In-Site
Summer 2010
Authors:
Kevin Greene
Welcome to the Summer 2010 edition of In Site. This edition covers the following
topics:
•
Letters of intent and counterparts clauses in RTS v Müller;
•
Pay-when-paid clauses;
•
Frustration;
+44.(0)20.7360.8166
•
Fraudulent misrepresentation in BSkyB v EDS;
Inga Hall
•
The Bribery Act 2010; and
•
Judicial support for collateral warranties in the Scottish Widows case.
kevin.greene@klgates.com
+44.(0)20.7360.8188
Robert Hadley
robert.hadley@klgates.com
inga.hall@klgates.com
+44.(0)20.7360.8137
Becky Rowell
becky.rowell@klgates.com
+44.(0)20.7360.8203
K&L Gates includes lawyers practicing out
of 36 offices located in North America,
Europe, Asia and the Middle East, and
represents numerous GLOBAL 500,
FORTUNE 100, and FTSE 100
corporations, in addition to growth and
middle market companies, entrepreneurs,
capital market participants and public
sector entities. For more information,
visit www.klgates.com.
For more information on any of these articles, or on any other issue relating to
construction and engineering law, please contact any of the authors or your usual
K&L Gates’ contact.
Letters of intent
Letters of intent are commonly used as a means of getting a project underway
before the formal contract terms are fully agreed. As such, letters of intent are often
a practical necessity, but they can create considerable confusion when it comes to
determining if, when, and on what terms a legally binding contract comes into
existence. Much can depend on the wording of the letter of intent, as well as the
subsequent conduct of the parties.
The complexity of the legal issues which can arise was well illustrated in RTS
Flexible Systems Limited v Molkerei Alois Müller Gmbh & Co KG [2010]
UKSC 14.
Müller engaged RTS to supply an automated packaging system in January 2005
and work commenced under a 4 week letter of intent whilst the parties negotiated
the contract terms. The letter of intent stated the parties’ intention that the final
contract would incorporate the MF/1 model form terms (as amended). The letter of
intent expired in May 2005, but RTS continued to work on the project and,
although most terms were agreed by 29 June, it was not until 5 July 2005 that the
parties had agreed all the contract terms. Although agreed, the contract
was never signed.
When a dispute later arose, the parties disagreed as to whether the contract was
based on the 29 June or 5 July terms. The material difference was that the 5 July
terms included a schedule (“Schedule 1”) setting out the MF/1 terms, which
included a counterparts clause stating that the contract "…may be executed in any
number of counterparts provided that it shall not become effective until each party
has executed a counterpart and exchanged it with the other.” The particular drafting
of this counterparts clause meant that it was effectively a “subject to contract”
clause.
The judge in the first instance decided there was no binding contract on the 5 July
terms because the counterparts clause prevented a contract coming into existence
on those terms in the absence of a signed agreement. The judge held that a different
contract had come into being between the parties after the letter of intent had
expired based on the 29 June terms (which did not include the counterparts clause).
In-Site
RTS successfully appealed that decision to the
Court of Appeal in 2009. It argued that there was
no contract between the parties at all and that
therefore it would have a quantum meruit claim.
The Court of Appeal was of the view that the
counterparts clause in Schedule 1 applied to the
whole of the draft contract, not just to the 5 July
terms. As such there could be no contract, on 29
June terms or otherwise, after the letter of
intent expired.
The case finally made its way to the Supreme
Court in 2010 when Müller appealed the Court of
Appeal’s decision that there was no contract. The
Court unanimously allowed Müller’s appeal and
agreed that it was unrealistic on the facts of the
case to suppose (as the Court of Appeal had) that
the parties did not intend to create legal relations.
Equally however, it made no commercial sense to
hold (as the judge at first instance had) that the
project was carried out on some, but not all, of
the 5 July terms. The Court held that the parties
had reached a binding agreement on the 5 July
terms and had waived the “subject to contract”
provision by continuing to perform.
Lord Clarke said in the judgment that “the
different decisions in the courts below and the
arguments in this court demonstrate the perils of
beginning work without agreeing the precise
basis upon which it is to be done. The moral of
the story is to agree first and start work later". We
all know that in practice this is not always
possible. However, this case is a warning about
what could happen if a contractual relationship is
not formalised: parties should be aware that
courts will look at factors such as
communications and conduct to decide the nature
of the relationship between the parties, and in
particular whether the protections offered by a
“subject to contract” clause have been waived.
When a letter of intent with a stated duration
expires, it is in both parties’ interests to agree on
what basis work is, or is not, to continue.
Pay-when-paid clauses
The case of William Hare Limited v Shepherd
Construction Limited [2010] EWCA Civ 283
shows the importance of regularly reviewing
standard form contracts to ensure that they deal
with any legislative changes.
