It pays to be reasonable – Court of Session implies term for “business efficacy”

The decision by the Court of Session in Mr Khaled Hassan Ibrahim Zahid v Duthus Group Investments Limited [2018] CSOH 59 has shown the importance of clarity in contractual drafting and the extent to which a court may consider implying a term for the purpose of business efficacy.

Facts

On 4 November 2014, Khaled Hassan Ibrahim Zahid (Zahid) and Duthus Group Investments Limited (Duthus) entered into a Letter of Intent (the Letter) that set out the terms on which it was proposed that Zahid would participate with Duthus in the ownership of a new architectural company (the Company) which was to acquire an existing business in Dubai. Zahid agreed to pay a purchase price for 49% of the Company. The Letter acknowledged that Zahid would pay a total of USD 1m as deposits to Duthus, refundable in the event that Zahid decided not to proceed with the transaction. Zahid made the decision not to proceed and sought repayment of the deposits from Duthus. However, Duthus denied that the deposits were owed and refused to repay Zahid. Zahid initiated criminal proceedings in Dubai against Duthus for repayment of the deposits.

Issue

The remaining contentious issue was in respect of a contractual indemnity contained within the Letter and whether Duthus was obliged to indemnify Zahid in respect of the legal costs that were incurred by Zahid in seeking payment from Duthus. Zahid averred that he incurred legal expenses amounting to USD 722,478.59.

The indemnity in the Letter stated that:

“[Duthus] (for itself and as agent for each of its affiliates) hereby fully indemnifies me in respect of all costs and expenses (including but not limited to legal costs and expenses) which I may incur in any jurisdiction in relation to the recovery of the Deposits ... in the event that the Deposits are not repaid ... as provided for in this Letter of Intent”.

Counsel for Zahid submitted that on a proper construction of the provision, Zahid was entitled to recover from Duthus all costs and expenses which had been incurred in relation to the recovery of the deposits and not only “reasonable” expenses. Counsel for Duthus, on the other hand, submitted that the commercially sensible construction of the provision was that it meant “all reasonable costs and expenses…which I may reasonably incur”, stating that the reasonableness qualifications were necessary to give the contract business efficacy and were so obvious that its implication went without saying.

Judgment

The court accepted that, on proper interpretation of the indemnity, the express terms are not capable of bearing the construction which Duthus suggested. It was deemed that Duthus could only succeed in its argument if a term would fall to be implied in the indemnity.

The court considered the criteria discussed in Marks and Spencer v BP Paribas Securities Services Trust Co (Jersey) Ltd, supra. The Marks and Spencer case reinforces the conditions for an implied term as being (i) reasonable and equitable, (ii) necessary to give business efficacy to the contract, so that no term will be implied if the contract is effective without it, (iii) so obvious that ‘it goes without saying’, (iv) capable of clear expression and (v) not contradict any express terms of the contract. Lord Neuberger opined that, in respect of the second of the provided conditions, that a term can only be implied if, without the term, the contract would lack commercial or practical coherence.

The court noted that, on Zahid’s construction of the indemnity, Zahid would be indemnified for all costs and expenses, even if such costs were unreasonably incurred. The court did not accept this construction as being what a reasonable reader of the contract would have interpreted it to intend. A reasonable reader would, instead, take the view that the intended meaning was that it was only reasonable costs that would be recoverable and that such an interpretation would be so obvious as to go without saying. Furthermore, the court took the view that the implication of reasonableness would be necessary to give the contract business efficacy. Each of the other conditions were deemed to have been met, and therefore the court decided in favour of Duthus.

Comment

The court’s decision has emphasised the importance of ensuring that contractual terms are clearly drafted to reflect the intention of the parties entering the relevant contract. Parties should give careful consideration to contractual drafting and consider using express terms to avoid a court implying contractual terms into the relevant contract.

The case demonstrates that the court is willing, where circumstances allow, and where business efficacy necessitates it, to read in implied terms. As such, this case acts as a clear reminder to parties that when drafting contract terms they need to be clear, unambiguous and represent what both parties intended the bargain to be at the time it was entered into.