subcontracting

Subcontracting: An Overview and Should you Back-to-Back?

Subcontracting is seen in a number of sectors including construction, transportation, manufacturing and information technology. A subcontract will always be related to another contract - often called the ‘main contract’ or the 'prime contract'. Two parties will have entered the main contract and then one of those parties may wish to subcontract some of their obligations. The scope of these subcontracted obligations can be as wide as the parties wish (subject to any subcontracting rules in the main contract). The key point here is that the main contract is still in place with the two original parties remaining liable to one another. The party to the main contract who subcontracts will therefore remain liable for any work undertaken by their subcontractor.

Subcontracting – general

For clarification we will use the following terms throughout this blog:

  • Customer – the party to the main contract who is paying the Main Contractor for the work that the Main Contractor must carry out.
  • Main Contractor – the party to the main contract who has agreed to carry out the work that the Customer needs.
  • Subcontractor – the third party who has been subcontracted by the Main Contractor to carry out some or all of the work that the Main Contractor has agreed to carry out under the main contract.

In general, the Customer is obliged to accept the Subcontractor’s performance if the Subcontractor fulfils all that the Main Contractor had agreed to do under the main contract. Although this may not suit the Customer, if they failed to expressly prohibit subcontracting in the contract they will be deemed to have consented to the subcontract, unless they can bring themselves within the scope of one of the legal restrictions on subcontracting.

Subcontracting – liability

This is the way the chain of liability will work in a subcontracting relationship: if the Subcontractor’s work does not fulfil its assigned obligations in the main contract, the Customer will be able to sue the Main Contractor for breach of the main contract, and the Main Contractor will be able to sue the Subcontractor for breach of the subcontract:

Customer

Main Contractor

Subcontractor

It would seem therefore that the Subcontractor would not be liable to the Customer. This is not always the case, however. A Subcontractor could be liable in tort, for example, where the Subcontractor is found to owe a duty of care to the Customer and is negligent in carrying out the work such that they, for instance, cause physical damage to the Customer’s property.

Back-to-back or stand-alone?

The term ‘back-to back’ agreement is used to refer to a particular kind of subcontract. This expression is used when all of the terms used in the Main Contract are incorporated by reference into the back-to-back subcontract. They are normally used when the rights and duties of the Subcontractor in relation to the Main Contractor closely mirror those under the main contract. Creating a back-to-back agreement might be as simple as changing the names of the parties on the main contract and including a 'back-to-back' clause therefore transferring all the duties in the main contract to the subcontractor. However, as we discuss in the next section, this can create problems.

In a full back-to-back subcontract agreement, the Main Contractor is essentially a front man for the Subcontractor. As such, the Subcontractor will normally be willing to assume full liability for the performance of the works as defined in the main contract, and there is often little difference in the pricing or wording of the two contracts. In a partial back-to-back agreement, the Subcontractor agrees to discharge some but not all of the main contractor’s obligations under the main contract.

A stand-alone subcontract agreement can be read and understood without reference to the main contract. The clauses in this sort of subcontract might have little in common with those in the main contract. The Main Contractor will need to be careful to ensure all the relevant obligations and liabilities are still passed to the Subcontractor.

Disadvantages of back-to-back agreements

Many reasons are given for being wary of back-to-back agreements. These include:

  • A mirror back-to-back layout will most likely not be appropriate for every clause in a main agreement. Careful consideration should be given to the question as to whether the simple transfer of an obligation from the main agreement to the back-to-back agreement will result in obligations that achieve the original intention of the parties and that they are enforceable. Provisions that might not ‘back-to-back’ neatly include intellectual property, confidentiality, limitations of liability, liquidated damages and data protection.

Example:

The main contract says that the Main Contractor will keep the Customer’s (as defined above) intellectual property confidential. The back-to-back subcontract will then say that the Subcontractor will keep the intellectual property of the Main Contractor confidential. This is wrong. The subcontract should say that the Subcontractor will keep both the Main Contractor’s and Customer’s intellectual property rights confidential (or any other arrangement agreed by the parties)!

  • Where there are multiple subcontractors and a complicated specification in the main agreement it can be difficult to work out which obligation falls on a particular subcontractor. Defining the subcontractor’s scope of work may result in as much effort as the drafting of a stand-alone subcontract.
  • A back-to-back contract is only as good as the main contract. The customer might be content to have simple sweeping obligations in the main contract, but the main contractor might see the need to spell out more detailed obligations in a tailor-made subcontract.

