02. terms

The question

A contract, once formed, has content: the set of obligations the parties have undertaken. The previous sub-unit examined how a contract comes into being; this sub-unit examines what it contains. The content of a contract is found in its terms, the provisions that state what each party is bound to do, and a dispute over a contract is very often a dispute about its terms, what they are, what they mean, and how important each is. This sub-unit asks where the terms of a contract are found, how they are classified, and how they are interpreted, so that the reader can determine the content of a bargain and the consequences that attach to each part of it. The answer distinguishes the terms the parties have stated from those the law supplies, and ranks the terms by the importance the law accords them.

Express and implied terms

The terms of a contract are of two kinds according to their source. An express term is one the parties have themselves stated, in words written or spoken, and the express terms are the primary content of the bargain, the provisions the parties have consciously agreed. An implied term is one the parties have not stated, yet that the law treats as part of the contract nonetheless, supplied to complete the bargain where the parties have not provided for a matter themselves. The distinction connects to the requirement of certainty examined in the previous sub-unit, for the implication of terms is one of the principal means by which the law completes an agreement that the parties have left incomplete.

Terms are implied from several sources, and these are broadly common across the traditions. A term may be implied from the presumed intention of the parties, where it is necessary to give the contract the effect the parties evidently intended, so obvious that it went without saying. A term may be implied by law, where the law attaches a standard obligation to a particular type of contract, as the law of sale implies that goods sold will be of satisfactory quality and will correspond to their description. A term may be implied by custom or usage, where an established practice of a trade is taken to form part of contracts in that trade, a source that connects to the analysis of custom as a subordinate source in Course 1. The implied term thus supplements the express terms, supplying what the parties have omitted from the sources the law recognises.

Consider a contract for the sale of goods that states the quantity, the price, and the delivery date but says nothing about the quality of the goods. The express terms govern quantity, price, and delivery; the quality of the goods is governed by a term implied by law, namely that the goods will be of satisfactory quality, which the law of sale attaches to such contracts. The buyer's right to goods of satisfactory quality thus rests not on anything the parties said but on a term the law supplies. The example shows express and implied terms combining to constitute the full content of the contract.

The content of a contract is therefore composed of express terms, which the parties state, and implied terms, which the law supplies from the presumed intention of the parties, from the law attaching to the type of contract, or from the custom of the trade, the two together making up the obligations by which the parties are bound.

The classification of terms

Not all terms of a contract are of equal importance, and the law classifies them by the gravity of the consequences that follow from their breach. This classification is most fully developed in the common law tradition, which divides terms into three classes, and a comparable distinction by the seriousness of breach operates, by different means, in the civil law tradition and in the harmonised international instruments. The classification matters because it determines what a party may do when the other breaches a term: in particular, whether the innocent party may terminate the contract or must be content with compensation.

In the common law analysis, a condition is a term of such importance that its breach entitles the innocent party to terminate the contract and to claim damages; a warranty is a term of lesser importance whose breach entitles the innocent party to damages but not to terminate; and an innominate term, also called an intermediate term, is one whose consequences depend upon the seriousness of the breach that has in fact occurred, so that the innocent party may terminate only if the breach deprives that party of substantially the whole benefit of the contract. The civil law traditions and the international instruments reach a similar result through the concept of fundamental breach, examined in the sub-unit on breach, under which the right to terminate depends on whether the breach is sufficiently serious to defeat the purpose of the contract. The connecting idea across the traditions is that the right to terminate is reserved for serious breaches, while lesser breaches yield only a right to compensation.

Suppose a contract for the supply of machinery contains a term fixing the date of delivery and a term specifying the colour of the casing. If time of delivery is treated as a condition because it is essential to the buyer's purpose, a failure to deliver on time entitles the buyer to terminate; if the colour of the casing is a warranty, supplying the wrong colour entitles the buyer only to damages. Were the term as to the machine's performance an innominate term, the buyer could terminate only if the defect in performance were so serious as to deprive the buyer of substantially the whole benefit of the contract. The example shows the classification determining the remedy available for breach of each term.

