Contractual Silence In Arbitration: Interplay Of Business Efficacy And Commercial Common Sense

Accuracy in the preparation of dispute resolution clauses in the hurly-burly world of business contracts is not only desirable but becomes a necessity. Arbitration, as a preferred mechanism for the resolution of commercial disputes, promises efficiency, confidentiality, and finality. But even the most advanced contracts can be marred by drafting oversights, leaving one to wonder whether the parties ever really meant to arbitrate. Can scattered references to arbitration, spread throughout an agreement, constitute a binding arbitration clause? How do courts weigh the sanctity of written contract against the commercial realities of intent?

Courts have evolved interpretative principles to resolve such conundrums, in particular the “business efficacy test” and the “doctrine of business common sense”. These principles allow judges to imply terms into contracts when it is necessary to preserve their commercial soundness.

The foundation of the business efficacy test is found in the ancient English case of The Moorcock (1889) 14 PD 64, where Bowen LJ stated that courts could imply terms in a contract so that it would be commercially effective and prevent commercial absurdity. In the United Kingdom, it has repeatedly been held by courts that interpreting contracts is not so much adhering to the words in letter as it requires wider examination of commercial intent, background of the contract, and common sense of commerce. In Antaios Compania Naviera SA v. Salen Rederierna AB, [1983] EWCA Civ J0708-1, the House of Lords ruled that where a literal textual meaning will give rise to a commercially absurd result, the meaning must give way to commercial sense. Where two interpretations are available, the court is to select the one that conforms to the contract's overall commercial purpose.

This rule was subsequently followed by the Supreme Court of India in the matter of Satya Jain v. Anis Ahmed Rushdie, Arising out of SLP (C) No.1891 of 2012. The Court held that a provision can only be implied if it is required to give the contract business efficacy in order to prevent a failure of consideration that the parties could not have reasonably contemplated. But in order to accomplish this, only the most restrictive term—the absolute minimum—should be inferred.

In the matter of Nabha Power v. Punjab State Power Corporation, Civil Appeal No. 2425 of 2023, the Supreme Court of India offered an orderly approach to apply the commercial efficacy test. To determine whether an implied term will be justified, the Court developed a five-pronged approach known as the "penta test":

1. The implied term should be aimed at ensuring fairness and justice between parties;
2. The implied term should not be inconsistent with any express term of the contract;
3. The implied term must be able to be clearly expressed without leading to further uncertainty;
4. In the absence of the implied term, the agreement would either be unworkable or commercially ridiculous;
5. The implied term must be so obvious that an officious bystander would find it self-evident.

By preserving the parties' intentions and guaranteeing the integrity of written agreements, these tests prevent contracts from breaking down due to minor drafting errors.

The test of business efficacy, is usually supplemented by the doctrine of business common sense. This doctrine acknowledges that contracts should be interpreted in a way that is compatible with commercial realities, and not strictly in accordance with a literal approach that defeats the intention of the contract.

In the case of Enercon India Ltd. v. Enercon GMBH, Civil Appeal No. 2086 of 2014, the Supreme Court of India cited Lord Diplock's comments in Antaios Cia Navieara SA v. Salen Rederierna AB, [1985] AC 191, where it was held that business common sense should take precedence over a meticulous, semantic interpretation of a commercial contract when it leads to an absurd consequence. In other words, the courts can intervene to reestablish business sense where implementing a term makes the contract financially unfeasible or unworkable.

The doctrine of business efficacy and common sense combine to prevent contracts from becoming tools of injustice or malfunction. They enable the courts to achieve a balance — maintaining the literal word where feasible but intervening where required to protect the genuine commercial intention of the parties.

The Supreme Court in the matter of Maharashtra State Electricity Distribution Company Limited v. Ratnagiri Gas and Power Private Limited & Ors, Civil Appeal No. 1922 of 2023, addressed the situations in which the doctrine of business efficacy can be applied. The conflict resulted from a Power Purchase Agreement (PPA, hereinafter) between the Purchaser Maharashtra State Electricity Distribution Company Ltd. and the Seller Ratnagiri Gas and Power Private Ltd. The PPA, which was meant to extend for 25 years, came under strain owing to an unexpected shortage of domestic gas across the country, leading the Seller to obtain more costly Re-gasified Liquefied Natural Gas (RLNG) in order to honour its commitments. The Seller desired to pass the extra costs on to the Purchaser, as it felt that such a revision was necessary to ensure business efficacy for the agreement. The apex court, however, held that it was not reasonable to depart from the specific terms of the PPA, as such a departure would undermine business efficacy by affecting the viability of the Seller negatively. The Court also expressed that inasmuch as implied terms were required to be drawn into a contract where the express terms of the agreement were specific and clear and unambiguous, the doctrine of business efficacy would not be invoked to alter the very essence of the contract or to rescue one party from an adverse bargain.