Should we have a standalone (not back-to-back) contract?

It depends on the context. As the answer will usually require careful analysis it is advisable to seek professional guidance. The solution we usually come up with is a hybrid - a back-to-back contract which also covers those areas in the contract where simply back-to-backing rights and obligations doesn't work.

Restricting subcontracting

The following are ways in which subcontracting can be restricted:

  • The main contract expressly or implicitly prohibits subcontracting. If a party wishes to stop subcontracting, they should include an express clause in their contract stating so. This usually comes in the form of a boilerplate clause.
  • The contractual obligations are of a special nature that require personal performance by the original contracting party. Examples include contracts for composing music or writing a book.
  • It can be implied from the circumstances that the original contracting party has promised performance. If it can be shown that the original contracting party was chosen because of their particular personal qualifications, skill, competency or financial position, then performance cannot be subcontracted.
  • Statutory or regulatory restriction. Certain regulated contracts can only be carried out by authorised persons, for example, insurance contracts, consumer credit agreements. If the subcontractor doesn’t hold the appropriate licences, the subcontract will be unenforceable.

Subcontracting - Data protection

It is important to consider that data protection obligations will pass down the subcontracting chain. The Subcontractor will be a sub-processor and all sub-processing arrangements are prohibited unless the Customer has given prior written consent. The Main Contractor should check the data processing provisions and subcontracting provisions in the main contract to see what they say about sub-processing. The Main Contractor must enter into a sub-processing agreement with the Subcontractor that imposes the same data protection obligations on the Subcontractor as are imposed on the Main Contractor by the Customer. The Main Contractor, as with other obligations assigned, will be fully liable for the performance of the Subcontractors’ data protection obligations.

Checklist

  • Is subcontracting allowed? Check that the main contract does not prohibit subcontracting.
  • Boilerplates in the main contract. The back-to-back agreement will incorporate by reference all the terms of the main contract including boilerplate clauses. Boilerplate clauses are found at the end of most contracts and cover issues found in all contracts such as how notices should be given or which legal system the contract operates in. It will be important to check that the boilerplate clauses in the main contract, if back-to-backing, are giving sufficient legal protection and do not need adding to.
  • Flow down of obligations from the main contract to a back-to-back agreement need to make sense.
  • Where there is an international element to the arrangements you need to ensure that the governing law of the main contract gives the main contractor effective recourse against the subcontractor and vice-versa.
  • Sub-contracting of data processing obligations – check that the Customer has given its prior written consent to the sub-contracting of any data processing obligation set out in the main contract.

Final thoughts

Subcontracting is common practice, especially in large projects requiring delivery of a range of skills and services, so it is important to understand how subcontracting works. If you are planning on engaging a subcontractor to help you deliver a project then make sure that you have the right contract in place that mirrors your obligations under the main contract. If your subcontract agreement is not drawn up properly you could be left being sued by the Customer because of your subcontractor's poor performance while unable to sue the subcontractor yourself.

If you have any questions about subcontracting or about contract law more generally please contact Neil Williamson.


liquidated damages clauses

Liquidated Damages Clauses: Supreme Court Overrules on Failed Software Delivery

Liquidated damages clauses exist to create certainty around how much can be claimed when a contract is breached. Put another way, they are introduced to deal with the difficulty of predicting the amount potentially recoverable as damages for breach of a contract. A recent ruling by the Supreme Court in Triple Point Technology Inc v PTT Public Company [2021] UKSC 29, explored liquidated damages clauses effectiveness in the context of the failed delivery of a software system. The case also explored the effectiveness of exclusion clauses and the definition of negligence.

Liquidated damages clauses

Liquidated damages clauses frequently appear in commercial contracts and, most commonly, in relation to late or defective performance, particularly in the fields of construction, engineering, supply of goods and shipping contracts. Advantages of liquidated damages clauses include:

  • The parties can know in advance what their liability is and how much they could receive in a breach specified by liquidated damages clauses.
  • They could make recovery of damages easier. This is due to the fact that liquidated damages clauses are enforceable regardless of needing to quantify the loss actually suffered by the innocent party, as would be the case when considering the amount payable to the innocent party when unliquidated damages apply (read our blog on the topic: Damages for Breach of Contract). The claimant simply must show that a breach of contract falls within the scope of the liquidated damages clause. It therefore follows that a claimant may be able to recover more than would be recoverable if the damages were unliquidated (as affirmed in Philips Hong Kong v AG of Hong Kong [1993] 61 BLR 41).
  • Vice-versa, liquidated damages clauses can work in favour of the party responsible for the breach where the damages caused would be more if unliquidated. When considering the drafting of such a clause, it is important to have these considerations in mind, including who is likely to be in breach and what sort of magnitude is imaginable, whilst also being aware that if liquidated damages clauses do not represent a genuine pre-estimate of potential damages, they could be deemed invalid.
  • They help with dealing with minor breaches in long-term contracts (such as construction) and so help to maintain a commercial relationship when there have been minor breaches throughout. In this vain, liquidated damages can be applied to specific obligations in a long-term commercial agreement and so compartmentalise potential breaches.