The classification of terms is therefore the means by which the law calibrates the consequences of breach to the importance of the term broken, reserving the drastic remedy of termination for the breach of important terms or for sufficiently serious breaches, and confining the breach of lesser terms to a remedy in damages.

Exclusion and limitation clauses

Among the express terms of a commercial contract, a particular importance attaches to the exclusion clause and the related limitation clause, terms by which a party seeks to exclude or to limit the liability it would otherwise bear, whether for breach of contract, for negligence, or for other wrongs. Such clauses are a normal and legitimate feature of commercial contracting, the means by which parties allocate and price the risks of their dealing, yet they are also capable of abuse, particularly where one party is far weaker than the other, and the law accordingly subjects them to control.

The control connects to the accommodation of party autonomy and fairness that the orientation unit identified as a central concern of commercial law. The law controls exclusion clauses by two principal techniques, broadly common across the traditions. The first is interpretation: a clause excluding liability is construed strictly against the party relying upon it, so that it excludes only the liability its words clearly cover, and any ambiguity is resolved against the party who seeks to rely on the clause. The second is direct control of validity: legislation in many systems renders certain exclusion clauses ineffective, particularly clauses that exclude liability for fundamental obligations or that operate against consumers, a control examined further in the unit on consumer and competition regulation. Between commercial parties of comparable bargaining power, the law generally upholds the allocation of risk that an exclusion clause effects, intervening more readily where the clause operates against a consumer or a markedly weaker party.

Imagine a supplier whose standard terms exclude all liability for defects in the goods supplied. Against a commercial buyer of comparable strength, the law will generally give effect to the clause as a legitimate allocation of risk, construed strictly against the supplier; against a consumer, legislation may render the exclusion ineffective as an unfair attempt to deprive the buyer of basic protection. The example shows the law upholding the exclusion clause as an instrument of risk allocation between commercial equals while controlling it where it operates against the weak.

The exclusion clause is therefore a legitimate term by which commercial parties allocate risk, subject to the law's control through strict interpretation and through direct limits on validity, the law respecting the allocation of risk between commercial equals while protecting consumers and weaker parties from the abuse of such clauses.

Interpretation

When the parties dispute the meaning of a term, the matter becomes one of interpretation, the process by which a court determines the meaning of the words the parties have used. The approach to interpretation is broadly common across the developed traditions and rests on a single governing idea: the court seeks the meaning that the contract would convey to a reasonable person having the background knowledge available to the parties, rather than the private and unexpressed intention of either party.

This objective approach connects to the value of commercial certainty, for parties and third persons must be able to rely upon the meaning a contract conveys on its face, and a search for unexpressed private intentions would defeat that reliance. The court reads the words in the context of the contract as a whole and of the commercial purpose the contract was evidently intended to serve, preferring an interpretation that makes commercial sense to one that produces an absurd or uncommercial result, while remaining faithful to the language the parties chose. The traditions differ in matters of detail, such as the extent to which evidence of the parties' negotiations may be considered, but they converge on the central principle that interpretation is objective and purposive, directed at the reasonable meaning of the words in their commercial context.

Consider a supply contract that requires delivery of goods "in containers" without specifying their size. A dispute arises over whether a particular size satisfies the term. The court interprets the words objectively, asking what a reasonable person with the parties' background knowledge would understand them to mean in the context of this contract and its evident commercial purpose, rather than what either party now claims privately to have intended. The interpretation that makes commercial sense of the bargain prevails. The example shows interpretation operating as an objective and purposive inquiry into the reasonable meaning of the contract.

Interpretation is therefore the objective and purposive determination of the meaning of a contract's terms, directed at the meaning the words convey to a reasonable person in the parties' commercial context, an approach that serves the certainty on which commercial parties and third persons rely.