In the matter of Adani Power (Mundra) Ltd. v. Gujarat ERC, Civil Appeal No.11133 of 2011, a three-judge Bench of the Supreme Court ruled that the doctrine of business efficacy — meaning the capability to attain the desired result — can be invoked only where a plain, literal interpretation of the terms of the contract is not sufficient to effectuate the outcome that the parties, as reasonable and prudent businessmen, wished to obtain.

Recently in the case of Lords Inn Hotels and Resorts Pvt. Ltd. v. Pushpam Resorts LLP, Arbitration Petition No. 14 Of 2025, the Bombay High Court addressed the question as to whether or not the parties had a valid arbitration agreement because the clause referring to arbitration lacked a corresponding clause describing the arbitration procedure. In the present case an agreement was entered into by the parties for the management of Pushpam's resort at Karjat by Lords Inn. Conflicts arose, and a notice of termination was issued by Pushpam, which was challenged by Lords Inn under Article XXIV of the agreement. Lords Inn contended that sporadic mentions of arbitration in several sections reflect an overwhelming intention to arbitrate, whereas Pushpam would argue that there was no express arbitration clause to validate this claim. Reference was made to various Articles and sections of the agreement which collectively established an unmistakable intent to settle disputes by arbitration. It was furthermore argued that the lack of a standalone arbitration clause was due to drafting negligence and not lack of intent. They underscored that Section 23.3 had specifically made provision for arbitration in case of disputes over key parts of the resort, further emphasizing that arbitration was the dispute resolution method contemplated. Conversely, Pushpam contended that the fact that there was no express arbitration clause was intentional. Reliance was placed on the previous drafts where there was indeed an arbitration clause but which was intentionally deleted in subsequent versions. Pushpam insisted that the mention of arbitration in the concluded agreement was residual language from previous drafts and that litigation had been deliberately opted for as against arbitration. They argued that enforcing an arbitration agreement where there was no validly expressed clause would be contrary to contractual certainty principles.

The Bombay High Court relying on the penta test as stated by the Supreme Court in the matter of Nabha Power (supra) held that the parties had the intention of settling their disputes through arbitration, even where there was no express clause of arbitration in the final agreement. Reliance was placed upon the officious bystander test and the test of business efficacy, and from these, inferred an implied arbitration clause, with the emphasis being that such implication was needed for making the agreement work. The repeated drafting process, in which mention of arbitration continued even after the removal of the clause, indicated a mistaken omission and not a conscious exclusion. The implied term was fair, could be stated concisely, and did not exclude the explicit terms of the agreement but instead provided cohesion to scattered references to arbitration.

The interaction of the business efficacy test and the business common sense doctrine is crucial for any effectiveness or meaning that might underlie the arbitration as a useful means for resolving any disputes at hand. The doctrines would thus allow the tribunal to fill the gaps, clear ambiguities, and preserve the commercial purposes of the parties to ensure the process of arbitration is of a practical, efficient and equitable nature. But these principles must be applied with circumspection, showing deference to party autonomy and not encroaching beyond judicial limits. It has been rightly held by the Delhi High Court, in the matter of Food Corporation of India v. Adani Agri Logistics Ltd., O.M.P. (Comm) 82/2022, that there must be a fair and equitable application of the test of business efficacy. The court emphasized that while commercial common sense is a valuable consideration, it cannot supersede the explicit terms of an agreement. If the parties have not only specifically excluded an arbitration clause, the tribunal ought not to read one in just to ensure the commercial viability of the contract. Further, relying on, Nabha Power Ltd v. Punjab State Power Corp. Ltd. (supra), the High Court made it clear that Penta Test would apply only to determine the intention of the parties when the contract is silent or unclear regarding a specific point. It would not come into force if the contract is clear and definite. The court also laid down that although if the arbitral tribunal discovers that the terms between the parties were unfair or weighted, then the tribunal may not alter the agreement to draft a fairer contract because any modification would take its jurisdiction and invalidate the sanctity of terms of the contracting parties.

Essentially, the heart of arbitration is the ability to conceive of the realities of commercial life and find equitable solutions. It is how arbitral tribunals use these interpretative tools that tip their scales nicely to create an ecosystem of dispute resolution that satisfies the demands of the business. This, in turn, ensures that arbitration continues to be seen as flexible and commercially minded and can further develop with every new change in international trade and commerce.

Author is an Advocate and Views Are Personal.