Can you still claim for general damages when liquidated damages clauses are included in the contract?

Usually, liquidated damages clauses relate to specific breaches and so only apply to the scope of the breaches referred to in the clauses themselves. Therefore, general damages will be claimable for breaches beyond the scope of liquidated damages clauses, subject to any other provisions in the contract. There have, however, been some unusual exceptions to this rule. Including:

So long as liquidated damages clauses clearly state the sort of breach they apply to and how they will operate, the exceptions referred to above should not apply. In Triple Point v PTT the case hinged upon some ambiguous wording in a liquidated damages clause, further proof that such clauses need to be considered at length. We now explore this recent case in depth.

Liquidated damages clauses: Triple Point v PTT

Triple Point Technology Inc (Supplier) contracted to design, install and maintain a software system for PTT Public Company (customer). Payment was due in instalments on completion of milestones. The supplier’s performance did not meet the contractual timetable. Some of the delayed work was accepted and paid for but the customer refused to make other payments for work not yet completed. The supplier suspended work and the customer terminated the contract.

Liquidated damages clauses point in Triple Point v PTT

The supplier brought an action for payment of its unpaid invoices. The customer counterclaimed for damages and liquidated damages under the contract, as provided under article 5.3:

“If the supplier fails to deliver work within the time specified and the delay has not been introduced by the customer, the supplier shall be liable to pay the penalty at the rate of 0.1% (zero point one percent) of undelivered work per day of delay from the due date for delivery up to the date the customer accepts such work, provided, however, that if undelivered work has to be used in combination with or as an essential component for the work already accepted by PTT, the penalty shall be calculated in full on the cost of the combination.”

As shown in bold above, the point here was whether PTT had to accept the work for the liquidated damages to be payable. Put another way, article 5.3 could be interpreted to mean that damages for delay would only be payable under this clause if the work was eventually completed and accepted by PTT, which was not the case. Whilst the Court of Appeal held that the clause did not apply because the work was never completed, the Supreme Court criticised this and ultimately overruled it, deeming it inconsistent with commercial reality and the accepted purpose of liquidated damages clauses. The Supreme Court said that parties must be taken to know the general law, that is, that the accrual of liquidated damages comes to an end on termination of the contract, and so given the work had not been completed up to this point, the clause would apply. After that point in time, the parties must seek damages for breach of contract under general law.

The limitation clause point in Triple Point v PTT

Article 12 of the contract placed a cap on the amount of damages that could be recovered and included an exception from that cap for “negligence”:

“… The total liability of the supplier to the customer under the contract shall be limited to the contract price received by the supplier with respect to the services or deliverables involved under this contract. … This limitation of liability shall not apply to the supplier’s liability resulting from fraud, negligence, gross negligence or wilful misconduct of the supplier or any of its officers, employees or agents.”

The Court of Appeal held that the word ‘negligence’ must mean some independent tort and did not mean breach of a contractual duty of skill and care. In other words, the Court of Appeal concluded that the cap applied to negligently performed contractual duties and therefore Triple Point’s liability for its negligent approach to contractual duties would be limited by the cap. The Supreme Court disagreed, holding that negligence should be given its natural and ordinary meaning of removing from the cap all damages for negligence on the supplier’s part, including damages for negligent breach of contract. Therefore Triple Point’s negligent approach to contractual duties was not capped and their total liability (including under the liquidated damages clause) amounted to just over $14.5 million.

Draft carefully

The context in which liquidated damages clauses classically apply is in a construction context. This is because construction projects span many years, many stages of development and, usually, many parties. Consequently, to thread these various elements together without allowing small-scale breaches to break down a project, liquidated damages clauses are a useful way to define exactly what remedy is available for failed or delayed sections of work. As shown by Triple Point v PTT, these clauses are also significant in any long-term delivery supply contract and employment contracts also often make use of them. This ruling will be received with relief by many, especially considering many were concerned by the lack of commercial consideration in the Court of Appeal’s decision.

