Watson, Farley & Williams Some aspects of English Contract Law Andrew Savage/Nigel Thomas Introduction Constituent elements of a binding contract The interpretation of contracts Direct and Indirect (or ‘Consequential’) loss Liquidated Damages clauses (or Penalty clauses?) Force Majeure Termination 2 Binding Contract: offer and acceptance Offer and acceptance are required. The offer can be revoked at any time up until acceptance. An “offer” which must be kept open must be supported by consideration (e.g. an option). That is then a binding contract. No “culpa in contrahendo”. Revocation must be communicated. Unqualified acceptance only: otherwise there will be a counter offer, which implies rejection. Following a counter offer, the original offer may no longer be accepted by the original offeree. 3 Binding Contract: consideration A gratuitous promise does not amount to a contract. Places a limit on the enforceability of contracts which would otherwise be valid and binding. “Something of value” must be given by the promissee in exchange for the promise: can be a benefit to the promisor or detriment to the promisee. Consideration need not be adequate: “A peppercorn does not cease to be good consideration if it is established that the promissee does not like pepper and will throw away the corn.” Past consideration is not good consideration. Though Williams v Roffey Bros “exception” – factual benefit to promisor of performing existing contractual duties. 4 Consideration Part-payment of a debt is not good consideration – the rule in Pinnel’s Case. Can avoid this rule by e.g. repayment at earlier time. Pinnel does not apply if payment of part of the debt is undertaken by a third party. “Lack of consideration” is rarely the fatal blow to a contract. 5 Consideration It might be thought that guarantees would be particularly exposed, but this is very rarely the case: Bear in mind that the consideration must move from the promisee, it need not move to the promisor. Consideration may be nominal. A unilateral promise unsupported by any consideration can be made binding by way of a deed. More thought is required where a guarantee is given after the transaction – i.e. past consideration. Nb/ Contract (Rights of Third Parties) Act 1999. 6 Binding Contract: intention to create legal relations Starting point is that this is not of great relevance in commercial context as regards most contracts. It is presumed commercial parties intend to reach binding legal relations. (Contrast with domestic relations). However, the issue can take an “express” form in respect of contracts made, e.g: “subject to contract, “subject to details”, “subject to documentation”. Usually this is a clear indication that the contract is not intended to be binding. The issue is more difficult in contracts where it is unclear if the terms are intended to be binding or indicative (e.g. Heads of Terms). 7 Binding Contract: intention to create legal relations There is a surprisingly large amount of litigation between commercial parties where there is disagreement as to whether commercially negotiated terms are intended to be binding. It should be simple to avoid this problem with clear language. Two “danger” areas are: “incompleteness” of agreements. Here so called “essential terms” are not agreed and thus the whole contract is said to be too uncertain to be enforceable. E.g. commencement or duration of a lease. English Courts prefer to find that parties have made binding agreements, but this can be a real issue. Linked to the above is the issue of “negotiation clauses”. 8 Binding Contract: certainty An agreement to “negotiate a price in good faith” would be unenforceable. A fundamental principle in English law is that one cannot “agree to agree”. Such a clause is unenforceable. Has been justified in various ways – the issue of good faith in English law, lack of certainty. (Walford v Miles) However “lock-out” agreements (supported by consideration) (Walford v Miles) are enforceable. (Because there is certainty). Knock-on effect is that where terms would be complete but for certain (essential) aspects of the putative contract being “to be agreed in good faith” or “subject to further discussion and agreement”, there is a very real risk of the entire contract being held to be unenforceable. Courts tend not to like such a result and will try where possible to implement objective machinery to ascertain unresolved matters where the parties fail or refuse to do so. 9 Binding Contract: certainty “..the hire shall be equitably decreased by an amount to be mutually agreed between Owners and Charterers..”