Home
Publications
Disputes Matter – Spring 2017

Disputes Matter – Spring 2017

Print newsletter

Commercial contract formation: Don’t forget first principles

In the commercial world, so much is about contacts, relationships and face-to-face communication. As such, […]

In the commercial world, so much is about contacts, relationships and face-to-face communication. As such, at the outset of many ventures, relationships are positive and parties are eager to get on with doing business together, often before legal documentation is put in place. As the recent case of MacInnes v Gross (1) [1] highlights, however, there are some real risks associated with proceeding in this way. An understanding of the basics of commercial contract law is crucial for managing those risks.

Formation of contracts: back to basics

A contract is formed when all of the following key elements are present:

offer;
acceptance;
consideration (i.e. money or money’s worth);
intention to create legal relations; and
certainty of terms.

Whilst a contract can be made orally (face-to-face or via some communication medium such as the telephone), it is important to remember that a party may have difficulty in establishing the existence of and/or proving the terms of an oral contract if a relationship breaks down and a dispute arises.

In addition, although in a commercial context there is a rebuttable presumption of an intention to create legal relations, the legal burden is on the party claiming that a binding contract has been made to prove the intention to create legal relations, and that can be evidentially difficult in the absence of any express agreement.

The recent case of MacInnes v Gross provides one example of how a lack of understanding and formality in relation to contractual arrangements can have devastating consequences.

MacInnes v Gross – an expensive mistake

In a very typical scenario, Mr MacInnes (who worked for Investec) and Mr Gross (who ran his own business, RunningBall) had made contact with each other in business from time to time over a number of years before they eventually spoke in any detail about working together. Then, in March 2011, following various exchanges between them, Mr MacInnes and Mr Gross talked about the potential sale of Mr Gross’ business one evening over dinner at a restaurant. Mr MacInnes later alleged, when claiming €13.5 million in these proceedings, that an oral contract was made during that discussion, in which it was agreed that he would provide services to Mr Gross with a view to maximising Mr Gross’ return on the sale of the RunningBall business, and that he would receive, in exchange, remuneration calculated by reference to a formula which gave him 15% of the difference between the target price of RunningBall and the actual sale price. Mr Gross, however, denied that there was any binding contract between himself and Mr MacInnes, either in the terms alleged or at all.

The High Court rejected Mr MacInnes’ claim and the following key points make essential reading for all commercial parties.

As mentioned above, whilst the starting point in commercial cases is that there is a presumption of the requisite intention to create legal relations, that presumption can be displaced either by express evidence to the contrary or by an objective assessment of the parties’ intentions.
In making that assessment, the court will consider not the parties’ subjective intentions, but rather what was communicated between them by words or conduct and whether that leads objectively to a conclusion that they intended to create legal relations [2].
A relevant factor is likely to be the degree of precision with which the alleged agreement is expressed, and vagueness and uncertainty may be grounds for concluding that there was no intention to create legal relations at all.
The court noted that the more complex the subject matter (and the alleged details of the contract in this case were quite complex), the more likely it is that the parties will want to enshrine any contract in a written document.
Further, while it is certainly possible to conclude a contract in an informal manner and in an informal setting, the court suggested that the greater the informality of the context, the greater should be the scrutiny of any claim of intended legal relations.
It was also relevant that, despite Mr MacInnes’ contention, the court found that no firm agreement had been reached on the critical question of Mr MacInnes’ remuneration.
In this particular case, English was not Mr Gross’ first language, and the court noted that this might suggest that further caution should be required before finding that a contract had been concluded in such informal circumstances.

Practical guidance

Commercial parties should review their negotiating practices and be aware of the risks associated with informality. On the one hand, the lack of any specific requirement for formality and/or documentation means that contracts can be formed orally and by conduct as well as in writing; and it is therefore important that parties should not discuss terms or act in any way that is inconsistent with their contractual intentions in case a contract comes into effect prematurely, inadvertently or on unsuitable terms. On the other, and as shown by the MacInnes v Gross (1) decision, the fact that an intention to create legal relations is a necessary component of any valid contract can mean that, depending upon the particular circumstances, it can be a costly mistake to assume that a contract has come into being at all.

It is essential that businesses educate their staff as to the risks of both inadvertent contract formation and of conducting business (and therefore going on to incur expenses and responsibilities) on the assumption that contractual backing exists when in fact it may not.