What becomes clear from looking at case law in this area is that the wording of liquidated damages clauses can have a significant impact on how they will be interpreted if a contractual relationship goes to litigation. Given the often-bespoke nature of these clauses because they concern the specific work to be done and any imaginable remedies, there is a risk that the wording can be loose and therefore seeking legal advice is very important. These clauses need to be meticulously thought through.

If you have any questions about liquidated damages clauses or about contract law more generally please contact Neil Williamson.


Varying a contract

Varying a Contract: Things to Consider

Varying a contract (changing it) can be done orally or in writing. However, most commercial contracts contain a clause which states that any changes made to a contract are ineffective unless made in writing and signed by or on behalf of both parties. This is called a variation clause or no oral variations clause. This generally means, therefore, that in the majority of cases when varying a contract, a written agreement needs to be in place between the parties to effect such a change. Read this blog to find out more about the law concerning varying a contract.

Varying a contract - consideration

Any agreement that varies the terms of an existing contract must either be supported by "consideration" or be executed as a deed.

What does "consideration" mean? In contract law it is required that some form of reciprocity takes place between the two parties to a contract i.e. one party cannot enforce a contract unless he has promised to deliver something to the other. Put another way, in order for a contractual relationship to exist there must be some form of exchange taking place in which each party agrees to give something to the other. The most obvious example of an agreement that is not supported by consideration, and therefore unenforceable, is an agreement to make a gift, that is, an agreement to provide a benefit with no act being required of the recipient.

Therefore, it follows that when varying a contract, in order for the variation of the agreement to be enforceable, it needs to be supported by consideration. This becomes complicated because it can often be the case that, when varying a contract, only one party is promising to do something new whilst the other party is simply re-affirming its obligations in the original agreement. One way of getting round this issue is by executing the variation agreement as a deed.

Varying a contract - execution as a deed or nominal consideration

Practically speaking, many commercial contractual parties vary contracts by deed and therefore negate the need to take consideration (as described in the last section) into account. This is because deeds are generally enforceable despite a lack of consideration. Deeds require additional formalities such as witness signatures and are used when varying a contract to avoid the potentially complex law around whether each party has given consideration to the other.

Another way of getting round the consideration problem is by referring in the written document, which is varying the contract, to the payment of a small sum. Such small sum will amount to consideration.

How to execute a deed?

  • In writing. A deed must be writing.
  • Face value requirement. It must be clear from the face of the instrument that it is intended to take effect as a deed.
  • A deed must be delivered. A deed becomes binding on the date of delivery, not from the date of execution.
  • By affixing the common seal of the company; or more practically, by the signatures of two authorised signatories (such as a director or secretary of the company); or the signatures of a director of the company attested by a witness.
  • By following any other formalities which a company may have in place for the execution of deeds.

Varying a contract - third party rights

Under the Contracts (Rights of Third Parties) Act 1999, where a third party has a right to enforce a contract term, the parties cannot vary it so as to extinguish or alter the third party’s right without its consent. However, the parties to the contract may expressly provide that no consent is required from third parties for varying a contract.

Unilateral right to vary

Unless the parties have agreed that one party should have such a right, a unilateral notification by one party to the other cannot constitute a variation of a contract. However, contract terms may give a party the unilateral right to vary obligations under a contract. It is important to check the terms of a contract on this point!

Varying a contract - some case law

Here are some relevant cases concerning the law around varying a contract:

Case: Rock Advertising Ltd v MWB Business Exchange Centres Ltd [2018] UKSC 24

Facts: Rock fell into arrears with MWB and, in a phone call, put forward an amended payment schedule. When MWB sought to terminate the relationship because of the arrears Rock argued that, in fact, the parties had varied the contract by agreeing the amended payment schedule in the phone call. Rock Advertising had paid an agreed sum of £3,500 on the same day as the phone call in accordance with this revised (varied) agreement. But then MWB went on to deny any revised agreement and stated a) variation of the original written contract had to be in writing since oral variation was denied by the terms of the contract (the contract included a no oral variations clause) and b) any variation would be unenforceable for lack of consideration.

Ruling: The supreme court found in favour of MWB on the basis that the no oral variations clause was effective and by doing so ensured commercial certainty between the parties. This was after the County Court ruled in favour of MWB and the Court of Appeal in favour of Rock! This shows this was a contentious case but also upholds the eventual strength of no oral variations clauses. It was mentioned by the judge Lord Briggs that if in the telephone call the parties had explicitly stated that the no oral variations clause did not apply to this new agreement varying the contract then it would have been effective! So be careful when discussing the relevance of such a clause.

