English Contract Law

Watson, Farley & Williams
Some aspects of
English Contract
Andrew Savage/Nigel Thomas
 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
Binding Contract: offer and
 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
 No “culpa in contrahendo”.
Revocation must be
 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.
Binding Contract:
 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.
 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.
 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.
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).
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”.
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.
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.
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).
 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.
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.
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
 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.
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
 A “lawyer’s approach” of construing a contract as a whole
may be inappropriate.
 Ambiguity not required.
This is an important point.
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.”
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
 But not a hard and fast rule: for example, “private
dictionary exception” – Proforce, Court of Appeal
2005 “Preferred Supplied Status”.
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
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.
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”.
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.
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 !
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
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
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.
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
 This decision was a significant departure from the traditional
rule and gave significant leeway to liquidation clauses.
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
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)
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 “
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
 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.
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.”
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.
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.
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.
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
 Thus if it is desired to relieve performance in the event of
significantly changed circumstances, it is prudent to use a
force majeure clause.
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
 Event relied upon must not be “self induced”.
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
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).
 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.
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
 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.
Termination: conditions,
warranties and innominate
 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.
Termination: conditions,
warranties and innominate
 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.
Termination: conditions,
warranties and innominate
 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
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
 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!
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.
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.
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.
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
 In Loan Agreements numerous ‘Events Of Default’ are
specifically stipulated. Any term can be an event of
default if drafted with enough specificity.
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.
Appendix 1: S1 Contracts
(Rights of Third Parties) Act
(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—
the contract expressly provides that he may, or
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).
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
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