CONSTRUING AND IMPLYING TERMS INTO ARTICLES OF ASSOCIATION: A-G OF BELIZE V BELIZE TELECOM LTD

The decision of the Privy Council in A-G of Belize v Belize Telecom Ltd [2009] UKPC 10, [2009] 1 WLR 1988 – a case kindly drawn to the attention of this blogger, which might otherwise have “slipped under the radar” – provides guidance, and the latest judicial thinking, at a very senior level, on the construction of articles of association, and the implication of terms into them, although the decision will have general application in both areas. 

The advice of the Board (comprising Lords Hoffmann, and Rodger of Earlsferry, Baroness Hale and Lords Carswell and Brown of Eaton-under-Heywood), was delivered by Lord Hoffmann, who adopted his standard approach to contractual matters of objective ascertainment of the parties’ intention viewed against “the relevant background”, as per Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896, 912-913.

Facts

The case arose out of the privatisation of the Belize Telecommunications Authority, whose “undertaking” was taken over by Belize Telecom Ltd (“BTL”), a company created for this purpose by the Belize Government.  The issue in the case concerned problems regarding the application of the articles of BTL regarding the removal of certain directors, when shareholdings changed, where the articles of association were silent. 

Under the articles of BTL, the Belize Government was granted a so-called “special share”, which, whilst it provided “no economic interest in” BTL, gave the holder a degree of “control” over the company, as it had a right of “veto” under the articles of association in various respects, but could not vote, amongst other things.  This share was able to be transferred with Government consent. 

There were also two classes of ordinary shares: B class and C class, under the articles.  The B class shareholders could appoint two directors, and the C class shareholders could appoint four directors.  The special shareholder could appoint two directors (known as “Government-appointed shareholders”).  Hence, there were eight directors of BTL. 

However, the Belize Government initially also had a sizeable number of C class shares.  This had consequences under the articles in relation to the appointment of directors.  If the holder of the special share had 37.5% of the C class shares, then it could appoint two out of the four C class directors.  Hence, with a little over a third of the shares, it could appoint or dismiss half the directors. [see para 6]  If the special shareholder had 25% of the C class shares, then there was a power of veto regarding certain “board and shareholder resolutions”.  And with no C class shares, the special share holder could still “appoint two directors”, plus veto certain members’ resolutions regarding the articles.  Thus, there were various gradations of power protecting the special shareholder’s “economic interest in” BTL [para 10; see also para 6].

BTL subsequently obtained the Government’s “special share”, plus “a majority of the B class and C class shares.  Thus, as BTL had over 37.5% of C class shares, it could now appoint “two special C directors”, amongst other things.  It is these directors who were the main problem in terms of the articles and implication.

Following a default by BTL on a loan for the shares, the Belize Government, which had by then sold its special share to BTL, exercised rights of pledge over the ordinary shares and reclaimed a large quantity of these shares.  This left BTL, which had appointed “two special C directors”, pursuant to its then greater than 37.5% number of C class shares, with less than 37.5% of the C class shares.  (BTL had also appointed two so-called “Government-appointed directors” under its special share.)

Hence, the issue arose: what was the status of these “two special C [class] directors”, as they could only be removed by “a special shareholder” who held at least 37.5% of the C class shares, and such a party no longer existed.  Also, the articles were silent about the situation concerning so-called “Government-appointed directors when the special share has been redeemed and no longer exists”.  [Para 14]

Argued

It was argued, by BTL, that such directors (the “special C directors” and the “Government-appointed directors”) were “irremovable”.  By contrast, the Attorney-General (on behalf of the Government) argued that the articles should be read as implying a term that such a director should vacate office when there is no longer a relevant “shareholding” with power to appoint.

Held

The Privy Council, not surprisingly, upheld the argument of the Attorney-Genera (and the judge at first instance), and implied such terms into BTL’s articles concerning the retirement of the directors in question. 

However, what is interesting for commercial practitioners is the approach taken to the construction of articles of association and, more significantly, the approach taken to the implication of a term into them.  As articles of association are contracts, pursuant to s 33 of the Companies Act 2006, the reasoning of their Lordships will have general application to contracts (and statutes).