Case: Nash and others v Paragon Finance Plc [2001] EWCA Civ 1466

Facts: This case concerned the existence of a unilateral right for varying a contract clause favouring Paragon. Mr & Mrs Nash obtained a mortgage from Paragon Finance. The mortgage agreement allowed Paragon to vary the rate of interest ‘at their discretion’. After the Bank of England base rate of interest dropped, Paragon failed to match the drop in interest and continued varying the contract and charging a significant amount above this rate. The Nash’s failed to make their payments and Paragon applied for an order of possession of their home.

Ruling: Under the Consumer Credit Act 1974 the rates could not be capricious, dishonest, improper or unreasonable. The court held that the rate was not applied in an unreasonable or unfair manner by Paragon and so the clause allowing discretion to unilaterally vary the contract was not void. Whilst the lenders had not reduced their interest rates in line with other lenders, they had a commercially legitimate objective in doing so, and so the court deemed Paragon to have acted ‘reasonably’ in line with the Consumer Credit Act 1974 and the unilateral right for varying the contract clause was deemed valid.

Case: Stilk v Myrick [1809] EWHC KB J58

Facts: And finally, a blast from the past. Decided over 200 years ago, this case explored the relationship between consideration and varying a contract. Stilk was contracted to work on a ship owned by Myrick for £5 a month, promising to do anything needed in the voyage regardless of emergencies. After the ship docked at Cronstadt two men deserted (constituting an ‘emergency’), and after failing to find replacements the captain promised the crew the wages of those two men divided between them if they fulfilled the duties of the missing crewmen as well as their own. After arriving at their home port, the captain refused to pay the money he had promised them.

Ruling: It was found that Stilk (and the rest of the crew) were under an existing duty to work the ship back to London and had agreed to submit to all the potential emergencies that could arise along the way. Therefore Stilk (and the crew) had not given any consideration for the promise of extra money by the captain. And so, they were not entitled to anything. This highlights the importance of looking at exactly what your obligations are in an agreement before assuming you have performed consideration for the variation of that contract. If you have not gone beyond the scope of your original obligations, then no consideration has taken place and varying the contract has been ineffective. (Of course, you can use a deed to get round this problem as described above).

Keeping it simple

The simplest way to vary a contract, and therefore the most used method in practice, is by executing a deed. It is also important to check if a no oral variations clause is contained in your contract (as will be in the majority of cases), especially when looking to rely upon informal arrangements, which alter contractual terms, during its performance.

If you have any questions about varying a contract or about contract law more generally please contact Neil Williamson.


Incorporated By Reference

Terms Incorporated by Reference - Contract Law

When scanning a contract it is common to encounter schedules, annexes, appendices that are incorporated by reference to other documents, additional contracts and supplementary terms and conditions. Often this referenced material is essential to the form and consequences of a legal agreement. And too often it is overlooked. But when can this additional material be insufficiently incorporated into a contract, rendering it of no legal consequence?

Reasonable notice must be given if terms are to be incorporated by reference

Terms and conditions which are not immediately visible will be effectively incorporated by reference into the relevant contract as long as reasonable steps are taken to bring existence of the terms and conditions to the notice of the other party (Parker v South Eastern Railway Company [1877]). Once drawn to the attention of the other party, incorporation will take place if the latter proceeds in such a way that he is deemed to have accepted the terms (i.e. he proceeds without raising any objections).

Notice

For a term to be considered incorporated by reference into a contract, notice of that term must be given before or during the time of contracting. In Olley v Marlborough Court Hotel [1949], the claimant booked a room in a hotel owned by the defendant. Inside the door of her room was a notice stating that the hotel was not liable for anything lost or stolen unless the item had been given to the management to look after. When the fur coat of the claimant was stolen from her room, she sued the defendant for damages. It was held that because the contract had been made at the reception desk before the parties got to the room, and because notice of the term was only given after the formation of the contract, it was not an incorporated term and the claimant could sue the defendant for damages.

Contractually binding

The second rule required for clauses to be considered incorporated by reference is that they must be found in a document intended to be contractually binding. In Chapelton v Barry Urban District Council [1940] the claimant hired a deckchair from Barry Urban District Council to use on a beach in Cold Knap (a district in South Wales). The claimant took two receipts from the beach attendant, on the back of which were the words "the council will not be liable for any accident or damage arising from the hire of the chair". The chair was defective and broke, injuring the claimant. He sued the council, who relied on the clause on the receipts to protect them from liability. The Court of Appeal held that the clause could not protect the council, as the receipt was not a document that one would expect to contain contractual terms.

