Contracts - Overview
1. Introduction
Commercial contracts are formed in a variety of different ways. At one end of the scale the parties to a contract may execute a document that is well over a 100 pages. At the other end of the scale parties may conclude a contract by the exchange of a few words in a meeting or by e-mail. In between these two extremes exists a range of other circumstances in which various parties may agree upon the terms of a contract.
Often contracts will include terms in a standard printed form. These may well be the standard terms of one of the parties.
Often the importance of the formation of the contract does not come to light until a dispute arises. Questions may then be asked of how, when and where the contract was formed and whether one party is bound by certain terms.
2. The Requirements of a Contract
In order for a contract to come into existence four requirements must be satisfied. There must be an offer, acceptance of that offer, consideration and an intention to create legal relations. Each of these is considered in turn below. These requirements will determine if and when a contract comes into existence and under what terms.
2.1 Offer
Any statement may be an offer if, objectively interpreted, it contains an unequivocal indication of a willingness to be legally bound if its terms are accepted. Therefore, a statement is likely to be construed as an offer if it contains the essential terms of the contract as long as it is expressed in reasonably certain terms. For example, the only requirements under a contract for the sale of goods are probably identification of the type and quantity of the goods and the price and delivery date. Whether any particular statement amounts to an offer depends on the facts of the particular case.
The courts have provided some guidance on some usual business practices. Generally adverts, estimates and price lists are not intended to be contractually binding. Invitations for tenders are generally regarded as “invitations to treat”, so that a business which invites potential suppliers to submit tenders does not bind itself to accept any particular tender. An “invitation to treat” usually describes a product at the pre-contract stage. For example, goods placed on a shelf within a shop are an invitation to treat for those wishing to buy those goods.
It must be remembered that none of these presumptions are an absolute rule. In any given circumstance what one party considers to be an advertisement may later be considered by the court to be an offer. The making of a valid offer requires relatively limited requirements. Even an informal statement, such as an e-mail request for the delivery of goods may be construed as an offer.
2.2 Acceptance
An acceptance of an offer must unconditionally assent to all the terms of the offer. Any response to an offer which introduces new terms is not an acceptance but a counter-offer which rejects the original offer. A counter-offer will only result in a contract if that is then accepted. The general rule is that acceptance is ineffective unless it is communicated to the offeror. Some exceptions to this rule exist. The offeror may waive the need for communication. Where acceptance is sent by post then it is effective on posting. Generally, communications sent by telephone, fax or by e-mail are not effective until received. An offer may be accepted by conduct. Thus if one party places an order for goods, the other party may accept it by conduct by the sending the goods out.
2.3 Consideration
Commercial contracts usually involve some degree of exchange. Generally goods or services are provided in return for either money or other goods or services. The key issue to remember about consideration in the context of commercial contracts is that past consideration is no consideration. In practical terms this means that after the contract has been concluded new terms cannot be included.
Example 1:
For example: “D-ream Paper Supplies” takes an order from “Suretype Stationers” to deliver a consignment of A4 paper. A price and delivery date is agreed by e-mail. The following day D-ream Paper sends out an Order Confirmation which includes D-ream's standard terms of trading, including a term which purports to exclude D-ream's liability for late delivery. Delivery is late. If D-ream seeks to rely on the terms Suretype would argue that the contract was concluded by e-mail and that D-ream's terms were not incorporated into the contract. Even if Suretype could be said to have agreed to the terms, D-ream has provided nothing extra (i.e. no consideration) for their agreement.
2.4 Intention to create legal relations
A court will not decide that a contract exists unless it is intended by both parties to be legally binding. It is generally assumed that commercial agreements are intended to be legally binding.
Certain commercial agreements, such as letters of comfort and letters of intent, will generally be presumed not to be intended to be binding.
Where parties are negotiating a contract a letter of intent may be used in order to require one party to commence performance whilst negotiations continue. If the parties fail to reach a final agreement there may therefore be no contract. However, should the parties reach an agreement its terms may expressly or impliedly apply to the work already carried out under the letter of intent. Although it is very rare for agreements not to be legally binding the above is not an absolute rule and the parties may agree between themselves that an agreement is not to be legally binding.
2.5. Formalities for Contract Formation
Generally there are no formal requirements for the creation of a valid binding contract in English Law. There are exceptions to this rule and in particular in relation to the supply of goods or services to consumers.
3. The Contract Terms must be Certain and Complete
An agreement will not constitute a legally binding contract unless its terms are sufficiently certain. If its terms are incomplete or uncertain it may be decided that the parties have not yet reached a concluded agreement or that they do not intend the agreement to be legally binding or simply that it cannot be enforced.
