The Formation of Contracts
“Signed, Sealed, Delivered I'm Yours" by Stevie Wonder spent six weeks at number one in 1970. Next time you are considering a contract, hum this tune to remind yourself of the essential facets of a contract:-
· Signed – there must be offer and acceptance and this is best evidenced by the contract being in writing and signed by the parties (although oral contracts are valid);
· Sealed – a Contract must have consideration or be sealed as a Deed; and
· Delivered – a contract must be delivered which means dating it.
Good old Stevie Wonder. So what did he mean?
To understand the provisions of any agreement used in legal practice, it is important to have a grasp of the basic principles of contract law. Contracts for the sale of land, supply contracts, franchise agreements, intellectual property assignments, employment contracts, shareholders' agreements, tax indemnities and business sale agreements - the structure and terms of all these documents are influenced by principles of contract law as well as the practicalities of the transaction concerned. In most cases, the conclusion of a binding agreement is preceded by a period of negotiation of the terms. Many things will be said or written during negotiations and it is often difficult to establish the point at which the parties have reached a binding agreement and the exact terms of that agreement. Lawyers must resort to basic contract law principles to establish these matters with certainty.
When is a contract formed?
A contract is a legally enforceable agreement giving rise to obligations for the parties to it. The formation of a contract is complete when the basic principles of offer, acceptance, consideration and intention to create legal relations are satisfied (the four basic elements).
Often the formation of an enforceable contract will be preceded by a protracted negotiation process. As a result, it can be difficult to pinpoint the precise moment at which the parties made the contract. Identifying this precise moment is crucial as it is the point at which the terms of the contract are finalised and each party takes on contractual obligations which can only be reneged upon by breaching the terms of the contract and incurring liability as a result.
Traditionally, the law considers that an agreement is formed through offer by one party with acceptance of that offer by another party. This involves a matching of the two communications of offer and acceptance.
Sometimes the court is prepared to overlook the match and be more flexible in its approach by finding that an agreement exists through reason of public policy, fairness, intention of the parties or a course of dealing (see Clarke v Dunraven [1897] AC 59, Gibson v Manchester City Council [1979] 1 WLR 294 andTrentham Ltd v Archital Luxfer [1993] 1 Lloyd's Rep 25). However, the parties should not count on this. For example, the Court of Appeal held in University of Plymouth v European Language Center Ltd [2009] EWCA Civ 784 that one party could not rely on an exchange of e-mails and telephone calls as establishing a binding contract with another party, even though the parties had worked together for some years The parties involved in the negotiation process should always have the four basic elements in the back of their minds. They should be careful not to bind themselves inadvertently to a contract at a time when they only intend to reach an understanding on the scope of the negotiations by agreeing preliminary matters.
Offer
An offer is a promise by one party to enter into a contract on certain terms. It must be:
· Specific.
· Complete.
· Capable of acceptance.
· Made with the intention of being bound by acceptance.
Therefore, an offer must contain the basic terms of the agreement and intend that no further bargaining is to take place.
To whom can an offer be made?
An offer can be made to a particular individual, a group of persons or even to the world at large (as in the case of an advertisement of a unilateral contract in Carlill v Carbolic Smoke Ball Co [1893] 1 QB 256).
Offer or invitation to treat?
Parties make many statements in the course of negotiations - some statements are offers and others are merely invitations to treat. An offer must be distinguished from an invitation to treat which merely invites the other party to make an offer and does not carry the intention of being bound.
In auction sales and tender procedures it is usually the bidder who makes the offer in response to the seller's invitation to treat. The seller should take care not to bind itself unwittingly to a contract by stating in its invitation that the highest bid (in an auction for sale) or the lowest bid (in a tender) shall be the successful bid. Such statements may go beyond an invitation to treat and may in fact amount to an offer which is accepted by a bidder (see Harvela Investments Ltd v Royal Trust Co of Canada
Common examples of invitations to treat include advertisements of bilateral contracts (for example, assets for sale) and the display of goods for sale in shops (however, the display of goods in an automatic vending machine may amount to an offer as no further bargaining is anticipated).