However it is important to note that if someone signs a contractual document it is automatically considered to be binding, even if the party has not read the terms. In L'Estrange v F Graucob Ltd [1934] 2 KB 394 the Court of Appeal held that a written document was contractually binding even though the claimant had not read the document and the clause was in "regrettably small print".

References

Referring a party to another document which contains terms can constitute reasonable notice, even if they don’t have the document and it’s difficult for them to access (Thompson v London Midland [1903]). The more onerous and unusual the terms are, the more clearly they have to be brought to the other party’s attention to get incorporated by reference. But if a document doesn’t look like it’s important/ part of the contract it’s less likely this will count as reasonable notice (Chapelton v Barry [1940]).

Visibility of term in relation to importance

The more burdensome or unusual the terms and conditions, the more clearly they should be drawn to the attention of the other party to be incorporated by reference. In this context, there is the well-known statement of Lord Denning that "some clauses I have seen would need to be printed in red ink on the face of the document with a red hand pointing to it before the notice could be held to be sufficient" (J Spurling Ltd v Bradshaw [1956]).

Thus there is a clear principle that, where there is a contractual provision which is particularly unusual or onerous, but not immediately visible, a party will not be able to rely on the clause unless he has done enough to bring the clause fairly to the attention of the other party and thereby successfully rendered the clause incorporated by reference. But also, it has been argued that, in some cases, unusual or burdensome terms set out in a contract which is about to be signed should also be brought to the attention of the signatory:

  • In One World (GB) Ltd v Elite Mobile Ltd [2012], the Court of Appeal was prepared to assume that the principle might apply to onerous and unusual clauses in a signed contract "in an extreme case where a signature was obtained under pressure of time or other circumstances".
  • In Amiri Flight Authority v BAE Systems Plc [2004], Mance LJ envisaged that the principle might apply where, for example, a car owner was asked to sign a ticket on entering a car park or a holiday maker asked to sign a long small print document when hiring a car.

Otherwise, the rule in L'Estrange v Graucob applies to signed contracts: the signatory will be bound whether he has read the contract or not.

Incorporation of terms by course of dealing

A customer may be bound even if, for example, the standard terms of sale only appear on the reverse of a post-contractual document such as the invoice (Spurling v Bradshaw), if the seller can establish a course of dealing incorporating the contested term. The party seeking to establish the course of dealing must show that:

  • There has been regular trading between the parties. Thus several transactions per month over a period of years might be sufficient for these purposes, but three or four transactions over a period of several years are unlikely to be enough. However, each case will depend on its own facts.
  • The trading has been consistent: previous trading must have been on the same terms and a consistent procedure must have been followed. In McCutcheon v David MacBrayne Ltd [1964], it was held that conditions set out on a risk note, which was only sometimes signed, were not incorporated into the parties' contract because each trade had consequently not taken place on the same terms.

Given the stringent and somewhat uncertain tests which must be satisfied before a court will hold that terms have been incorporated by a course of dealing, it is clear that this is an argument of last resort for the seller, to be used in negotiations and, if necessary, in court, if the customer has challenged the seller's terms. It is no substitute for proper contracting procedures.

Certainty of terms

A problem for the signing party now would be that if they argue that the terms were not incorporated by reference, then a court may not be able to enforce the contract as a whole because ‘unless all the material terms of a contract are agreed, there is no binding obligation’ (Foley v Classique Coaches [1934]). Given that the signing party of a contract may still want the benefit of the contract this could be a problem.

Watch out

Incorporation of terms applies to all areas of law. When you go to exercise your share option, for example, and you haven’t checked all the applicable rules because they are in supplementary documents. Or when you have been selling to the same customer for years but haven’t necessarily made every transaction subject to the same terms. Or when you seek to limit liability to a great extent but don’t draw attention to what could very arguably be an ‘onerous’ obligation on the other party of the contract. Being alive to these issue can have substantial impact.

