of the parties or the court to read an implied term and provide an alternative interpretation under the guise of giving expression to the true intention of the parties.

However, when there is an ambiguity with respect to a particular term/expression or lack of clarity with respect to the true intention of parties, it shall be open to the parties or the court, having regard to the surrounding circumstances, to read an implied term so as to break the impasse and give force to the true intention of the parties.

Given the frequents disputes that arise in commercial contracts, the principle of business efficacy is proving to be a great asset in settling the disputes and upholding the true intention of the parities.

b) Contra Proferentum

Typically, contracts are well negotiated agreements between two parties with similar bargaining power. However, in certain cases, the negotiating power of one party may predominate over the other party’s power. In such cases, the dominant party has the liberty and the advantage to exploit this power and draft the contract to serve his/her best interests and to the disadvantage of the other party.

That being said, the weaker party is still expected to read the contract thoroughly and decide against the execution of the contract if he/she feels that the terms of contract are to his/her disadvantage. Wherefore, irrespective of how unfair the terms of the contract are, if they are clear, unambiguous, legal and not against the public policy, and if the contract was not executed by force, fraud or misrepresentation, the contract is binding on both the parties.

There being a clear difference in bargaining power in such cases, the dominant party who has the undue advantage is expected to lay out the terms in a very clear and precise manner so as to avoid any ambiguity. If the contract drafted by the dominant party lacks clarity or is not capable of giving clear meaning to the weaker party, then the weaker party will be pretty much left to bind himself/herself with terms and conditions which were not bargained or even understood by him/her.

In order to prevent the exploitation of weaker parties and provide a safeguard to them, the rule of contra proferentem is applied in most countries wherein the ambiguous term or clause, if present, will be interpreted or read in favour of the weaker party.

Contra Proferentum as defined by Halsbury's Laws of England (fifth edition- Volume 60 Para 105)

The principle of contra proferentum is stated thus:
Where there is ambiguity in the policy the court will apply the contra proferentem rule. Where a policy is produced by the insurers, it is their business to see that precision and clarity are attained and, if they fail to do so, the ambiguity will be resolved by adopting the construction favourable to the insured. Similarly, as regards language which emanates from the insured, such as the language used in answer to questions in the proposal or in a slip, a construction favourable to the insurers will prevail if the insured has created any ambiguity

Indian Case Laws
In case of doubt or ambiguity, terms are construed against the party who drafted it.

The Hon’ble Supreme Court has referred to this principle in the case of Industrial Promotion and Investment Corporation of Orissa Ltd. v. New India Assurance Company Ltd., 2016 SCC Online SC 842, and stated as follows:
Quite apart from contradictory clauses in policies, ambiguities are common in them and it is often very uncertain what the parties to them mean. In such cases the rule is that the policy, being drafted in language chosen by the insurers, must be taken most strongly against them. It is construed contra proferentes, against those who offer it. In a doubtful case the turn of the scale ought to be given against the speaker, because he has not clearly and fully expressed himself.

Nothing is easier than for the insurers to express themselves in plain terms. The assured cannot put his own meaning upon a policy, but, where it is ambiguous, it is to be construed in the sense in which he might reasonably have understood it. If the insurers wish to escape liability under given circumstances, they must use words admitting of no possible doubt.

In case of an ambiguity in contractual matters, it is inappropriate to import the principles of public policy.

The Hon’ble Supreme Court in Life Insurance Corporation of India Vs Insure Policy Plus Services Private Limited And Others, 2015 SCC Online SC 1384, in Para 18, has discussed the principle of contra proferentem and stated as follows:
We also think that it is not appropriate to import the principles of public policy, which are always imprecise, difficult to define, and akin to an unruly horse, into contractual matters. The contra proferentem rule is extremely relevant in as much it is the appellant who has drafted the insurance policy and was, therefore, well positioned to include clauses making it specifically impermissible to assign policies. In the absence of any such covenant, the applicant cannot be heard to say such transfers or assignments violate public policies. In any event, as we have seen above, the general global practice is to permit assignments of insurance policies.

When the words of a statute/contract are clear, plain or unambiguous, the rule of contra proferentem cannot be invoked.

The Supreme Court of India in United India Insurance Company Limited v. Orient Treasures Private Limited, (2016) 3 Supreme Court Cases 49: 2016 SCC Online SC 33, has held that:
Secondly, in the absence of any ambiguity, the respondent is not entitled to invoke the principle of underlined in the rule of contra proferentem for interpreting the clauses of the policy and lastly, presence of ambiguity in the language of policy being sine qua non for invocation of the contra proferentem rule, which is not present here, we cannot apply the rule for deciding the issue involved in the case.

It is a settled rule of interpretation that when the words of a statute are clear, plain or unambiguous i.e. they are reasonably susceptible to only one meaning, the courts are bound to give effect to that meaning irrespective of consequences.

Though the rule of contra proferentem seeks to protect the interest of the party with the weaker bargaining power, it should be used sparingly and cautiously. The default rule in interpreting contracts is to give expression to the plain meaning of the terms used in the contract. Rules such as contra proferentem which allows you to read an implied term should be applied only in cases where terms used in a contract are incapable of giving a clear and precise meaning.

While the rule of contra proferentem incentivizes clear drafting, it penalizes ambiguous and obscure drafting. The most essential condition of any contract is that both the parties entering into the contract should clearly understand and comprehend all its terms and provisions, thereby leaving no scope for any kind of ambiguity or uncertainty in the contract. Therefore, the rule seeks to ensure that contracts are drafted in a clear and unambiguous language.

It is only logical to give effect to the express terms and plain meaning of the contract rather than speculating on the implied terms.

Therefore, the literal rule (literal interpretation) is the most important and default rule in the interpretation of contracts. The propensity of the judiciary in giving expression to the plain meaning of the contract mandates that the true intention of the contracting parties be expressed in clear and precise terms so as to avoid any kind of ambiguity.

Wherefore, if there is any ambiguity in the contract and if it fails to give expression to the true intention of the parties, then the literal rule becomes inapplicable and a dispute arises between the parties. With the intention of ascertaining the true intention of the parties and safeguarding the weaker parties, the courts often apply certain rules and principles to determine the dispute between the contracting parties.

The principles of business efficacy and contra proferentem have helped solve many such disputes and they also serve as a means to ensure that the language and terminology to be used in a contract is capable of self-expression by virtue of its clear and well-defined meaning.

Written By: Mudassir Husain

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