Clare Kelly, Partner
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When you’re trying to run a business, it is easy to get frustrated by all of the legalities and red tape. After all, you may have been working for months on making a big sale, or doing a particular deal, and you don’t want it scuppered at the last minute by the ‘suits’ – the lawyers, accountants and other professionals who only seem to be there to spoil your fun! However, it is important to make sure that the basic formalities are in place otherwise you could find yourself stuck with a contract interpreted by the Courts, and that might be different from the contract you thought you were entering into.
In the recent case of RTS Flexible Systems Limited v Molkerei Alois Muller, the Supreme Court found that there was an enforceable contract even though no contract had ever been signed between the parties.
Muller is a well known supplier of dairy products, and in January 2005 RTS successfully tendered to supply Muller with an automated system to supply yoghurt pots. The value of the contract was £1.68 million. Both parties were keen to start working, and so it was agreed that they would act in accordance with a ‘Letter of Intent’ whilst the final contract was being negotiated. The Letter of Intent included, amongst other things, confirmation of the contract price and also that the parties intended to incorporate contains provisions relating to liquidated damages, and limitation of liability.
The Letter of Intent expired in May 2005, but the parties kept on working together and by 5 July 2005 had reached agreement on almost all of the terms of the final contract. A draft contract was agreed which stated that it would not become effective until each party had signed and exchanged a copy of the document. That was never done.
Between June and August 2005, RTS ran into real difficulties with supply and towards the end of August 2005, the parties met and agreed a variation to the ‘contract’. There was no suggestion at this stage that there was not a binding contract between them.
RTS subsequently delivered the equipment to Muller, but did not carry out the on site testing which it had promised in its tender. Muller also alleged that the equipment had defects and refused to pay the whole of the contract price. The Court was asked to rule on whether a contract had in fact come into effect, and the terms of that contract.
The Supreme Court held that there was a contract in existence between the parties, even though nothing had been signed and the negotiations were expressed to be ‘subject to contract’. The Court felt that it was unrealistic to suggest that there was no contract between the parties, considering the work which had been carried out. Furthermore, the price had been agreed between the parties, and that must have formed part of the contract.
The Court found that the terms of the contract had been substantially agreed by 5 July (enough to make the agreement enforceable) and then varied by the parties on 25 August. The 5 July terms included the terms relating to liquidated damages and limitation of liability, and so these were held to be part of the contract (against Muller’s wishes).
The Court reiterated the fact that “The Court should not impose binding contracts on parties that they have not reached”. Whilst this may be true, the danger is that a binding contract may be imposed which is slightly different to the contract which you thought had been reached, and this could have far reaching financial and other consequences.
Things to consider
The important points to take from this case are as follows:
- You may find that if you have not agreed on enough of the terms, that there is no contract in place, even if you thought that there was and have started working.
- If there is held to be a contract in place, then it might not be on the terms that you were expecting. You may have stated that the agreement is ‘subject to contract’ hoping to amend clauses before signing, but, as here, the Court may find that the terms are binding regardless.
- There is scope for considerable uncertainty if there is no finalised written contract in place. This could lead to litigation over whether there is a contract at all, and the terms of the contract. Each of the Courts hearing this case (the High Court, Court of Appeal and finally the Supreme Court) came to a different conclusion, which shows the levels of confusion which can be created.
- If you do need to start working before the contract is finalised, then the next best thing is a ‘Letter of Intent’ stating clearly what work you will do, the price and the period of time that the letter covers. If it expires and there is still no contract in place, then agree an extension in writing.
- This case has been dealt with by the High Court, the Court of Appeal and the Supreme Court, and the costs will be extremely high. Whilst the loser is normally ordered to pay the winners costs, you are unlikely to recover all of your costs, such as the costs of management time spent dealing with the dispute (and considering that this has been going on for five years, these will be substantial).
In the words of Lord Clarke in the Supreme Court, “the moral of the story is to agree first and to start work later”.
For more advice on drafting contracts, contact Mark Cornish and for contractual disputes contact David Wedgwood.