An understanding of some key contractual principles, as well as an awareness of the practical scenarios in which informal commercial discussions may arise for any particular business, will be key to getting the balance right between being able to quickly obtain sufficient comfort to enable parties to proceed with their plans, and becoming legally bound when that is actually required.

___________________

[1] Please note that this briefing is concerned with MacInnes v Gross (1) [2017] EWHC 46 (QB) – the commercial contracts dispute.
[2] as per the test set out in the leading case of RTS Flexible Systems Ltd v Molkerei Alois Muller GmbH & Co KG [2010] UKSC 14

Contract interpretation: Key case update

Walker Morris has written previously on the leading cases of Arnold v Britton and M&S […]

Walker Morris has written previously on the leading cases of Arnold v Britton and M&S v BNP Paribas, which offered Supreme Court clarity on crucial legal principles underpinning the correct approach to contractual interpretation and the implication of contractual terms respectively. Despite such authority, however, myriad questions surrounding the interpretation of commercial contracts have continued to hit the legal headlines. What do the most recent cases tell us, and what practical lessons can commercial clients and lawyers learn?

In this article we simply summarise some of the key issues to come out of commercial contract cases from recent weeks, but please do not hesitate to contact us for a more detailed discussion on any of the issues covered, or indeed any other commercial contract query or concern.

‘Subject to contract’ and subsequent communications

In Global Asset Capital, Inc v Aabar Block S.A.R.L. [1] the Court of Appeal considered whether (and if so, the point at which) a contract had come into existence, during an exchange of communications. The basic principles of contract formation are explained in our previous article, Commercial contract formation: Don’t forget first principles (also in this issue of Disputes Matter) and in our earlier piece, Contract formation: What constitutes acceptance? One tactic that is frequently deployed with the aim of preventing a contract from being formed prematurely is to mark correspondence ‘subject to contract’.

In this case a ‘subject to contract’ letter setting out proposed contractual terms had been sent. Global then alleged that a contract was concluded during a subsequent telephone call which simply required that the letter be re-sent in an open and binding form. The Court of Appeal disagreed with Global, noting:

Whilst it is not an absolute guarantee that ‘subject to contract’ correspondence cannot in any circumstances constitute a clear offer that can be unequivocally accepted to give rise to a contract, that will usually be the case – and it was here.
Communications marked ‘subject to contract’, if accepted, will generally amount to no more than an agreement to agree. These arrangements are often legally invalid by reason of uncertainty and do not remove the condition that a binding contract is still to follow.
When deciding whether a contract has been concluded, the court should look at the whole course of communications.
It is correct that one cannot refer to subsequent correspondence or events when interpreting the meaning of a concluded contract, but that is a different question to whether or not a contract has been concluded at all.

The key takeaway from this case is that the court does place significant weight on the ‘subject to contract’ endorsement and will hold it to negate contractual intention in the majority of commercial cases. All communications and travelling drafts should therefore be clearly marked ‘subject to contract’ if (as is recommended) commercial parties intend their contractual arrangements to be embodied in written contractual documents containing all appropriate terms which come into legal effect at the intended time, and not before.

One case, three issues, no contract

In Teekay Tankers Ltd v STX Offshore & Shipbuilding Co. Ltd [2] a contract for the purchase of some ships provided that the delivery date “shall be mutually agreed” and that the shipbuilder would use its “best endeavours” to deliver the ships within a particular time period. The High Court had to consider: (1) whether the clause in question was enforceable or void for uncertainty; (2) if it was unenforceable, whether a term could be implied to lend sufficient certainty; and (3) the impact of the phrase “best endeavours“.

Concluding that, despite the parties’ clear intention to be legally bound, the purported contract was void for uncertainty, the High Court held:

A provision that a key term is still to be agreed amounts to no more than an agreement to agree and can be fatal to the existence of a contract.
For in-house legal teams and contract managers, the detailed principles underpinning the analysis of ‘to be agreed’ provisions are set out (albeit non-exhaustively) in the Mamidol-Jetoil and BJ Aviation cases [3].
The courts will try to save an agreement that will otherwise be unenforceable as an agreement to agree by implying a term which lends sufficient certainty to the contract. However, in accordance with M&S v BNP Paribas [4] on implied terms generally, the court will not imply a term where to do so would be inconsistent with express wording within the agreement.
In this case, to imply a delivery date term by reference to reasonableness (as would be necessary to make the agreement workable) would be inconsistent with the express ‘best endeavours’ provision. The court would not, therefore, imply the necessary term, and the purported contract could not be saved.
As the contract was unenforceable overall, so too was the ‘best endeavours’ provision. However the court noted that this particular clause would have been difficult [5] to enforce in any event, as it did not contain any objective yardstick against which to measure those endeavours.