Principles Concerning Implied Terms

Early on in his advice, Lord Hoffmann made various “general observtations” concerning implied terms, which, on the face of them, appear to recast the position regarding implied terms by seeming to subsume the old tests for implication (e.g., “goes without saying”, “necessity”, and “business efficacy”) into his “reasonable person with the relevant background” matrix from Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896, 912-913.  Lord Hoffmann began (at para 16) in orthodox fashion by saying (at para 16) that it is not for court “to improve upon the instrument” it has to interpret: “be [it] a contract, a statute or articles of association”.  Moreover, he said, the court is not permitted to “introduce terms to make it fairer or more reasonable.”  

His Lordship then warmed to a familiar theme, and went on to say that the court’s sole concern is discovering “what the instrument means”.  Such “meaning” will be what “meaning” is conveyed “to a reasonable person” who has “all the background knowledge … reasonably available to the audience to whom the instrument is addressed (see Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896, 912-913): it does “not necessarily or always” correlate with “what the” document’s “authors or parties … would have intended”.  Thus, one is looking at the parties’ “intention or … [that] of Parliament” in an “objective” sense.  [Para 16].

Lord Hoffmann continued by saying that where an “instrument” does not explicitly deal with a situation which has arisen, normally “nothing … happen[s]”, as the instrument would have reflected the parties’ intentions and so said something about the “event”, with any “loss” lying “where it falls”.  [Para 17].  But a term will be implied where a “reasonable addressee” would regard the instrument as meaning “something else”, namely, that, given the nature of the instrument, as a whole, in the light of “the relevant background [,] … something is to happen”, and this “event” will impact upon the parties’ “rights”.  Hence, whilst the instrument does not say this, “this is what it must mean”, objectively speaking.  Here, a term is implied, by the court, regarding “what will happen if the event in question occurs”.  Lord Hoffmann concluded these opening remarks by stating (consistently with the ICS case) that implying a term does not constitute “an addition to the instrument”: rather, it merely “spells out what the instrument means”.  [Para 18].

Status of the Old Tests

More significantly, after outlining these “canons of construction”, Lord Hoffmann turned his attention to criteria used in previous cases regarding the implication of terms, and examined them in the context of the above “canons”.  His Lordship went on to say that statements, such as, (i) an ‘implied term must “go without saying”’, and (ii) it has to ‘be “necessary to give business efficacy to the contract” etc, whilst “helpful” to “a court … in providing an answer”, should “not … be treated as different or additional tests” to the sole “question” of: “what [would] the instrument, read as a whole against the relevant background …. reasonably be understood to mean?” [Para 21, referring to the use of these phrases in the judgement of Lord Pearson in Trollope & Colls Ltd v North West Metropolitan Regional Hospital Board [1973] 1 WLR 601, 609, quoted, at para 20, in the Belize Telecom case] 

His Lordship felt it was dangerous to treat “these alternative formulations of the question as if they had a life of their own”, and proceeded to explain why he thought this.  In relation to implying a term in a contract as it is ‘“necessary to give [it] business efficacy”, this “formulation” highlights “two important points”.  First, that the reference to ‘“business”’ means that the objective reader, knowing “the relevant background”, should consider what “the practical consequences of deciding that [the instrument] means one thing or the other”, and that where the instrument is “a commercial” agreement, that reader “will consider whether a different construction would frustrate the” parties’ “apparent business purpose”.  [Para 22]  Secondly, the reference to ‘“necessary”’, his Lordship said, means it is insufficient “for a court to consider that the implied term expresses what it would have been reasonable for the parties to agree to.”  [Para 22]. 

What Lord Hoffmann considered was dangerous was the detachment of “the phrase “necessary to give business efficacy” from the basic process of” interpreting “the instrument”.  Hence, a contract may be “perfectly” workable, as the parties to it are able to carry out their explicit contractual “obligations”, however, the result of doing so is to transgress/a contradiction of “what a reasonable person would understand the contract to mean”.  [Para 22].  However, it is suggested that this fear is, perhaps, a little over-exaggerated, as people will, normally, read the contract “in the round”, and take the view that to make it work, as the parties’ intended, in a commercial sense, a term needs to be implied.

Similarly, Lord Hoffmann felt that saying an “implied term must ‘go without saying’” was simply “another way of saying that, although the instrument does not expressly say so, that is what a reasonable person would understand it to mean”.  His Lordship also considered that “it [was] not necessary that the need for the implied term should be obvious in the sense of being immediately apparent, even upon a superficial consideration of the” contract’s provisions plus “the relevant background”.  [Emphasis added.]  This was because a term often has to be implied because of a drafting omission in a complex document resulting from a failure to “fully” consider and appreciate possible “contingencies … even though it is obvious after a careful consideration of the express terms and the background that only one answer would be consistent with the rest of the instrument”.  [Para 25]. 