. (The Didymi). Held: Enforceable – “equitable” was an objective measure. Arbitration clauses can be relevant. Price of a van to be “on hire purchase terms over two years”. Held: unenforceable – “hire purchase terms” encompassed too broad a range of possibilities. Result would have been the same if the words “to be mutually agreed” had been inserted. “For each type of crude oil will be applied the pricing which will be more or less the common practice at the time of nomination. E.g the average of the means of 3 or 5 quotations after B/L date. A certain number of quotations before/after or around NOR at discharge port etc. The precise pricing will be given by Seller to Buyer together with the nomination of cargo. Buyer has the right not to accept the proposed pricing and suggest an alternative.” Held – binding clause. The (10 year) contract had already been performed for a number of years when the point was raised and the Court found there to be a sufficient objective basis for price determination in the absence of agreement. (Mamidoil). 10 Binding Contract: certainty Plaintiffs had the right to buy “…under the MOA to be finalized as per terms and conditions stated herein…”. It was argued “to be finalized” meant “to be agreed” but it was held that it meant “to be formalized”. (Global Container Lines). Lessons. Where terms are in summary form, always consider whether the document is intended to binding or not and expressly state the position. Avoid leaving any terms subject to negotiation. Adjustment provisions need to be related to some form of objective criterion. This can be quite loose. 11 Interpretation of Contract: the traditional approach Traditionally English courts have favoured the ‘literalist’ approach to construction. The intentions of the parties should be ascertained by reference to the words set out in the contract. The court should look to the ‘natural ordinary meaning’ of the words used. The court should avoid looking beyond the ‘four corners’ of the contract except in cases where there is significant ambiguity. 12 Interpretation of Contract: the modern approach Modern ‘purposive’ approach to construction was reaffirmed by Lord Hoffman’s five ‘principles’ in Investors Compensation Scheme: Meaning which a ‘reasonable person’ would understand. Look to the ‘matrix of fact’. Prior negotiations excluded – still the case? Dictionary definitions of words used do not necessarily show the true intention of the parties. Courts can re-interpret terms of a contract where it is clear that the words used can not show the true intention of the parties given the ‘factual matrix’ – ambiguity no longer required. 13 Interpretation of Contract Reasonable person is a person in possession of the information reasonably available to the person or class of persons addressed by the contract. “Reasonable person” may or may not consult a lawyer depending upon the context. In some circumstances it will be assumed that the parties were familiar with relevant case law – e.g where standard form contracts are adapted to take account of developing law. A “lawyer’s approach” of construing a contract as a whole may be inappropriate. Ambiguity not required. This is an important point. 14 Interpretation of Contract “….the sum actually paid by the Reinsured in settlement of losses or liability…” House of Lords said “actually paid” meant “actually payable”. “…The Applicant agrees to accept the terms set out in the documents attached in full and final settlement of all or any claims whether under statute, common law or in equity of whatsoever nature that may exist…” House of Lords said this wording to not preclude later claims by the Applicant for “stigma damages”. Lord Bingham: “The clause cannot be read literally.” 15 Interpretation of Contract Subsequent statements and conduct of the parties are also excluded. The rule that prior drafts can not be used to ascertain the intention of the parties is well-established. Principle is that underlying (and changing) intentions “crystallise” at the moment the contract is entered into. But not a hard and fast rule: for example, “private dictionary exception” – Proforce, Court of Appeal 2005 “Preferred Supplied Status”. 16 Direct and Indirect Loss and Exclusion Clauses Critical to appreciate rules on the recoverability of losses in order to draft effective exclusion clauses. Contract damages aim to put a party into the position it would have been had the contract been performed. However, some losses so assessed may be too remote. Remoteness – the rule in Hadley v Baxendale: 1 Losses flowing naturally from the breach (i.e. those which would have been reasonably foreseeable to the reasonable man at the time of entering into the contract) will not be too remote. In general, a profit is foreseeable; and 2 If special circumstances mean that losses beyond those that naturally flowed from the breach are incurred by the defendant, such losses will only be recoverable if the possibility of their being incurred was in the reasonable contemplation of both parties. 