The key takeaway from this case is that, although it might be possible in some circumstances to imply terms to save an uncertain ‘agreement to agree’ and/or to give effect to an ‘endeavours’ provision, both of those options will depend on the facts of the case and the remainder of the wording of the contract. By far the better course is to ensure that your commercial contracts are clearly and tightly drafted to include certain and measurable obligations from the outset.

Breach of express/implied terms: Innovative arguments fail to find favour

When Chevrolet wound down its UK business during 2013/14 (reducing financial incentives, selling off UK stock and imposing deadlines on factory orders), two of its franchisees (collectively known as Toomey) sued for breach of express or implied terms in the franchise agreements [6]. Toomey argued that Chevrolet was in breach of express terms regarding (non-exhaustively): the provision of financial incentives; maintaining UK stock; maintaining a network of UK dealers, which could be construed from the recitals to the franchise agreements. In the alternative, Toomey argued that terms to the same effect were implied into the contract: (a) because they were commercially and practically necessary (in accordance with M&S v BNP Paribas); and (b) by virtue of the parties’ prior course of dealings. Despite legal submissions which the High Court described as “excellent”, the court rejected Toomey’s claim on all counts, finding:

The recitals explained the nature of Chevrolet’s UK operations and set out the overall purpose of the franchise agreements, but they did not contain any operative provisions. On the contrary, they referred to the fact that the terms on which the parties agreed to do business, and their responsibilities to each other, were set out elsewhere within the body of the agreements.
In the absence of any operative provisions, and despite the fact of a prior course of dealings, the recitals could not be construed as express terms as Toomey had alleged.
The M&S v BNP Paribas commercial and practical necessity test for implying terms is an objective test which considers the perspective of the ‘officious bystander’. The test does not consider the perspective of a particular party. Without the terms contended for by Toomey the contract might well work, albeit to the commercial disadvantage of that party. The test for implying terms was, therefore, not met.
A prior course of dealings is not a valid legal head in itself for implying contractual terms. Rather, a course of dealings can, in some cases, mean that express terms which have not otherwise been included in the contract should be incorporated. There is a subtle but significant difference between these two concepts.

One key takeaway from this case is that, whilst it is often a good idea to include recitals to explain the purpose and intentions behind the contract in case that can aid in the construction or interpretation of contractual provisions in the event of a dispute, such provisions will not operate as express terms with binding contractual force if they do not contain operative obligations. Another is that, while a course of dealings between parties can be relevant in ascertaining the express terms of a contract where those terms may not be written or otherwise clearly evidenced, that will not be sufficient to enable a court to imply new terms. It bears remembering that, in any case, the implication of terms into commercial contracts is potentially intrusive, such that no court will imply terms lightly.

The enforceability of ‘endeavours’ clauses

Finally in this key case round-up, the question of what different ‘endeavours’ clauses demand came before the High Court in Astor Management AG v Atalaya Mining Plc [7].

It is trite law that the phrase “best endeavours” imposes the highest endeavours obligation on a party; “reasonable endeavours” imposes the least onerous obligation; and “all reasonable endeavours” (as appeared in this case), “commercially reasonable endeavours”, and the like, fall somewhere in between. But what an endeavours clause actually demands of a party, and whether it is certain enough to be contractually enforceable, can often fall to the court to decide.

In Astor v Atalaya the defendant submitted that an endeavours clause is only enforceable if the object of the provision is sufficiently clear and there are objective criteria against which to measure the reasonableness of a party’s endeavours [8]. However the High Court disagreed and the following points arise:

The role of the court is to give effect to what the parties have agreed where that is at all possible, not to refuse to do so just because the parties have not made the task easy. To hold that an endeavours clause is unenforceable for uncertainty should therefore be a last resort.
It should almost always be possible to give effect to an obligation to use reasonable endeavours (or any incarnation of that obligation) because whether a party has complied with an obligation is a question of fact for the court to decide by making a value judgment as to whether the endeavours undertaken (if any) were sufficient.
The burden of proof is on the party alleging that the other has failed to comply, but the fact that that may be difficult to prove does not mean that the obligation itself is invalid.