Issues most frequently arise where one party is arguing their standard terms and conditions apply and the other argues they weren’t incorporated by reference. A checklist for incorporation in simple terms would be: if the contract has been signed then the parties are normally taken to have agreed to them (L’Estange v Graucob); terms have to be brought to the other party’s attention before the contract is concluded (Parker v South Eastern Railway) – the more onerous, the more clearly they have to be brought to the other party’s attention; if the documents referred to don’t look important or part of the contract then it’s less likely this will count as reasonable notice (Chapelton v Barry); incorporation is possible by a course of dealings (McCutcheon v MacBrayne) but requires a high threshold of proof – i.e. the other party actually knew about the terms and agreed to them.

If you have any questions about terms being incorporated by reference, incorporation of terms in other contexts, contract law more generally or if you need help with resolving a dispute please contact Neil Williamson.


Heads Of Terms

Heads Of Terms For Buying A Company

When buying a company, heads of terms (also known as letters of intent, memoranda of understanding and heads of agreement) are by and large contained in a short document that sets out the principle terms of an agreement. Heads of terms constitute serious intent, and may have moral power, yet are not necessarily binding. This will rely upon the substance of the heads of terms and the goals of the parties.

Heads of Terms Purpose

Heads of terms will not always be valuable with regards to arranging an exchange and they might be of more use to one side than the other, yet heads of terms can assist with avoiding mistaken assumptions and give a helpful guide when consenting to a proper arrangement. Parties should be wary that an exchange of the heads of terms can slow down over marks of pointless detail, which in actuality ought to appropriately be tended to at a later stage. This can postpone readiness of the full contract and increase the length and cost of dealings.

Content

Generally, the heads of terms should cover the bargain at hand and significant components as opposed to routine ones. Often the two parties treat the heads of terms as a practice of the real agreement. Time spent arranging the heads of terms ought to be limited to talking about the bargain on a basic level. Contentions over the fine print ought to be left for the final arrangements.

Below are some examples of suggested principles to be applied to heads of terms:

  • State the exception and defer the rule - If it is fundamental that, for example, certain sellers will not join in the giving of warranties and indemnities, or that only very limited warranties will be given, the heads should say so. If not, it should be sufficient to indicate that the final agreement is expected to include warranties, indemnities (and limitations on them) appropriate to a transaction of this type.
  • State the principle and defer the detail - Unless an issue is very complicated or unusual, the heads of terms should state the principle underlying the issue and leave the detail for the formal agreement. For example, if there is to be a post-completion audit and balancing payment based on net asset value, that is probably all that needs to be said in the heads of terms. Timing, agreed adjustments to the accounts and accountants that prepare the initial version can be dealt with later. If, however, the parties have agreed a specific unusual formula for calculating the net asset value this may need to be set out in the heads of terms to avoid any later disagreement.
  • Consider carefully, and take professional advice, before making significant concessions - If one side wants the agreement to be governed by foreign law, the other party should understand how this may affect its rights before making this concession. Similarly, both parties should take advice on the tax consequences of the basic deal structure. Such issues highlight the importance of taking appropriate advice or at least including reservations to the extent this has not yet been possible.

Are Heads of Terms legally binding?

Heads of terms may be fully binding or partly binding or not binding at all. Typically, however, they are not legally binding apart from sections dealing with confidentiality (where the parties agree to keep their discussions confidential) and exclusivity (where the seller agrees not to talk with any other potential buyer for an agreed period while the buyer carries out due diligence and hopefully concludes the purchase). Where the heads of terms include provisions that are intended to be binding, these must be clearly identified and the legal requirements for creation of a valid contract must be satisfied. Among other things, under English law:

  • The terms must be sufficiently certain to be enforceable. An "agreement" to continue negotiations in good faith, for example, is nothing more than an "agreement to agree" and normally unenforceable (Walford v Miles). Much depends on the facts however.
  • Unless the heads of terms are executed as a deed, there must be consideration moving from the party benefiting from the agreement to the other party, either in the form of a promise in return, or a payment, action or forbearance. Where there is no actual consideration, however, and execution as a deed alone is relied upon, specific performance is unlikely to be available. For more information on the specific formalities relating to the execution of deed by a company, see section 46 Companies Act 2006.

Third parties

Regard should also be had to the implications of the Contracts (Rights of Third Parties) Act 1999. If a term expressly provides that a third party has the right to enforce that term, or if the term purports to confer a benefit on a third party, then that term may give the third party directly enforceable rights. For example, a parent company, or another group subsidiary of a party to the heads of terms may wish to benefit from the confidentiality provisions. Where there is more than one prospective buyer, the seller may intend the successful buyer to have the benefit of confidentiality undertakings given by the others. On the other hand, if there is a risk that a term may be enforceable by a third party and the parties do not wish to create any third party rights, then an express exclusion should be included to that effect.

