The majority of Indian law favours an objective mode of interpretation while interpreting the terms of commercial contracts. The court uses the subjective theory of the presumed intention of parties as a safeguard to prevent the contract from being interpreted in a way that is inconsistent with the parties’ intention. The business efficacy test is looked at in this article as a substitute or even a countervailing factor to guarantee that the agreement reached between the parties is also given priority in arbitral awards involving the interpretation of business contracts.
Which theory to rely on while interpreting the terms of business contracts?
The interpretation of the terms of a commercial contract is required when there arises an ambiguity in the terms of the contract which gives rise to more than one possible interpretation.
As stated in the case of Nabha Power Ltd vs. Punjab State Power Corporation Limited(2017) there lie two possible theories of interpretation i.e., objective theory and subjective theory.
The objective theory focuses more on the literal interpretation of the contract terms than taking into account the parties’ intentions.
The subjective theory relies on the Latin term consensus ad idem which means the meeting of minds. This theory uses the intention of parties as the guiding factor. The intention of parties as the guiding factor in the subjective theory is culled out by the Courts by relying upon the pre-negotiation deliberations or the parol evidence of the parties.
Keeping in mind the facts of the case which can be summarised herein as- the Punjab State Electricity Board (PSEB) called for a competitive bid in order to finalise the developer for the power station in Punjab. In pursuance of the bid, M/S L&T Power Development Ltd. was successful in acquiring 100% shareholding in NPL. NPL entered into a 25-year Power Purchasing Agreement (PPA) with PSPCL (successor of PSEB) under which NPL was supposed to supply required coal to PSPCL.
The Dispute between the parties was with regard to the Formula Clause in the agreement.
The appellants contended that the ‘cost’ in the agreement included the cost of washing. They added that the cost incurred by them was inclusive of all costs till the transportation of coal to the project site.
However, the respondents contended that the cost of washing was not exclusively written in the terms of the contract, and moreover, if the parties intended to add the cost of washing the coal, then the same shall be set forth in the terms of the agreement. The terms of the agreement only included the costs of purchase, transport and unloading of the coal to the project site.
The Honourable Court while deciding the above dispute, i.e., whether the cost of washing the coal is inclusive/implied in the terms of the contract while determining the final costs paid to the appellants applied both the theories such as objective and subjective theory as stated above.
While applying the objective theory, the court applied the literal interpretation in determining that washed coal is inclusive of the term ‘coal’ in the agreement. Now, in order to determine the same, the court also adhered to the subjective theory which talked about understanding the intention of the parties and the commercial aim of the contract. The Court opined the fact that only the washed coal can bolster the efficiency of the intended business operation.
Conclusively, it can be said that the court took a middle stance between the two theories while interpreting the ambiguity in the terms of the contract. It is pertinent to note that the court not only relied on the literal interpretation of the terms of the contract but also stated that while applying the literal interpretation the same should not be contrary to the presumed intentions of both parties. Although the objective theory is justified by the implication of the provisions in business contracts, the courts must read the terms of the contract to avoid distorting or replacing the business insight of the professionals who created them. In order to ensure the disputed parties that the terms and conditions of the contract would be respected by the court, the same shall be done by giving careful consideration to the presumed intentions of both parties. Accordingly, the Court in this case found a suitable balance between the two theories, giving the objective interpretation the highest priority but also adopting the subjective theory of inferred intention of parties that is necessary to fulfil the commercial aim of the business contracts.
Business efficacy test
In India, the principle of ‘business efficacy’ has been recently frequently used by the Honourable Courts in India. The term is largely referred to when the contract terms are ambiguous. The principle of business efficacy is vividly used to achieve the contractual aim set by the contracting parties. Even if the contract’s provisions are unclear, the contracting parties have the right to ensure that the result they expected when they entered into the agreement is realised. In order to achieve this, the courts use the “Business Efficacy” principle to interpret an implicit phrase in a way that is consistent with the intention of the parties.
In the case of Transmission Corporation of Andhra Pradesh Ltd. Vs. GMR Vemagiri Power Generation Ltd. (2018), it was well established by the Honourable Supreme Court of India that in case of ambiguity, the terms of the contract shall be construed in a way, so as to give effect the collective intent of the parties which is visible in the commercial aim of the business contract.
Recently, in the case of M/S. Adani Power (Mundra) Ltd. vs Gujarat Electricity Registered Commission (2019), the three-judge bench of the honourable Supreme Court of India connoted the business efficacy test to be the power to produce intended results.
The court further said that it is necessary to comply with the business efficacy test in order to comply with the intended result agreed upon by the parties.
It is necessary to give effect to the terms of the commercial contracts by their literal and plain meaning. The literal rule of interpretation is considered to be the most important rule of interpretation when it comes to the interpretation of any ambiguous terms in commercial contracts. The proclivity of the judiciary in giving a clear understanding of the true meaning of the contract mandates that the true intention of both parties must be expressed clearly to avoid any ambiguity. However, in case of ambiguity,the Indian judiciary applies the business efficacy principle to solve disputes between the parties keeping in mind the overall commercial aim intended by the parties in commercial contracts.
Author(s) Name: Tanu Mehta (The Northcap University)
Nabha Power Ltd v Punjab State Power Corporation Limited (2017) Civil Appeal No.179/2017
Transmission Corporation of Andhra Pradesh Ltd. v GMR Vemagiri Power Generation Ltd (2014) Civil Appeal No. 874/2014
M/S. Adani Power (Mundra) Ltd. v Gujarat Electricity Registered Commission (2011) Civil Appeal NO.11133/2011