17 Direct and Indirect Loss and Exclusion Clauses Exclusion/limitation clauses often seek to exclude liability for (a) direct losses (b) indirect losses (c) consequential losses. Direct losses means losses under the 1st limb. Indirect losses means losses under the 2nd limb. Consequential losses means losses under the 2nd limb. 18 Direct and Indirect Loss and Exclusion Clauses “The Company will not in any circumstances be liable for any indirect or consequential loss, damage or liability arising from any defect in or failure of the System or any part thereof or the performance of this Agreement or any breach hereof by the Company or its employees”. Hotel Services Ltd v Hilton International Hotels. Held: this did not exclude a loss of profits claim for “ordinary profits”. “… in no event shall DAVY by reason of its performance or obligation under this CONTRACT be liable ….for loss [of] any anticipated profits, catalyst, raw materials and products or for indirect or consequential damage”. Held: lost profits excluded, but only because of express reference to “anticipated profits”. 19 Direct and Indirect Loss and Exclusion Clauses “The Seller will be liable for any loss, damage, cost or expense incurred by the Purchaser arising from the supply by the Seller of any such faulty goods or materials or any goods or materials not being suitable for the purposes for which they are required save that the Seller's liability for consequential loss is limited to the value of the contracts.” Held: only “second limb” losses excluded. Here, that meant very substantial losses claimable for increased costs of production. (British Sugar). In order to effectively exclude liability for loss of profits or other direct losses, the clause should make express reference to the exclusion of such. Contra proferentem rule applies and see Canada Steamship in relation to the exclusion of negligence. 20 Direct and Indirect Loss and Exclusion Clauses "once a phrase has been authoritatively construed by a court in a very similar context to that which exists in the case in point, it seems to me that a reasonable businessman must more naturally be taken to be having the intention that the phrase should bear the same meaning as construed in the case in point." In short, in this context, Investors Compensation Scheme won’t help ! 21 Liquidated Damages Clauses Liquidated Damages or Penalty Clause? If a liquidated damages clause, the sum specified will be payable – no more no less – even if the loss suffered is greater or smaller. Attractive for commercial parties as it gives certainty. If a clause is a penalty, the loss recoverable according to ordinary principles is still recoverable. What if the contract stipulates that only contractual remedies are available to the parties? – problematic. Arguably such term will fall away if there are no such remedies because the liquidated damages clause is held to be an unenforceable penalty. If a clause is a liquidated damages clause, claiming sums in addition will only be possible if the clause can be so construed. 22 Liquidated Damages Clauses Traditional approach set out in Dunlop Pneumatic Tyre: The sum must not be extortionate and unconscionable in comparison with the greatest loss that could conceivably be proved to have resulted from the breach. It is no obstacle that the consequences of the breach are such as to make precise pre-estimation of the costs an impossibility. But, “the essence of liquidated damages is a genuine covenanted pre-estimate of damage”. This can be impractical and gives rise to argument. 23 Liquidated Damages Clauses Philips Hong Kong Ltd – the fundamental requirement is that the clause does not aim principally to deter the counterparty from breaching i.e. inequality of bargaining position. “.. the court has to be careful not to set too stringent a standard and bear in mind that what the parties have agreed should normally be upheld. Any other approach will lead to undesirable uncertainty especially in commercial contracts” This decision was a significant departure from the traditional rule and gave significant leeway to liquidation clauses. 24 Liquidated Damages Clauses 10.03(A) In the event of default by the Borrower in the payment on the due date therefor of any sum expressed to fall due under this Agreement (or on demand in respect of any sum expressed to fall due under this paragraph (A)), the Borrower shall pay interest on the participation of each bank in each [unpaid sum] from (and including) the date of such default to (but excluding) the date on which such sum is paid in full (as well after as before judgment) at a rate per annum equal to the aggregate of (i) one per cent. (1%), (ii) the Margin and (iii) the cost as determined by such Bank of obtaining dollar deposits (from whatever source or sources it shall think fit) to fund its participation in the unpaid sum for such period or periods as the Agent may from time to time determine. Penalty interest enforceable? “the borrower in default is not the same credit risk as the prospective borrower with whom the loan agreement is first negotiated”. Lordsvale Finance 25 Liquidated Damages Clauses “It is perfectly true that for upwards