Termination of offers
An offer is generally revocable and can be terminated in a number of ways:
· Lapse of time. This occurs when the offer is open for a certain period of time (for example, an offer to shareholders of a target company in a takeover bid) or, where no time limit is set, after a reasonable time has elapsed. In practice, it is advisable for the offeror to specify a time limit on the offer to avoid any uncertainty as to what may amount to a reasonable time.
· Withdrawal by the offeror. This is often referred to as revocation. Any withdrawal should be communicated to the offeree. An offer can be withdrawn at any time before the offeree has accepted. This is the case even if the offer expressly states that it is to be open for a fixed time. (The reasoning being that the offeree does not usually give consideration for the offer to be open for a particular period (Routledge v Grant (1828) 130 ER 920)).
· Rejection by the offeree. Once an offeree has rejected an offer he cannot subsequently change his mind and accept it. Rejection terminates the offer and any further communication by the offeree could amount to a counter offer. This frequently arises in the so called battle of the forms situation
· Failure of a condition precedent This may arise, for example, on an offer to sell goods with the offer being made subject to grant of an export licence or the sale of business assets subject to clearance from the regulatory authorities. If the necessary conditions cannot be satisfied the offer will lapse and will no longer be capable of acceptance.
· Death of the offeror. Death of the offeror will generally make an offer incapable of acceptance as the parties are no longer able to reach an agreement. However death may not automatically terminate an outstanding offer if the offeree has accepted the offer without knowledge of the offeror's death (Bradbury v Morgan (1862) 1 H & C 249), or if the offer is a continuing offer.
Acceptance
A binding contract is only formed if an offer is accepted.
What amounts to acceptance?
Acceptance is final and unqualified assent to an offer. It is made in response to an offer and corresponds exactly with the terms of the offer with no variation of the terms. It is generally the case that acceptance must be communicated to the offeror to be effective, although sometimes conduct will be considered acceptance (an example might be where a supplier does not communicate acceptance of an order, but it delivers the goods ordered and takes payment).
Acceptance or counter offer?
If an offeree purports to accept an offer but his acceptance does not match the terms of the offer (disregarding trivial variations) then no contract is formed. Rather than accepting the original offer, the offeree makes a counter offer (but see Butler Machine Tool Co. Ltd v Ex -Cell-O Corp. Ltd [1979] 1 All ER 965 where the court decided that a contract was formed, despite the fact that offer and acceptance did not match exactly, as the parties had carried on with performance of the contract).
A counter offer amounts to a rejection of the original offer so that no contract exists (Hyde v Wrench (1840) 3 Beav 334) and it amounts to a new offer that the original offeree can choose to accept. A counter offer must be distinguished from an offeree's request for further information (on receipt of an offer) - this does not amount to a counter offer (Stevenson v McLean (1880) 5 QBD 346).
Where a counter offer is accepted then its terms (rather than those of the original offer) become the terms of the contract (A Davies & Co (Shopfitters) Ltd v William Old Ltd (1969) 67 LGR 395).
Battle
A common situation when counter offers arise is with the so called battle of the forms, in the negotiation of supply agreements using standard terms and conditions. Standard terms of sale are often used by suppliers and it is also becoming more common to see them used by buyers (especially large national retailers).
Where both the supplier and buyer purport to impose their own standard terms into the supply contract, difficulties can arise in determining which terms prevail. Where a supplier offers to contract on its terms and the buyer attempts to accept but tries to impose its own terms, there is no acceptance at all. Instead this is a counter offer which can be accepted by an unequivocal acceptance by the supplier or by performance.
In practice, this means that the last set of terms despatched prior to acceptance or performance (the last shot fired in the battle of the forms) will prevail.
One drafting solution which has attempted to address the battle of the forms situation is to incorporate a so-called prevail clause (see below) which stipulates that (where, for example, the terms are issued by the supplier) the supplier's terms will prevail over any terms issued by the buyer:
"Application of terms
Subject to any variation under condition [NUMBER] these Conditions form part of the Contract to the exclusion of all other terms and conditions (including any terms or conditions which the Buyer purports to apply under any purchase order, confirmation of order, specification or other document)."