The key takeaway from this case is that endeavours clauses will, in the majority of cases, be legally enforceable, but that does not necessarily mean that they are always practical and helpful to the parties. In the interests of avoiding any dispute in the first place, it is surely preferable to consider whether a contractual obligation to use best/reasonable endeavours is really the best solution for your contract – might it not be better to set out specific obligations and measurable objectives? Endeavours clauses are great for getting draft contracts agreed quickly and for giving wiggle room to the person with the obligation, but they can significantly increase the potential for dispute and can simply delay the argument from the contractual negotiation stage to the dispute.

In this article we have summarised some of the key issues to come out of commercial contract cases from recent weeks. Taken together, these cases demonstrate that the interpretation and practical application of contractual provisions remain fertile ground for dispute. If you have any query or concern arising from your existing contractual arrangements, or if you would like some assistance in getting your commercial contracts right from day one, please do not hesitate to get in touch.

___________________

[1] [2017] EWCA Civ 37
[2] [2017] EWHC 253 (Comm), see paras 110 – 210
[3] Ibid paras 129 – 133; [2000] EWCA Civ 406 and [2002] EWCA Civ 163
[4] [2015] UKSC 72
[5] albeit, crucially, note that the court did not say that the clause would be impossible to enforce, and see our comments below in relation to the Astor v Atalaya case
[6] Toomey Motors Ltd v Chevrolet UK Ltd [2017] EWHC 276 (Comm)
[7] [2017] EWHC 425 (Comm)
[8] The defendant sought to rely on Dany Lions Ltd v Bristol Cars Ltd [2014] EWHC 817 (QB)

Charting a new course for exclusion clauses

The scope of a clause intended to exclude or limit a party’s liability is often […]

The scope of a clause intended to exclude or limit a party’s liability is often one of the most important provisions within a commercial contract but the law underpinning the drafting of such clauses is complex and fraught with traps for the unwary. A recent shipping case, Star Polaris LLC v HHIC-Phil Inc [1], highlights that the way such clauses are interpreted is changing. Partner Malcolm Simpson explains the case and the relevant legal background, and offers his practical advice.

The legal context and the case

Remoteness of damage, or ‘foreseeability’, is an important principle by which English law determines which consequences flowing from a defendant’s breach of contract should be compensated in damages. The leading case, Hadley v Baxendale [2] provides that a loss will only be recoverable if it was “in the contemplation of the parties“, and foreseeable losses under the H v B test fall into two ‘limbs’:

Losses arising naturally, according to the normal course of things, from the breach of contract itself (commonly referred to as ‘direct’ losses); or
Such losses (commonly referred to as ‘indirect’ or ‘consequential losses’) as may reasonably be supposed to have been in the specific contemplation of the particular parties at the time they made the contract, as a probable result of the breach. This second limb covers the particular parties’ knowledge of special circumstances at the time the contract was made.

The terminology is, unfortunately, confusing. Plus, the line as to which losses are direct or indirect is not always clear cut and whether a loss is a direct loss or an indirect/consequential loss is context-specific – what might be a direct loss in one scenario may be indirect/consequential loss in another. (Compare this to the position under US law where, for example, loss of profit is always classed as an incidental or consequential loss, which is generally recoverable.) However a correct understanding of the categorisation of a type of loss can be crucial as it can mean the difference between that loss being recoverable in an action for breach of contract, or not.

Commercial contracts often include clauses which seek to exclude liability for what are described in the contract as “consequential losses”. However, to further complicate matters, it is all too frequently the case that the types of losses that the parties actually intend to catch in such clauses are losses which may not fall within the legally recognised H v B second limb definition. (Common examples include loss of profit and loss of use.)