Many business agreements use vague language. Often this is done deliberately in the interests of flexibility. However, should they be too vague then enforcement of an agreement by either party may prove impossible.
Minimum Terms
Courts will generally seek to enforce commercial and business agreements, especially where one or both parties have commenced performance and all that is generally required is agreement in clear terms on the core provisions of the contract such as the price and date for performance. Even no comment by the parties on these matters may not prove fatal since in contracts for the supply of goods or services it will be an implied term that if no price is agreed a reasonable price should be paid and if the contract does not fix a date for performance the contract should be performed within a reasonable time.
Reasonable Endeavours
An agreement under which one party undertakes to use ‘reasonable' or ‘best endeavours' to achieve a result is not uncertain and does not make the contract unenforceable. This type of wording is frequently used in commercial contracts when one party does not want to give an absolute undertaking to achieve a result, but merely to use his reasonable or best endeavours to bring it about.
Agreements to Agree
Certain expressions may indicate that the parties have not yet concluded a binding contract. As a general rule the courts will not enforce agreements to agree or arrangements to negotiate. Therefore if D-ream Paper Supplies and Suretype Stationers agree that D-ream should supply Suretype with paper “at a price to be agreed” then the court will probably decide that a binding agreement was not reached. Since they have agreed that the price is to be agreed they have excluded the implied term that a reasonable price should be paid.
4. Pre-Contract Negotiations: Statements and Terms
There may be extensive negotiations between the parties leading to the conclusion of the contract. This may encompass oral and written communications, including letters, price lists, advertising and sales literature as well as formal contract documents.
When a dispute arises it may be necessary to decide what exactly was said and written and what effect, if any, these communications had. Questions which might be asked include: Did they form part of the contract? Were they terms or representations? Were they just sales talk with no legal effect? If they were terms, were they conditions or warranties?
Even where the contract is eventually set out in a formal document, statements outside that document may have to be considered as possible supplemental terms, unless any terms outside the formal document are expressly excluded by that document.
Entire agreement Clauses
Often written contracts will include an ‘entire agreement clause' for the purpose of avoiding the difficulty of classifying statements and the consequent uncertainty in identifying the terms of the contract. Clauses such as these are designed to reinforce the presumption that where the parties have entered into a written agreement they would intend for that written document to include all the terms of their agreement. The clause would make clear that no statements outside the written contract are intended to have contractual effect.
Although entire agreement clauses can be very useful, they are subject to certain limitations, especially where one party is contracting with a consumer. When one party to a contract is acting as a consumer then the clause will be subject to a test of fairness under the Unfair Terms in Consumer Contracts Regulations 1999. It appears that the Office of Fair Trading generally regards entire agreement clauses as unfair for the purposes of the Regulations.
Classification of Statements: Terms and Representations
Statements are either classified as a term or a representation. The classification of statements during negotiations is very important because it will affect the remedy available if the statement proves to be false.
Representations & Terms
A representation is a statement of past or present fact made during negotiations which induces the representee to enter into the contract. Statements of law, opinion, and future intention cannot generally constitute representations.
A statement made during the negotiations will become a term of the contract, if viewed objectively, it was intended to be binding as a promise. The following factors may be relevant to the question of classification:
- The relative knowledge of the parties: a statement made by the party with greater knowledge is more likely to be regarded as a term;
- The importance of the statement to the parties;
- The time when the statement was made: statements made close to the time of conclusion of the contract are more likely to be regarded as terms;
- Where the parties record their agreement in a formal document, then statements not included in the document are less likely to be regarded as terms. However, it may be possible in an appropriate case to show that such statements were intended to have contractual effect, either as terms of the written contract, or as a separate contract.
Remedy
Breach of a term gives the claimant the right to damages. If the term is a minor one then this is all the claimant will be allowed to claim. If, however, the breach is of a major term, or a condition of the contract, then the claimant may also be allowed to discharge the contract altogether in addition to claiming damages.
Misrepresentation may entitle the innocent party to rescind the contract, if certain other criteria are satisfied. Rescission effectively puts both parties in the position they were in before the contract was concluded. If the misrepresentation is either made fraudulently or negligently then damages may also be claimed.
5. Incorporation of Terms
A fundamental issue in many disputes that arise out of commercial contracts is whether a particular statement formed part of the contract. As mentioned above there will be a presumption (that can be rebutted) that a written contract will contain the terms that the parties have agreed upon.