This clause is unlikely to be effective, since the standard terms and therefore the clause itself will not form part of the contract because it will not have been accepted by the buyer where the buyer is itself seeking to impose its own standard terms by means of a counter offer. However, parties continue to use clauses of this kind as they may bluff the operational staff of the other party into assuming that there is nothing to be gained from seeking to impose their own terms. Sales departments should be fully aware of this potential problem so that when they receive purchase terms containing such a provision, they know that the supplier's terms can still prevail, and that they should therefore respond in the usual way with an acknowledgement of the order bearing the supplier's standard terms.
Another possibility for a supplier when faced with a battle of the forms could be to decide to deal with the conflict of terms directly, by discussing the sale terms with the customer and, if possible, agreeing any variations in a side letter. The disadvantage is that this involves a negotiation of the standard terms, consequently incurring time and expense, which the use of standard terms is designed to avoid. However, where the customer in question is seen as particularly important, and there is the possibility of significant repeat business, the extra time and expense involved in agreeing special terms, which could also be used for future transactions, might well be justified.
Alternatively, the supplier could ensure that its terms are included in as many pre-contractual documents as possible, refrain from raising the standard terms as an issue with the customer and attempt to fire the last shot in the battle of the forms by ensuring as far as possible that the supplier's terms appear on the last document passing between the parties before the delivery of the goods. The advantage of this is that no time is wasted in negotiating amendments to the supplier's terms and that, assuming that the battle of the forms is won, the supplier's terms will be incorporated without amendment. The disadvantage is that the risk that the customer might succeed in firing the last shot cannot be entirely eliminated, in which event the customer's terms would be incorporated without amendment. This was illustrated in one case where the supplier delivered a consignment of whiskey to the buyer's warehouse: the supplier's employee handed over a delivery note containing the supplier's standard terms and, instead of signing the note, the buyer's warehouseman stamped it "Received on [the Buyer's] conditions". It was held that the buyer's terms prevailed (British Road Services Limited v Arthur Crutchley & Co Ltd [1968] 1 All ER 811).
As well as the courts deciding that the supplier's terms or the customer's terms prevail, there is a third possibility. In the case of GHSP Inc v AB Electronic Ltd [2010] EWHC 1828 (Comm), the High Court held that neither party's standard conditions governed the parties' relationship. Instead, the judge found that the parties had concluded a contract that was governed by, and incorporated, the implied terms of the Sale of Goods Act 1979.
Communication of acceptance
The general rule is that an acceptance has no effect until it is communicated to the offeror. This is the point at which the contract comes into being.
There are two main rules on acceptance:
· The reception rule, that is, the contract will be formed once the acceptance is received by the offeror. This applies to instantaneous forms of communication such as telephone calls (Entores v Miles Far East Corp [1955] 2 QB 327).
· The postal rule which applies to delayed forms of communication with the effect that acceptances are deemed to be effective at the time of sending (Adams v Lindsell (1818) 1 B & Ald 681).
If an offer specifies how and when acceptance is made, this will trump both these rules.
The postal rule can cause problems as the contract may be formed (provided the offeree correctly addresses and stamps the letter) at a time when the letter of acceptance has not found its way to the offeror. This is the position even if the letter is delayed or lost in the post.
In practice, it is best to provide for the method and timing of acceptance in the terms of the offer to avoid the postal rule.
Note that at present, no statutory or common law rules have been formulated for the communication of acceptance by e-mail. Either the postal rule or reception rule could be applicable. Although not making a recommendation on this issue, the Law Commission indicated some years ago that it would be desirable to have legislation on this matter and its initial view was that the transmission process is complete when the communication reaches the recipient's internet service provider.
If an offer does not specify the method of communication for acceptance then the offeree may communicate his acceptance in any way he chooses. In practice, the offeror will want to make matters certain by prescribing the method of acceptance (for example, the bidder will set out the manner of acceptance by the target's shareholders in a takeover offer document).