In the recent Star Polaris case, the contract for the purchase of a ship provided in the exclusion clause that the defendant shipbuilder would have “no liability or responsibility whatsoever or howsoever arising for or in connection with any consequential or special losses… unless otherwise stated herein“. The contract also included a 12 month guarantee given by the shipbuilder against all defects due to defective materials, design error, construction miscalculation and/or poor workmanship. When the vessel suffered an engine failure, the shipbuilder contended that its liability was limited, by virtue of the wording of the exclusion clause and the guarantee together, to the cost of repair of physical damage. The purchaser, however, argued that the phrase “consequential or special losses” should be interpreted narrowly in accordance with the established legal meaning of the losses falling within the second limb of H v B. This rather technical legal distinction was of huge practical significance because the purchaser was claiming for the diminution in value of the vessel, which amounted to a vastly higher sum than the cost of repair, and which would not necessarily be excluded if the purchaser’s interpretation of the exclusion clause was correct.

The High Court found for the shipbuilder, and the following key points arise:

Although there is an historical line of authorities pointing to the H v B meaning and the purchaser’s preferred interpretation, the court decided that:
- taking into account the whole of the contract; and
- the natural meaning of the wording;
- bearing in mind the principle of ‘freedom of contract’;
- and the fact that the contract was negotiated between two commercially sophisticated parties,

the contract demonstrated that the H v B meaning was not the intended meaning of the parties and that the historical line of authorities was therefore not relevant to the case.

The established meaning of words or phrases, including those such as ‘indirect’, ‘consequential’ or ‘special losses’, is secondary to the wording of the contract itself.
The particular contract and context are paramount, such that even if the same or similar wording has been construed in a certain way in another case, legal precedent may be of limited value and a court may reach an entirely different conclusion in different circumstances.
This latest decision is consistent with the modern authorities of Arnold v Britton and Transocean Drilling v Providence Resources [3], respectively on contractual interpretation generally and the interpretation of exclusion clauses. It therefore seems to chart a departure from the traditional course that clauses excluding or limiting liability for consequential losses will be interpreted narrowly in accordance with the H v B second limb.

Practical advice

It is possible, with careful and accurate drafting, to consider precisely what losses are likely to flow from a breach of contract; to categorise them correctly in the context of the particular contract and case; and to deal with them exactly as the parties intend in any exclusion or limitation of liability clause. It is now, more than ever, essential that parties get their drafting right, to ensure that their contracts, and in particular the allocation of risk and liability provisions, properly reflect their intentions. Established phrases and standard or precedent documents should be used with real caution. The safest course is to take specialist, local legal advice when dealing with any English law commercial contract.

___________________

[1] [2016] EWHC 2941 (Comm)
[2] [1854] EWHC Exch J70
[3] [2015] UKSC 36; [2016] EWCA Civ 372; and see our earlier briefings: Contract is King, says Supreme Court; Interpreting a mutual indemnity: It takes two to exclude.

New Business and Property Courts

The judiciary has announced that, as from June 2017, the specialist civil courts (including the […]

The judiciary has announced that, as from June 2017, the specialist civil courts (including the Commercial Court, the Technology and Construction Court and the courts of the Chancery Division dealing with financial services, intellectual property, competition and insolvency) will comprise one umbrella specialist business dispute resolution jurisdiction known as The Business and Property Courts.

The new Business and Property Courts will preserve the familiar practices of the existing courts (so no immediate procedural changes are anticipated), but will allow for greater flexibility in the cross-deployment of judges with specialist expertise. There will be Business and Property Courts in Birmingham, Manchester, Leeds, Bristol and Cardiff (with expansion to Newcastle and Liverpool likely in future), enabling greater connection between work undertaken in the regions and in London.

The judiciary’s press release states that the new structure will enhance the UK’s reputation for international business dispute resolution. It is to be hoped that the increased flexibility, the closer working and the enhanced regional connection may ultimately result in increased efficiency and improved service delivery for business court users.

Commercial Dispute Resolution Team invests in talent with four promotions

The Commercial Dispute Resolution (CDR) Team continues to go from strength to strength as it […]

The Commercial Dispute Resolution (CDR) Team continues to go from strength to strength as it announces four promotions.

The promotions comprise the appointment of Nick Lees as a Partner and Nick McQueen and Louise Norbury-Robinson as Senior Associates. The promotions will come into effect from 1 May.

The promotions underline the Team’s commitment to investing in high quality lawyers and reinforce its commitment to talent engagement.

Contacts

Gwendoline Davies - Partner, Commercial Dispute Resolution at Walker Morris LLP square

Gwendoline Davies
Partner
Learn More

Malcolm Simpson, Managing Partner, Litigation & Dispute Resolution at Walker Morris LLP square

Malcolm Simpson
Partner
Learn More