In relation to other statements and documents not in the written contract it will be necessary to consider the time when the statement was made and the nature of the document in which it was contained. Problems often arise when a party wishes to rely on clauses contained in its standard terms and argues that those terms were incorporated into the contract. A very large number of commercial disputes are decided on the question of whether an alleged term, such as an exclusion clause, was effectively incorporated into the contract.
Timing
A statement cannot for part of a contract unless it was made before the contract was concluded. Statements or new terms introduced after the conclusion of the contract can only become terms of the contract if there is a contractually binding variation of the contract. Terms that are printed on a document sent out after conclusion of the contract cannot become part of the contract.
Example 2:
For Example: D-ream Paper Supplies receives an order over the telephone from Suretype Stationers for 1000 sheets of flipchart sized paper. D-ream and Suretype agree a price and delivery date. D-ream sends out the paper three days later as agreed and encloses with the delivery its invoice which has D-ream's standard terms and conditions printed on the back.
Unfortunately for D-ream its standard terms will not be incorporated into the contract, which was concluded over the telephone. Many companies have been caught out by printing their terms on the back of their invoices in respect of work done long after the contract has been concluded or faxing confirmations of order and not also faxing the terms on the back. The only exception to this is if D-ream can establish a course of dealing with Suretype, which will be examined later.
Written documents
Incorporation of terms in a written document depends on two factors:
1. was the document signed, and, if not,
2. had reasonable steps been taken to draw the terms to the notice of the other party?
Signed documents - Generally, in the absence of fraud or misrepresentation, a person who signs a document containing or referring to contractual terms is bound by those terms even if he has not read them.
Unsigned documents – A person will generally not be bound by terms in an unsigned document unless he was aware that the document contained writing or printing. Subject to this, he will be bound if: 1. he was aware that the document contained contract terms; or 2. if the person seeking to rely on the terms had taken reasonable steps to give him notice of the terms.
The need for reasonable notice requires that the document in which they appear should be the sort of document which might reasonably be expected to contain contract terms. Typical business documents, such as orders or acknowledgements of orders, generally contain or refer to contract terms and so should satisfy this requirement.
It is probably sufficient for terms to be printed on the back of a business document as this is common practice. However, incorporation is more likely if the terms are at least referred to on the face of the document by some formula such as “we acknowledge receipt of your order and agree to supply you subject to the terms set out overleaf”.
Terms contained in a separate document may even be incorporated by reference, e.g., “We acknowledge receipt of your order and agree to supply you, subject to our standard terms of trading, a copy of which is available on request”. However, it is clearly preferable to give better notice than this as it is then more likely that the requirement to take reasonable steps to give notice of the terms will be satisfied.
Course of Dealing
Where parties do business with each other on the same terms on a regular basis over a period of time there may be said to exist a course of dealing between the parties. As a result of this certain terms normally used between them will be impliedly incorporated into their contracts. In example 2 where businesses have sent out terms on the back of an invoice or other document then we said that they would be prevented from incorporating those terms into the contract. If a course of dealing can be established then those terms might be incorporated and provide a way round the rule on the timing of incorporation of terms. Course of dealing is generally regarded as an argument of last resort and it is best practice to ensure that your terms of trading are sent to the other party before the contract is concluded on every occasion.
Battle of the Forms
A great number of businesses use standard terms to govern their contracts. The actual incorporation of such terms into the individual contracts depends on the factors we have discussed earlier. Problems arise, however, when two businesses wish to contract with one another but both seek to rely on its own standard terms. This is commonly referred to as the ‘battle of forms'.
Example 3:
For Example: D-ream Paper Supplies orders paper in bulk from Perfect Paper Mill Ltd on its own standard order form which incorporates D-ream's standard terms of purchase. Perfect Paper acknowledges the order with a form which purports to accept the order, but contains its own standard terms of sale, which differ markedly from D-ream's terms.
Dealings of this nature are not uncommon and tend to be assessed in terms of offer and acceptance which we referred to earlier. Thus in example 3 – Perfect Paper has probably made a counter offer to D-ream's offer and therefore there is no contract at this stage. The effect of this is that the battle is won by the party who fires the last shot. For in this instance if Perfect Paper sends out the paper and D-ream retains it without objecting to Perfect Paper's terms, then D-ream may be taken to have accepted Perfect Paper's counter-offer by conduct. Alternatively though, if D-ream replies to Perfect Paper's acknowledgement by referring again to its own terms, then Perfect Paper could be taken to have accepted D-ream's terms by manufacturing and supplying the paper without objecting to those terms.