If the offeror prescribes a method then the offeree must use that method to accept. Any attempt to accept in another way will amount to a counter offer (Western Electric Ltd v Welsh Development Agency [1983] QB 796). This rule may be relaxed where, for example, an offeror specifies a manner for acceptance but does not make it clear that only acceptance in that manner is binding - if the offeree uses a method of communication that is no less advantageous (from the offeror's point of view) than the method prescribed, then a contract is concluded (Tinn v Hoffman & Co (1873) 29 LT 271).
Consideration
Contract law is based on the notion of reciprocity (that is, a promisee cannot enforce a promise unless he has given or promised something in exchange for it). If a contract lacks consideration, it will only be enforceable if it is made as a deed.
The law is not concerned with the value of consideration and it will not interfere with the bargain between the parties. However, consideration must have some value even if it is not adequate (hence the peppercorn rent) - it is up to the parties to decide what consideration they want. A case which illustrates the flexibility of the courts in finding good consideration is Stream Healthcare (London
Consideration must move from the promisee (Tweedle v Atkinson (1861) 1 B & S 393). This means that the person who seeks to enforce a promise must have provided consideration - this is related to the doctrine of privity.
Although a contracting party will usually be consciously aware of what consideration he is giving for the promise he is accepting, it is not necessary to have given conscious thought to what is being given by way of consideration in a contract, provided that there is consideration (Anthony Pitts and Others v Andrew Jones [2007] EWCA Civ 1301).
A distinction is often drawn between executed and executory consideration. Executed consideration is where the promisor asks for something in exchange for his promise and the promisee provides consideration by giving the promisor what he has requested. An example of this was where Mrs Carlill used the smokeball in return for the company's promise to pay £100 for anyone who used it and yet caught influenza (Carlill v Carbolic Smoke Ball Co (1893) 1 QB 256). Executory consideration is where the parties exchange promises, for example where one party promises to deliver goods in two weeks' time and the other party promises to pay for them.
Past consideration
As a general rule past consideration is no consideration. If a party performs an act which is merely discharging a pre-existing obligation, then there is no consideration (Stilk v Myrick (1809) 2 Camp 317). But if a party does more than he was already bound to do then there may be consideration (Glasbrook Brothers Ltd v Glamorgan County Council [1925] AC 270).
The case of Williams v Roffey Bros [1991] 1 QB extended this general rule so that performance of an existing contractual duty can amount to consideration for a new promise in circumstances where there is no fraud or duress or where practical benefits accrue to the promisor.
In the past the courts have found various ways around the problems of past consideration by looking at the whole transaction between the parties and not just looking at whether the promise was made after the promisee performed the particular act or service (see Pao On v Lau Yiu Long (1979) 3 All ER 65 and Lampleigh v Braithwait (1615) Hob 105).
What if no consideration is given in return for a promise?
It is an established rule of law that if a debtor pays part of an existing debt, this does not amount to consideration for a creditor's promise to accept a lesser sum in full settlement (Foakes v Beer (1886) 9 App Cas 605). This rule has been much criticised and the equitable doctrine of promissory estoppel has been introduced to deal with circumstances where no consideration has been provided for a promise.
Where a party waives his contractual rights against another and that other party changes his position in reliance on the waiver, equity may deem it unjust to allow an action against him on the original contract to succeed (that is, the party who waived his rights is estopped from denying that he intended the waiver to be binding (Hughes v Metropolitan Rail Co (1877) 2 App Cas 439 and Central London Property Trust Ltd v High Trees House Ltd [1947] KB 130)).
There are three key elements to promissory estoppel:
· A promise by one party that it will not enforce its strict legal rights against the other.
· An intention on the promisor's part that the other will rely on that promise.
· Actual reliance by the promisee on that promise.
The requirement of reliance is normally treated as one requiring the person who alleges that there has been a promissory estoppel to show that he or she has acted to his or her detriment as a result. However this feature of the doctrine is not settled - in the High Trees case, Lord Denning argued that detriment was not required.