Lastly, by way of comment, Lord Hoffmann said the five potentially overlapping criteria or “conditions” used by an earlier Privy Council in BP Refinery (Westernport) Pty Ltd v Shire of Hastings (1977) CLR 266, 282-283, per Lord Simon of Glaisdale, are “best regarded, not as series (sic) of independent tests which must each be surmounted, but rather as a collection of different ways in which judges have tried to express the central idea that the proposed implied term must spell out what the contract actually means, or in which they have explained why they did not think that it did so”.  (As readers will recall, the five criteria, referred to as a “list” by Lord Hoffmann, are that the implied term has to be (i) “reasonable and equitable”; (ii) “necessary to give business efficacy to the contract, so that” a “term will [not] be implied if the contract is effective without it”; (iii) “so obvious that ‘it goes without saying’”; (iv) “capable of clear expression”; and (v) such that it does “not contradict” an “express” contractual provision.)  [Paras 26 and 27]

With regard to criteria (i), (iv) and (v), described as “the other formulations”, if a potential “implied term” was “inequitable or unreasonable”, or contradicted “what the parties expressly said”, or was “incapable of” being clearly expressed, then these would be “good reasons” to say “a reasonable” person “would not have understood that to be what the instrument meant.”  [Para 27].

The Decision

In coming to their decision to imply terms regarding the various directors demitting office when there was a change in the shareholding, their Lordships noted two matters: first, BTL’s board of directors was “constructed so that its membership” reflected its shareholders’ “interests”: namely, the Belize Government’s “political interest” via “its special share”, and its “economic interest” via its C class shares; as well as the B class and C class members’ “economic interests”.  Secondly, there was a careful gradation of “the powers” conferred on the Belize Government (or any party succeeding it as the “special shareholder”) to reflect its “economic interest in the company at the relevant time”.  [Para 28].  The difficulty was that the articles did not explicitly address themselves to rectifying “the situation” of an alteration of BTL’s shareholders resulting “in the board no longer reflecting the appropriate shareholder interests” by permitting the removal of the relevant directors.  [Para 30].

As a consequence, the Privy Council took the view that, because of “the role of the Government-appointed directors and the policy of” permitting “the Government” to redeem “the special share”, so that the Government no longer influenced what the company did, one could not say that the reasonable (or objective) meaning of the articles of association was “that the Government-appointed directors should” stay as directors once “the special share” has ceased to exist.”  One had to “read” the articles “as providing by implication that when the special share” went, so did “the Government-appointed directors”.  [Para 30]

Thus, “if … it would be plainly necessary to imply such a term” regarding “the Government-appointed directors”, then it followed when the special share was redeemed, then “the special share C directors” should “also cease to hold office”.  [Emphasis added].  These directors hold office because due to “the special share”, and so when “the special share” ceases to exists, there is “no one” having the power, pursuant to “the articles to remove them”, and so the/there is no “basis” for distinguishing them “from ordinary C [class] directors appointed by the majority of the C [class] shareholders”, pursuant to the articles, is not applicable any more.  [Para 31].

The Privy Council concluded by saying that “if the implication is necessary to” avert “absurd consequences” arising due to the special share being redeemed, then “no difficulty” arose regarding the application of “the same principle” where there is a “special shareholder” (here, BTL), but that special shareholder does not have the requisite 37.5% of the shares to permit them “to appoint and remove special C directors”.  [Emphasis added].  Hence, here an implied term was “required to avoid defeating what appears to have been the overriding purpose of the machinery of appointment and removal of directors”, i.e., ensuring the board of directors reflected “the appropriate shareholder interests in accordance with the scheme laid out in the articles”.  [Para 32].

Commentary

It was clear (or, dare I say, “obvious” and “necessary”) that terms had to be implied into the articles here, so that they worked, and an absurdity, almost bordering on a “Catch 22” type situation was avoided.  As this was a private company, then, unlike a public company, there was no process of directors retiring by rotation (as to which: see, for example, article 21 in Schedule 3 (public companies) of the Companies (Model Articles) Regulations 2008 (SI 2008/3229).  If there had been such a mechanism, then one would simply have waited for the directors to retire.