In an attempt to win this battle many companies include in their standard terms of business a clause such as, “The terms of this order are to govern any contract between the buyer and seller and shall prevail over any terms put forward by the Seller”.
The effect of such a clause is not certain. It could be interpreted as preventing any conduct of the buyer being interpreted as acceptance of the seller's terms. Again though, the seller may also have included such a clause and again neither party may have obtained the upper hand. At this point one of the parties might raise an argument that the other has impliedly waived all of its terms, including the term excluding the other party's terms.
Where both parties are equally determined then it is often difficult to assess who will win the battle of the forms. The outcome may be that there is no contract at all or that there is a contract but on neither party's terms.
6. Variation of Contract
After a contract has been concluded either party or indeed both parties may wish to change its terms or their obligations under it. The longer the duration of the contract the more likely it is that variation of it will be sought due to a change in circumstances.
Example 4:
For Example: Perfect Paper Mill Ltd contracts with D-ream Paper Supplies for a period of two years to supply D-ream with A4 paper at a price of £50 per 1000 sheets. After six months the price of raw materials goes up substantially due to new environmental legislation affecting commercially grown trees. Perfect Paper wishes to increase the price payable under the contract.
Generally, a contract can only be varied if both parties agree to the variation and each party's agreement is supported by consideration from the other. Where the variation benefits both parties, or might benefit either, each party's consent to it will be in consideration for the others and the variation will therefore be binding. This will not be the case in example 4.
Where the variation benefits only one party, the party who benefits from the variation must provide consideration for the other's acceptance of it, for instance, by undertaking some extra obligation. Performance of existing obligations will generally not be consideration for the new promise from the other party.
Price escalation is a commonly anticipated event and the original contract may allow for this to occur. A variation which is sanctioned by the terms of the original contract will be binding without the need for fresh consideration. A term allowing one party to unilaterally vary the terms of the contract is valid at common law. However, such a term in a contract with a consumer may not be binding on the consumer as a result of the Unfair Terms in Consumer Contracts Regulations 1999.
7. Interpretation of Contracts
In many cases the most contentious issue between parties is the correct interpretation of the contract. One needs to be aware of the approach a court is likely to take on interpretation. There have been important developments in this area in recent years, culminating in the House of Lords' decision in Investors Compensation Scheme Ltd –v- West Bromwich Building Society. The following principles can be extracted from the cases:
- The Court's objective when interpreting a contract is to ascertain the intention of the contracting parties, in order to give effect to it;
- The parties' intention is to be determined objectively, by reference to the words used in the contract;
- A court will, however, strive to give effect to what it perceives to be the commercial objective of the parties and to interpret the contract in a ‘common sense' manner;
- This means, in particular, that the words used are interpreted against the background of the commercial and factual context in which they were used. Words in a particular clause are therefore interpreted in the light of the contract as a whole. Contracts are also interpreted against their commercial and factual background, including any previous dealings of the parties and any relevant trade practices or customs.
- The court will seek to ascertain the commercial objective of the contract as a whole and then interpret particular clauses or terms so as to give effect to that objective;
- On the other hand, evidence of the parties' negotiations is normally excluded from consideration as not necessarily reflecting the parties' final intention. Similarly, evidence of the parties' conduct subsequent to the making of the contract is normally excluded from consideration when determining the meaning of the original contract. However, the fact that the parties performed the contract other than in accordance with its original terms may indicate an implied agreement to vary the contract as originally drawn, or operate so as to raise an estoppel against one of the parties.
- Finally, a court will generally be reluctant to give a contract term a meaning which produces a result which the court considers to be unreasonable. Thus if a clause is capable of two or more interpretations, the court is likely to favour that which it considers more reasonable. If an ‘unreasonable' result is intended, the parties must make that unambiguously clear by using explicit language.
April 2009
This article gives a general overview only and the legal position at the time of writing this article. It cannot be relied upon in any particular case. Specific legal advice must always be considered to include consideration as to whether the legal position contained in this article has changed since going to print. For further information and advice, please contact Martin Evans, Nial Ledingham or David Halfhead on 01793 527141 or alternatively by email on Martin.Evans@lemon-co.co.uk, Nial.Ledingham@lemon-co.co.uk or David.Halfhead@lemon-co.co.uk.
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<p><strong><a href="http://www.lemon-co.co.uk/article_contracts-overview.php">Contracts - Overview</a></strong><br />
Commercial contracts are formed in a variety of different ways. At one end of the scale the parties to a contract may execute a document that is well over a 100 pages...</p>
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