The doctrine is used as a shield not a sword - it does not create a cause of action and can only be used as a defence to an action brought by the parties wishing to enforce his strict legal rights. It will not be available as a defence if the promisee has behaved inequitably. The promisor will not always be estopped from enforcing his strict legal rights. He may be able to revive them by giving reasonable notice or making it clear by his conduct that he will insist on his strict rights at a later stage (Tool Metal Manufacturing Co. v Tungsten Electric Co [1955] 1 WLR 761).
Promissory estoppel has been used as a defence in transactions involving disputes between landlords and tenants and in loan finance transactions. For example, the court held that, following the interim rescheduling of payments, a bank was prohibited by promissory estoppel from enforcing its security without further notice to the borrower (Emery v UCB Bank plc [1997] EWCA Civ 824). The Court of Appeal has held that the doctrine may be applied where a creditor's promise to accept part payment of a debt in full settlement is not supported by any consideration from the debtor (Collier v P & M J Wright (Holdings) Ltd [2007] EWCA Civ 1329).
Intention to create legal relations
A contract cannot be made without intention to create a legally binding arrangement. Where no intention can be attributed to the parties, there is no contract. An objective test is used to establish the intention of the parties by asking if reasonable people would regard the agreement as legally binding (Merritt v Merritt [1970] 1 WLR 1211).
Presumption in commercial circumstances
In commercial circumstances there is a rebuttable presumption that the parties intend their agreement to be legally binding. If a party wishes to rebut this presumption he will have to produce clear evidence to that effect (Edwards v Skyways [1964] 1 All ER 494). In practice whether the parties intended to create legal relations arises frequently with letters of comfort, letters of intent, heads of terms and the use (or not) of the words "subject to contract".
In the case of Investec Bank (UK) Ltd v Zulman and another [2010] EWCA Civ 536, the Court of Appeal dismissed a claim to enforce a guarantee that was not signed by the guarantors, holding that, despite the fact the guarantee was not expressed to be subject to contract, it contained a provision recommending that the guarantors seek legal advice before signing the document. This provision would be pointless if the parties had intended they should be bound by an oral agreement made before the draft guarantee was drawn up. The case illustrates that the presence or absence of an express subject to contract provision is not conclusive in questions of contract formation. The Court of Appeal has treated a counterparts clause like a "subject to contract" clause in RTS Flexible Systems Ltd v Molkerei Alois Muller GmbH & Co KG [2009] EWCA Civ 26) although the Supreme Court later upheld an appeal.
Interim or pre-contract documents are known by many names, for example, letter of intent, memorandum of understanding, heads of agreement or heads of terms.
Heads of terms are a common part of most big deals - they are frequently used when negotiating commercial transactions such as outsourcing arrangements, as well as mergers and acquisitions, joint ventures, project financing and privatisations. They are particularly common in international transactions.
Heads of terms are used for many purposes, one of which is to record a non-binding outline of the terms that the two parties have agreed. Heads of terms allow them both to see how close they are to a deal and serve as a framework for future negotiations.
There is a risk attached to entering heads of terms as they create a strong moral commitment to observe the terms agreed. Even if they are not legally binding, the parties may find it difficult to manoeuvre if something emerges during the course of the negotiations that they had not taken into account earlier.
The parties may wish to ensure that the heads of terms (or at least many of its provisions) are not legally binding. This depends on the parties' intentions. The name of the document itself usually does not have a significant influence on its legal status. It is just evidence of the intention of the parties. Thus, merely calling it "heads of terms" will not ensure that it is not legally binding.
The use of the phrase "subject to contract" can be helpful in rebutting the presumption of contractual intent. It is usually taken to mean that the parties have not yet reached agreement and are still in the process of negotiation, or that the agreement the parties have reached is not to be binding until it is signed. However, this phrase is not foolproof. For the sake of certainty, the parties may wish to include a statement in the heads of terms that its provisions are not intended to be legally binding; and if they do intend for any specific parts of the heads of terms to be binding, then they should also make express statements to this effect in the document.