Lord Hoffmann has been one of the greatest jurists of the late 20th and early 21st century, particularly in terms of company law and the interpretation of contracts, and, no doubt, when in practice at the Chancery Bar in London, would have had to construe articles of association for clients on many occasions.  However, with all due respect, the reasoning in this case is unhelpful to practitioners having to advise clients when a term can be implied and, dare I say it, perhaps, a little confusing.

The problem, it is suggested, is two-fold.  First, a method of construing contracts (which has not escaped criticism) now seems to have been converted into a type of “all-embracing” formula for dealing with contractual problems, as it has been applied, by Lord Hoffmann, to remoteness of damage (see Transfield Shipping Inc v Mercator Shipping Inc; the Achilleas [2008] UKHL 48, [2009]1 AC 61, and now to the implication of terms in a contract.  Whilst contract is a consensual bargain between parties, normally, to obtain certain benefits, and so one needs to see what the parties’ agreed (in an objective sense), there is, to use Lord Hoffmann’s words “a danger” “the reasonable person with the relevant background” approach to construction, will “take on a life of its own”, with an impact upon other rules concerning contracts.  And we have seen there can be difficulties when particular approaches do “take on lives of their own”, such as, the reference to “legitimate expectations”, in relation to “unfair prejudice” petitions under the then s 459 of the Companies Act 1985 (now s 994 of the Companies Act 2006) (see O’Neill v Phillips [1999] 1 WLR 1092, 1102, or the two-part test for negligence in Anns v Merton London Borough Council [1978] AC 728, 751-752.  The result is a tendency to slot things into the “formula”, which may have unforeseen consequences.

The second problem is that by using this “all-embracing” formula, in relation to implied terms, the reasons for the implication can be obscured or subsumed into the formula.  Hence, after reading the contract objectively, with “the relevant background” in mind, one still needs to assert a reason or basis for implying a term.  By subsuming the “time-honoured” tests of “goes without saying”, “necessity” or “business efficacy” into the formula, the reason for implication can be lost.  If one applies the approach in Belize Telecom, the implication process has now become, effectively, a one-stage process: what does the contract say, objectively, whereas, in reality, it is at least a two-stage process: (i) what does the contract objectively say? and (ii) in view of what has happened, which the contract is silent on, do we need to imply a term into it, and, if so, why?  To paraphrase the late Professor Birks, this is how the human mind thinks: it breaks things down into smaller categories or stages.  In regard to this second stage of why should we imply a term, the old tests provide the basis for doing so, in the context of the contract.

What is somewhat curious with this seemingly new approach of what does the contract mean, based on the reasonable person with the relevant background” is that, first, when the House of Lords was considering implied terms in J & H Ritchie Ltd v Lloyd Ltd 2007 SC (HL) 89, [2007] Bus LR 944, in the context of sale of goods, their Lordships did not refer to the ICS case, but were content to use the test of “necessity to give the contract business efficacy” approach: see, for example, Lord Rodger, who delivered the leading speech, at paras [34] and [37] in that case.  Hence, if it was acceptable in a more complicated case like Ritchie, why do we need to relegate the old tests to an, at best, assistant’s role. 

Secondly, nonetheless, the Privy Council in Belize Telecom still makes reference to implied terms being “necessary”, so, perhaps, “old habits do die hard” (see also on this the comments of Lord Clarke of Stone-cum-Ebony MR in Mediterranean Salvage & Towage Ltd v Seamar Trading & Commerce Inc [2009] EWCA 531, [2009] 1CLC 909, para 15, who feels the need to show “necessity”, as stated in Liverpool City Council v Irwin [1977] AC 239, 253 (a case not referred to in Belize Telecom), was not abandoned in Belize Telecom.)

The decision in Belize Telecom is, undoubtedly, a significant one, and will be of great importance in relation to the implication of terms.  It is suggested, though, that practitioners will continue to objectively construe a contract objectively, but will still search for a reason, by means of the old tests, to imply a term in a contract., i.e., "it is necessary to give the contract business efficacy", i.e., it is needed to make it work.  Whilst one does not want to do Lord Hoffmann any disservice, in these hastily constructed blogged thoughts, the problem, it is suggested, with Belize Telecom, is that it over-emphasises the construction issue with the actual implication one, and, effectively, roles them into one.

 

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