The 2008 sub-contract between the parties was
based on a standard form that Shepherd (the main
contractor) had been using since around 1998. It
included a term that Shepherd would not be
obliged to make any further payment to William
Hare (as sub-contractor) where the employer
under the main contract was insolvent. The subcontract definition of insolvency was, however,
based on outdated wording.
Section 113(1) of the Housing Grants,
Construction and Regeneration Act 1996 (“the
Act”) outlawed pay-when-paid clauses in the
construction industry unless it could be shown
that the third-party employer was insolvent. The
relevant part of the definition of a company’s
insolvency originally included in section
113(2)(a) of the Act (and mirrored in Shepherd’s
standard terms) was limited to the making of an
administration order by order of the court.
Shepherd’s standard form wording was not
updated to reflect the fact that the Enterprise Act
2002 (Insolvency) Order 2003 amended the
definition of insolvency in section 113(2)(a) of
the Act to include “self-certifying” routes as well
as court orders.
When the employer on the project went into
administration by a self-certifying route,
Shepherd sought to rely on the pay-when-paid
clause to withhold from William Hare substantial
sums otherwise due to it. William Hare
successfully disputed this on the basis that the
insolvency of the employer did not fall within
the terms of the pay-when-paid clause in the subcontract. As such, Shepherd's withholding notice
was invalid. Given that the mis-drafted clause
worked (even if a reasonable person may suspect
there was an error) there is little reason for the
courts to intervene. This decision shows that
Shepherd should have updated its pay-when-paid
clause to take account of the amended
legislation, or drafted the definition of
insolvency sufficiently broadly in the first place
to take account of changes in the law.
Can a recession frustrate a
contract?
Gold Group Properties Limited v BDW Trading
Limited (formerly known as Barratt Homes
Limited) [2010] EWHC 323 (TCC) is a rather
extreme example of how the construction
industry has dealt with the economic downturn.
It is a reminder to anyone thinking of arguing
that a contract has been frustrated by the difficult
market conditions to think again: frustration of
contracts operates in very few circumstances.
Gold (as landowner) and Barratt (as developer)
entered into a development agreement in 2007,
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under the terms of which sales revenue generated
by the sale of the units on the developed land
would be split between the parties. A schedule of
minimum sales prices for the units was included
in the agreement.
An absence of honest belief is needed to succeed
in such an action. In contrast, an action for
negligent misrepresentation will be made out if
the false statement is made carelessly, or without
reasonable grounds for believing its truth.
When the property market took a turn for the
worse, Barratt realised that the minimum sale
prices for the units were unlikely to be achieved
and Barratt eventually wrote to Gold making the
case that the contract had been discharged by
frustration. Barratt put the keys to the site through
the letterbox in the hoarding and wrote to Gold
claiming monies owing for work allegedly
done on site.
The computer case of BSkyB Ltd and anor v HP
Enterprise Services UK Ltd (formerly t/a
Electronic Data Systems Ltd) and anor [2010]
EWHC 86 (TCC) emphasises that the distinction
between negligent and fraudulent
misrepresentation is a significant one.
Contractual liability caps are not effective to
limit liability for fraudulent misrepresentation,
but will limit liability for negligent
misrepresentation. A well-drafted entire
agreement clause can exclude liability for
negligent pre-contract misrepresentations, but
not fraudulent ones.
The Court looked at previous decisions regarding
frustration, including Pioneer Shipping Limited v
BTP Tioxide Limited (The Nema), where the
Court said that frustration is "not likely to be
invoked to relieve contracting parties of the
normal consequences of imprudent commercial
bargains". Frustration only occurs if there is a
serious event which is both unexpected and
beyond the control of the parties and which will
make the performance of the contract in the
changed circumstances fundamentally different
from performance under the contract which the
parties originally entered into.
The court in Gold v Barratt held that the
agreement was not frustrated for four reasons:
•
the parties foresaw the possibility that the
property market would drop;
•
as a result, the agreement made express
provision for the possible reduction in the
minimum sales prices;
•
there was no injustice to Barratt in obliging
them to progress the works while
renegotiating the minimum prices; and
•
there was no supervening frustrating event as
the drop in the market had been envisaged.
In short, there was no need for the court to
intervene and dissolve the agreement. The hard,
but simple, lesson from this case is that the courts
will not allow parties to escape from a bad
bargain simply because of a recession.
Fraudulent misrepresentation
In order for an action for fraudulent
misrepresentation to be made out, it is necessary
to establish that a false representation has been
made knowingly, or without belief in its truth, or
recklessly as to its truth (Derry v Peek (1889)).