Letters of comfort are used in loan finance transactions. They are issued by third parties to banks in relation to loans. They are not guarantees but merely letters which provide encouragement or comfort for the bank to proceed with the loan. They commonly arise with groups of companies. For example, the parent may give a comfort letter to the bank for a loan to its subsidiary. The letter may state that the parent company’s policy is to ensure that its subsidiaries are always in a position to meet their liabilities under the loan facility with the bank (Kleinwort Benson v Malaysia Mining Corp Sdn Bhd [1989] 1 All ER 785 and Re Atlantic Computers plc (in administration) National Australia Bank Ltd v Soden & another [1995] BCC 696). A parent company may prefer to give a comfort letter rather than a guarantee for a number of reasons such as preservation of its own credit rating and gearing.
There has been some debate about whether these letters have contractual effect enabling the bank to sue the parent company for the subsidiary's default. As the letters arise in a commercial context, there is a presumption of contractual intention. However, in the Kleinwort Benson case the court said that uit is a matter of construction in the light of the relevant surrounding circumstances to decide if the letter constitutes a contractual promise as to the future policy or intentions of the parent.
The title given to the document will not prevent the courts from giving effect to the meaning of the words used. So if, on their proper construction, the words used amount to a promise, the issuer of the letter may be liable to make good the recipient if the parties intended to create legal relations. It is for the issuer of the letter to show that there was no intention to create legal relations (Edward v Skyways Ltd). Factors to be taken into account in this regard include whether the issue of the letter was approved by a board resolution or whether the letter states that it is a condition precedent or prerequisite to the lender's agreement to participate in the loan facility. In practice, to rebut the contractual intention, it is advisable to expressly disclaim contractual intent in the letter itself.
There is no overriding obligation on the issuer of a comfort letter to act in good faith, but if statements in the letter of comfort are untrue when made, then the letter may give rise to some degree of legal responsibility, as it will contain at least representations as to present fact (even if it does not contain promises as to future conduct). If those representations are false, the issuer of the letter may be liable for deceit or negligent misstatement even if the letter is, or is expressed to be, non-legally binding. It is therefore essential that the party giving the comfort letter should be satisfied that the statements in it are true as at the date when given. Any purported exclusion of liability will be subject to the reasonableness test in the Unfair Contract Terms Act 1977 which may be hard to satisfy in practice. Additionally, the representor may be liable for damages in tort for fraudulent misrepresentation
If the issuer revokes any stated intentions then liability will depend, on the terms of the letter and the circumstances in which it is given. There may be an express or implied commitment not to revoke the stated intentions, which may amount to a continuing representation. If the comfort letter only contains general policy statements, then the issuer is free to change its policy. The courts may imply terms in a comfort letter. Whether a court will do so depends on the extent to which the letter is clear and whether or not the surrounding circumstances indicate that a particular term must necessarily be implied in order to give effect to the intention of the parties. If the letter is legally binding it will not give rise to a claim for a liquidated sum (unlike a guarantee). Instead, the claim will be for breach of contract - damages and a duty for the lender to mitigate its loss.
Certainty of terms
For a binding contract to exist, the terms must be certain. Parties should ensure that they are not too vague in their intentions and have not expressed themselves in incomplete terms. If their agreement is vague or ambiguous it may not amount to a legally enforceable contract despite their intentions. The willingness of the courts to fill in the gaps left by the parties will often depend on the facts of the situations and so it is difficult to lay down general principles.
A contract that is difficult to implement is not necessarily void for uncertainty (Scammell v Dicker [2005] EWCA Civ 405).
In commercial circumstances the court is keen to give effect to the intentions of the parties but it is not always possible for it to do so if the agreement is uncertain. For example, the issue of uncertainty arose in Walford v Miles [1992] 1 All ER 453, where the House of Lords ruled that a "lock- out agreement" (where the seller in return for consideration agreed not to negotiate with any other party for the sale of the business) was void for uncertainty. The agreement was for an unspecified duration and the court felt that it could not bridge the gap and imply a term to give effect to the agreement.