of a century the courts have been at pains to define penalties by means of distinguishing them from liquidated damages clauses. The question that has always had to be addressed is, therefore, whether the alleged penalty clause can pass muster as a genuine preestimate of loss. That is because the payment of liquidated damages is the most prevalent purpose for which an additional payment on breach might be required under a contract. However, the jurisdiction in relation to penalty clauses is concerned not primarily with the enforcement of inoffensive liquidated damages clauses, but rather with protection against the effect of penalty clauses. There would therefore seem to be no reason in principle why a contractual provision, the effect of which was to increase the consideration payable under an executory contract upon the happening of a default, should be struck down as a penalty if the increase could in the circumstances be explained as commercially justifiable, provided always that its dominant purpose was not to deter the other party from breach.” (Lordsvale) 26 Liquidated Damages Clauses “17.1 In the event of a Wrongful Termination by way of liquidated damages the Company shall forthwith pay to the Executive a sum equal to one year's gross salary, pension contributions and other benefits in kind …. In the event of a dispute as to the value of any benefit in kind the amount payable shall be determined by the Company's auditors. 17.2 Subject to any rights accrued at the date of termination of the Executive's employment under the provisions of any pension scheme, option scheme or bonus or benefit plan of the Company, any payment of liquidated damages by the Company shall be made in full and final settlement of all and any claims arising out of the Executive's employment, its termination, or ceasing to hold the office of director of the Company or any associated company “ 27 Liquidated Damages Clauses Defendant gave 8 weeks’ notice. Was the clause a penalty ? Clause did not take account of claimant’s duty to mitigate and find another job and the same sum was payable irrespective of how much notice was given. Although the clause was arguably not a genuine preestimate, the Court of Appeal found the clause was not so extravagant as to act as a deterrent. Therefore it was not penalty clause and served a legitimate commercial purpose. 28 Liquidated Damages Clauses Caution – still better to try to tailor the estimate if possible. Compare the ‘extravagant’ results of such clauses in Duffen v FRA.BO and Murray v Leisureplay. “Upon the termination of this Agreement by the Agent pursuant to clause 6.3 the Principal shall immediately become liable to the Agent for and shall pay to the Agent forthwith the sum of £100,000 by way of liquidated damages which sum is hereby agreed by the parties to be a reasonable pre-estimate of the loss and damage which the Agent will suffer on termination of this Agreement by reason of the failure of the Principal to pay the sums which but for the Principal's breach hereof would have been payable to the Agent under the terms hereof.” 29 Liquidated Damages Clauses Contract was a 4 year sales agency. Court of Appeal found that since the loss suffered by the agent could range between £180,000 and £10,000 depending on when the contract was terminated, the clause was a penalty. An obvious risk the clause would be disproportionate if the sales agency was terminated with a month or two to run. 30 Liquidated Damages Clauses Some clauses provide that a fixed sum will be payable on certain events. It has been argued that since the claim will then be for a debt rather than damages resulting from a breach, penalty rules do not apply. ‘Take or pay’ clauses – will generally not fall foul of the rule as will be commercially justifiable - M &J Polymers. Clause stated purchaser “will pay for the minimum quantities of Products as indicated in this Article… even if they have not ordered the indicated quantities during the relevant monthly period”. Court decided penalty rule could apply, but judge decided case on basis that clause was commercially justifiable. 31 Liquidated Damages Clauses Forfeiture of deposits are open to challenge. A clause providing for a payment to be made on the breach of a confidentiality agreement is likely to be a penalty clause as it would be hard to argue that it was not included primarily as a disincentive to breach. 32 Force Majeure Not a common law concept. “Frustration” bears some similarity (supervening events outside the parties’ control) but is rather different – automatic discharge of the contract. Frustration is draconian and not generally applicable. Events must not be contemplated by the contract (so a force majeure clause would tend to preclude the possibility of frustration). Matters merely making performance difficult or very expensive are highly unlikely to comprise frustrating events. Thus if it is desired to relieve performance in the event of significantly changed circumstances, it is prudent to use a force majeure clause. 