Ramsay J found in this case that EDS (an IT
supplier) made fraudulent misrepresentations
about its ability to deliver a project within the
agreed timescale, and in particular that it had
falsely represented that it had carried out a
proper analysis of the time needed to deliver the
project. The judge found that EDS’s intention in
making those claims was to induce BSkyB to
award the £48 million contract to EDS and as
such the case for fraudulent misrepresentation
was made out. Accordingly, all losses flowing
from the fraudulent misrepresentation were
recoverable, and the £30 million contractual
liability cap in the contract did not limit EDS’
liability (assessed on interim basis to be in the
order of £200 million). Commenting on the
dishonesty of the bid team leader (whose state of
mind was attributable to the company) Ramsay J
said that “he acted deliberately in putting
forward the timescales knowing that he had no
proper basis for those timescales. At the very
least he was reckless, not caring whether what
he said was right or wrong”. The case is
therefore a reminder of the importance of
ensuring that bid team members do not make
statements during contract negotiations that
cannot be backed up, and of keeping copies of
working documents such as draft programmes
and resource calculations to show that, even if
mistaken, statements were not made negligently
or fraudulently.
This case is also a caution for the drafters of
entire agreement clauses. EDS had also made a
negligent misrepresentation about its assessment
of required resources. Unfortunately, however,
for EDS, the Court held that the entire agreement
clause in EDS’s contract did not have the effect
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of excluding liability for negligent
misrepresentation (although liability for such
misrepresentations was subject to the £30 million
liability cap). The safest course of action in such
a situation is usually to refer expressly to the
parties’ intention to exclude liability for negligent
pre-contract misrepresentation when drafting
such clauses.
For UK companies, and foreign companies
carrying on any business in the UK, especially
those operating in difficult jurisdictions or in
high-risk industries, the risk of being subject to
UK process if representatives abroad should
cross the line will increase significantly and not
to have proper anti-corruption
policies/procedures in place is asking for trouble.
The Bribery Act 2010
For more information on the Bribery Act 2010
please contact Robert Hadley on 020 7360 8166
or at robert.hadley@klgates.com
The UK has fragmented and complex bribery
offences at common law and in the Prevention of
Corruption Acts 1889 to 1916. These will be
replaced with the Bribery Act 2010, which will
provide a more effective legal framework to
combat bribery in both the public and private
sectors. The Act received royal assent on 8 April
2010 and is expected to come into force
later this year.
A detailed examination of the provisions of the
Bribery Act is beyond the scope of this article,
but the Act creates two general offences covering
the offering, promising or giving of an advantage,
and the requesting, agreeing to receive or
accepting of an advantage in connection with
someone's "improper" performance of his duties.
There is also a specific offence relating to bribery
of a foreign official. That offence in particular
has implications for what would generally be
regarded as ordinary corporate hospitality.
The Act also creates a new offence of failure by a
commercial organisation to prevent a bribe being
paid on its behalf. This will mean that any UK
company will commit a UK criminal offence if
any person providing services on its behalf
anywhere in the world commits bribery, the
company’s offence being a failure to prevent the
bribery. It will be a defence if the organisation
has “adequate procedures” in place to prevent
bribery. At present those “adequate procedures”
are undefined, although the Act does require the
Secretary of State to publish guidance about
procedures that relevant commercial
organisations can put in place to prevent bribery
on their behalf. These guidance notes are
expected to be published shortly.
As well as criminal prosecution resulting in
unlimited fines and/or up to 10 years
imprisonment, conviction for a corruption
offence can also lead to debarment from public
contracts in the EU in the future.
Collateral warranties
Supporters of collateral warranties will welcome
the Scottish case of Scottish Widows Services &
Anor v Harmon/CRM Facades [2010] ScotCS
CSOH 42 in which Lord Drummond Young
gives clear judicial support for the commercial
intention behind collateral warranties.
This case concerned a collateral warranty given
by the main contractor to a beneficiary and
subsequently assigned to Scottish Widows, and
Scottish Widows’ ability to recover the costs of
remedying defects from the main contractor
under that collateral warranty.
Lord Drummond Young said: “Such warranties
are an important feature of modern practice in
the construction industry. In my opinion they
must be construed in such a way as to further
their essential purpose, namely to ensure that the
party who suffers loss has a right of action
against any contractor or member of the
professional team who has provided defective
work.”
He went on to say that the “fundamental
purpose” of collateral warranties is “to provide a
right of action to a person who is liable to suffer
loss as a result of defective performance of a
building contract or a contract for professional
services in connection with a building project.”
The views expressed by Lord Drummond Young
in this case should give pause to detractors of
collateral warranties who argue that they are “not
worth the paper they’re written on”. Welldrafted collateral warranties, covering the right
things, given by the right people, continue to
have a role to play.
Summer 2010
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In-Site
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