However in the case of Petromec Inc and others v Petroleo Brasileiro SA and others [2005] EWCA Civ 891, the Court of Appeal held that where a written contract includes provisions for good faith negotiations and legal advisers have been consulted in the drafting of these terms, such provisions may be enforceable. Also, in a 2005 case to decide whether, read together, certain documents constituted an agreement of sufficient certainty to be an enforceable agreement, the Court of Appeal held that the court must strive to give legal effect to what parties have agreed and that although the parties may think that they have entered into a binding agreement, an agreement to agree an essential term or terms is not such an agreement. The court cannot make for the parties the agreement which they have not made for themselves (Willis v Cable & Wireless plc and Pender Insurance Ltd [2005] EWCA Civ 806).
The courts may decide that a contract exists before all the terms have been agreed, especially if the parties start performing the contract. In the construction industry, works often start before the written contract has been signed. It may be possible that in such cases by starting work without commenting on the proposed contract, a party is treated as having accepted the terms agreed so far in negotiations. For example in VHE Construction Ltd v Alfred McAlpine Construction Ltd [1997] EWHC TCC 370, the parties were civil engineering contractors and McAlpine persuaded VHE to start work on a subcontract to the main contract before the terms of the subcontract had been agreed. Taking into account all communications and circumstances between the parties, the court found that a subcontract existed.
In establishing the terms of an oral contract, the Court of Appeal has held that evidence of the parties' conduct subsequent to the formation of an oral contract was admissible for the purposes of testing the accuracy of the parties' recollections as to what the terms of the contract were (Maggs v Marsh & another [2006] EWCA Civ 1058).
The form of a contract
Some contracts may be written, or oral, or partly written and partly oral. Other contracts may need to be written or by deed to be legally enforceable In the past, courts have found that contracts do not always have to be signed. Even though the parties to a contract had not executed the draft agreement that had been drawn up, and they had initially intended that it should not be binding unless and until the agreement was executed, the contract was binding on the parties as, on the evidence, they had been acting in accordance with the contract's terms and they had, on the facts, effectively decided that the agreement did not have to be executed after all. However, this decision was overturned on appeal on the construction of the facts,.
In another case, the Court of Appeal held that a counterparts clause prevented a contract from being formed, even though the parties had performed a substantial part of the contract. However, this decision was overturned in March 2010 by the Supreme Court, which held that although the parties never signed the formal written agreement, that agreement had come into effect notwithstanding that the agreement was expressed to be subject to contract. The parties had by their conduct waived the subject to contract provision. Lord Clarke commented that "the different decisions in the High Court and Court of Appeal and the arguments in the Supreme Court demonstrate the perils of beginning work without agreeing the precise basis upon which it is to be done. The moral of the story to is to agree first and to start work later." Businesses may not always find it possible to act on Lord Clarke's advice, but should be aware that by beginning to carry out their side of the contract they may waive the protection offered by a "subject to contract" provision.
Written contracts and the parol evidence rule
Where a contract is written, all the statements in that written contract are its terms. The written document is taken to be the whole contract and as a general rule no extrinsic evidence can be admitted to add to, vary or contradict the written terms. This is the parol evidence rule.
However, there are many exceptions to the parol evidence rule. For example, if it can be shown that a reasonable person would not think that the written document was meant to be the whole contract, then evidence varying its terms will be admissible. This variation does not apply to certain types of contract (for example, a lease).
It may be possible to work round the parol evidence rule by arguing that the parties have entered into a collateral contract. This is a separate and independent contract which stands alongside the main agreement. In this way an oral statement may give rise to contractual remedies, not because it varies the terms of the written contract but because it is a term contained in a separate collateral contract.
Sometimes in written contracts parties seek to exclude the ability to adduce extrinsic evidence by stating that the written agreement contains the entire terms of the contract. This is often used as an attempt to exclude reliance on any representations made by the parties or their representatives which are not incorporated in the body of the agreement. These clauses (known as entire or whole agreement clauses) are often used in acquisition agreements and in supply contracts using standard terms.