33 Force Majeure Force majeure clauses are recognised, interpreted and enforced in the ordinary way. Hence the following issues can be important: The clause must be specific about the events to be considered “force majeure” events. A general extension to “any other force majeure events” will cause uncertain and it is doubtful that it will extend the events beyond those listed. In British Electrical and Associated Industries “the usual force majeure clauses” was held to be too vague. English law considers an FM clause to equate to an exclusion clause. A party relying on such clause bears the burden of bringing itself within it. So this supports clarity. Event relied upon must not be “self induced”. 34 Force Majeure Uncertainty about the “causative potency” of FM events. The drafting will determine what is required “Neither party shall be entitled to rely on this Force Majeure clause to the extent that the effects of the Force Majeure Events could have been avoided by a party properly performing all its obligations under this Contract”. Issue can be whether FM events apply where negligence applies. Allocation of resources provisions (if a party is disabled from performing all its contracts due to limited resources). Notice provisions must be respected. Therefore it is preferable to provide clear guidance in the contract as to when notice of a force majeure event should be given – “as soon as possible” may be unhelpful - and what its contents should be. Clause may provide that performance is “hindered” or “prevented”. 35 Force Majeure Clause must be specific about effects on the contract (suspension of both parties’ performance, when the effect ends, possible adjustment provisions – though note Walford v Miles, agreement to agree point). 36 Termination An important area as regards drafting and considering the position when things “go wrong”. Starting point is to consider the position if the contract is silent on termination i.e. common law rights of termination. Time and again the Courts have said that they will be slow to find a party has given away such rights in the absence of very clear and express wording. 37 Termination Breach of contract creates right to damages though not necessarily to termination. Instances when an innocent party can terminate: Where the Defendant has renunciated i.e. where ‘by words or conduct he evinces an intention not to perform, or expressly declares that he is or will be unable to perform, his obligations under the contract in some essential respect.’ Such a breach is “repudiatory”. The innocent party may “accept the repudiation”. Where performance has become impossible as a result of Defendant’s actions (otherwise frustration). Where the defendant is guilty of substantial failure to perform i.e a breach which goes to the ‘root of the contract’. Breach of condition or sometimes intermediate term. Breach of warranty not enough – damages claim only. 38 Termination: conditions, warranties and innominate terms The law may determine that a particular term is a condition (Sale of Goods Act 1979). Thus per SOGA 1979, certain terms implied by that Act regarding title, sale by description, quality and sale by sample are conditions. A term may also be a condition by implication in the context of the contract as a whole (must go to the root of the contract). (But “the Courts should not be too ready to interpret contractual clauses as conditions”). The parties may expressly provide that a term is a condition; usually determinative but not always. 39 Termination: conditions, warranties and innominate terms A ‘Warranty’ is a less important contractual stipulation, breach of which entitles the innocent party to damages only i.e. not to termination. Again, some terms are defined as warranties by statute e.g. Sale of Goods Act. Thus the term that goods are free from any charge or encumbrance not disclosed or known to the buyer before the contract is made and that the buyer will enjoy quiet possession of the goods is classified as a warranty: s12. 40 Termination: conditions, warranties and innominate terms In Hong Kong Fir Shipping the Court of Appeal came up with a middle ground. Breach of a clause in a time charter stating that a ship was ‘in every way fitted for ordinary cargo service’ could be both trivial and so fundamental as to go to the heart of the contract. Whether such a breach would entitle the innocent party to terminate would depend on the consequences of that breach. Creates flexibility for courts – they can look at the result of the breach rather than the term itself. Classification as an innominate term can lead to a lack of certainty. 