A well-drafted entire agreement clause should contain the following:
· A statement that the document concerned contains the whole agreement between the parties and supersedes any previous agreement.
· An acknowledgement by the parties that they have not relied on any representation which is not set out in the agreement.
· An acceptance that the only remedy the parties will have is for breach of contract.
· To the extent such a clause constitutes an exclusion or limitation of liability, a confirmation that the clause is not attempting to exclude liability for fraud or fraudulent misrepresentation.
Oral contracts and contracts which are partly written and partly oral
Where the contract is an oral contract or a contract that the parties intend to be partly written and partly oral, all statements made will have to be examined to decide whether or not they are terms of the contract or merely representations.
Oral or written contract?
Although oral contracts are legally enforceable, it is prudent to have a written contract to record the terms which can then be used for evidential purposes if necessary. There are situations where a written contract is required by law or in order to fulfil some registration requirement. Common examples are:
· The assignment of the benefit of contractual rights (section 136, Law of Property Act 1925).
· A contract for the sale of land, an equitable charge or a mortgage of a legal estate in land (section 2, Law of Property (Miscellaneous Provisions) Act 1989).
· An assent of a legal interest in land (section 36(4), Administration of Estates Act 1925).
· A transfer of shares (section 770, Companies Act 2006). (Exceptions to this include share warrants to bearer (section 779, Companies Act 2006) and listed companies whose shares are admitted to CREST where the shareholder holds the shares in uncertificated form. In this case, share transfers can be effected electronically and do not require written transfers (sections 783, 784(3), 785 and 788, Companies Act 2006 and The Uncertificated Securities Regulations 2001 (SI 2001/3755)).
· Assignment of a number of intellectual property rights (sections 90(3) and 222(3), Copyright Designs and Patents Act 1988).
· Guarantees (section 4, Statute of Frauds, 1677).
Must the contract be a deed?
A deed is only necessary for a relatively small (but important) category of transactions. The most important are:
· Land transfers. The transfer of land or of any interest in land (including a mortgage or charge) is void for the purpose of conveying or creating a legal estate unless made by deed (section 52, Law of Property Act 1925).
· Leases. All leases must be created by deed if they are to take effect at law except leases which take effect in possession for a term not exceeding three years at the best rent reasonably obtainable without taking a fine (sections 52(2) and 54(2), Law of Property Act 1925).
· Appointments of trustees. A document appointing a new trustee must be by deed if there is not a separate transfer of the trust property into the names of the new trustees (section 40, Trustee Act 1925 as amended by the Trusts of Land and Appointment of Trustees Act 1925).
· Powers of attorney. The grant of a power of attorney must be executed as a deed by the donor of the power (section 1(1), Powers of Attorney Act 1971).
· Gifts of tangible goods. A gift or voluntary assignment of tangible goods that is not accompanied by delivery of possession must be by deed (Irons v Smallpiece (1819) 2 B & E Ald 551 and Cochrane v Moore (1890) 25 QBD 57).
· Releases and variations. At common law, a contract contained in a deed could only be varied or discharged by another contract contained in a deed (for example, Pinnel's case (1602) 5 Co Rep 117a and Cross v Sprigg (1849) 6 Hare 552 and Kaye v Waghorn (1809) 1 Taunt 428); but in equity such contracts could be varied or discharged by parol evidence if there was consideration (Webb v Hewitt (1857) 3 K and J 438). The equitable rule now prevails (section 49, Senior Courts Act 1981, and for example, Plymouth Corporation v Harvey
There are also situations in which a party may insist on the use of a deed for a transaction because, for example, it is unclear whether valuable consideration is given (guarantee of an existing debt, tax indemnity on share sale) or to have the benefit of the longer limitation period (12 years (section 8, Limitation Act 1980)) from the date on which the cause of action accrued for deeds, as opposed to six years for a simple contract (section 5, Limitation Act 1980).