41 Termination Clauses Subject to remoteness rules (Hadley v Baxendale), upon termination, innocent party entitled to claim for damages caused by breaches prior to termination plus loss of bargain and expenses incurred (though not insofar as there is overlap). Unfortunately there can be a lack of certainty at common law e.g. is a breach repudiatory, is a term a condition. In addition, it is well established that serving notice to terminate when not so entitled can be (and usually is) itself repudiatory and entitles the opposing party to terminate (whether or not such party is in breach). The “innocent” party thereby loses right to substantial damages. Parties therefore often draft bespoke termination provisions. Such clauses must be drafted with care! 42 Termination Clauses Rice v Great Yarmouth: “if the contractor commits a breach of any of its obligations under the Contract;… the Council may, without prejudice to any accrued rights or remedies under the Contract, terminate the Contractor’s employment under the Contract by notice in writing having immediate effect.” Court of Appeal held ‘any breach’ had to mean a repudiatory breach or cumulative breaches amounting to a repudiatory breach. In The Antaios “any breach of this charterparty” was held to refer to a repudiatory breach. 43 Termination Clauses National Power v UGC: “Either party shall be entitled to give notice of termination of this Agreement with immediate effect if the other party shall be in material breach of any of its obligations hereunder and fails to commence to remedy the same within seven (7) days after notice requiring such breach to be remedied”. ‘Material breach’ held to be a lower standard than repudiatory breach. 44 Termination Clauses Crane Co v Wittenborg: “Either party shall be entitled forthwith to terminate this Agreement by written notice to the other if that other party commits any substantial breach of any of the provisions of this Agreement and in the case of breach capable of remedy fails to remedy the same within 90 days of receipt of a written notice giving full particulars of the breach and requiring it to be remedied.” ‘Substantial’ breach held to mean repudiatory breach. 45 Termination Clauses Note that provisos in termination clauses (e.g. as to notices to remedy) must be strictly complied with. “Notice to remedy” clauses common, though note a fairly frequent issue is the meaning of the usual carve out that the breach must be “capable of remedy”. Consider the example of a breach of a confidentiality clause. In Loan Agreements numerous ‘Events Of Default’ are specifically stipulated. Any term can be an event of default if drafted with enough specificity. 46 Termination Clauses A contractual right to terminate will not replace the innocent party’s common law right to terminate unless clearly stated Stocznia Gdanska v Latvian Shipping Co. Context was a ship building contract. Court of Appeal has just confirmed (Stocznia Gdanska v Gearbulk) that unless the contract expressly provides, even by terminating under an express termination clause, a party may not be restricted to the rights expressly stated to arise in respect of such termination. Terminating party may also be able to claim loss of bargain as if it had terminated at common law. Lesson is that when drafting termination provisions, think not just about what termination rights you wish a party to have, but what rights you don’t wish the party to have: which is why an understanding of the right to terminate is crucial. 47 Appendix 1: S1 Contracts (Rights of Third Parties) Act 1999 (1) Subject to the provisions of this Act, a person who is not a party to a contract (a “third party”) may in his own right enforce a term of the contract if— (a) the contract expressly provides that he may, or (b) subject to subsection (2), the term purports to confer a benefit on him. (2) Subsection (1)(b) does not apply if on a proper construction of the contract it appears that the parties did not intend the term to be enforceable by the third party. (3) The third party must be expressly identified in the contract by name, as a member of a class or as answering a particular description but need not be in existence when the contract is entered into. (4) This section does not confer a right on a third party to enforce a term of a contract otherwise than subject to and in accordance with any other relevant terms of the contract. (5) For the purpose of exercising his right to enforce a term of the contract, there shall be available to the third party any remedy that would have been available to him in an action for breach of contract if he had been a party to the contract (and the rules relating to damages, injunctions, specific performance and other relief shall apply accordingly). 48 Times 49 Watson, Farley & Williams All references to 'Watson, Farley & Williams' and 'the firm' in this presentation means Watson, Farley & Williams LLP and/or its affiliated undertakings. Any reference to a ‘partner’ means a member of Watson, Farley & Williams LLP, or a member or partner in an affiliated undertaking, or an employee or consultant with equivalent standing and qualification.