Reasons for using Heads of Terms

Whether or not the parties draw up heads of terms is purely a matter of choice: there are both advantages and disadvantages. The perceived advantages of using heads of terms are:

  • Moral commitment. Heads of terms are usually considered to confirm a moral commitment on both sides to observe the terms agreed (which can be an advantage or disadvantage depending on the circumstances).
  • Complex transactions. Where a transaction is complex, heads of terms can help focus the negotiations, bring out any misunderstandings and, by highlighting major issues at an early stage, prevent the parties wasting time and money if those issues cannot be resolved at this stage.
  • Framework for binding commitments. Heads of terms frequently contain a binding exclusivity agreement, a confidentiality agreement and, in some cases, provide for payment of costs and break fees in the event of negotiations breaking down. Obtaining exclusivity for a limited period, and some protection against wasted costs, should enable the buyer to proceed with more confidence.
  • Third parties. Where a deal has to be explained and sold in advance to persons not directly involved in the negotiations, the heads of terms can provide a useful statement of the key terms of the proposed deal.
  • Basis for clearance submissions. Heads of terms can provide the basis of a joint submission for clearance or guidance from the relevant competition authorities and might assist in the preparation of tax clearance applications.
  • Basis for instructing advisers. Draft heads of terms can sometimes be a helpful tool for the parties to instruct their respective advisers.
  • Provide seller with a tactical advantage. Because heads of terms are normally prepared early in the transaction process, before the buyer has commenced detailed due diligence, the seller will know considerably more about the business being sold than the buyer.

Reasons against using heads of terms

  • Limit room for manoeuvre. Heads of terms carry strong force, so they can limit room for manoeuvre in the subsequent negotiations. They should therefore be approached with caution, especially on the part of a buyer, who at this stage normally has much less information than the other side. If the buyer is required to sign heads of terms, then consideration should be given to inserting into the document the key assumptions on which the buyer is relying. This was illustrated by the ill-fated acquisition of PRB by Astra Holdings PLC in 1989. PRB went into liquidation a year after the acquisition and the Department of Trade and Industry (now BEIS) launched an investigation into the matter. In their report, the inspectors mentioned the fact that Astra had, before taking legal advice, entered into heads of terms which included certain unfavourable terms (the acquisition agreement was to be drafted by the seller's lawyers, governed by Belgian law and was to contain only limited warranties). Although it was not legally binding, it severely tied Astra's hands in the subsequent negotiations. It was the seller's "firm view that the [heads of terms] had set the agreed goal posts, and they did not want them moved".
  • Create legal relations inadvertently. In some jurisdictions, heads of terms can create a legally binding agreement between the parties unless an express term is included to the effect that there is no intent to create legal relations.
  • Accelerate need for public announcement of deal. Where either party is a listed company, an AIM company or otherwise has financial instruments that bring the company within the Market Abuse Regulation (596/2014/EU) it will need to consider whether one effect of negotiating and signing heads of terms may be to precipitate an early announcement of the deal.
  • Adverse tax consequences. In the UK, the heads of terms can be evidence of an "arrangement" which restricts the ability of the parties subsequently to take advantage of certain tax reliefs.
  • Increase in workload. The time taken to agree heads of terms may be disproportionate to the benefit. Care needs to be taken to avoid effectively negotiating the main agreement twice.

Here to help

Drafting heads of terms can be an exciting moment in pursuit of a deal. It is crucial to have an insight into how best to play your hand and what the legal consequences will be of your commercial strategy. The most significant legal question will be whether or not any of the terms are binding.

A document will usually be enforceable when it is adopted into a parent contract and is subsequently agreed upon. Until that point, a heads of terms will not usually be legally binding (Fletcher Challenge Energy Ltd v Electricity Corp of New Zealand Ltd [2002]). However, such documents can be legally binding if the agreement document contains terms or language which explicitly indicates a binding intention. Equally, a letter which contains no expression of whether its terms were intended to be binding can be found to be binding due to language used. (RTS Flexible Systems Ltd v Molkerei Alois Müller GmbH & Co KG [2008]) This is also dependent on the circumstances of the transaction and includes the conduct of the parties themselves.

If you have any questions on heads of terms or need help drafting such a document please contact Neil Williamson.


Damages for breach of contract

Damages For Breach Of Contract

The principal (but not the only) remedy in English law for breach of contract is an award of damages. This blog focuses on the law of damages for breach of contract where damages are awarded by a court to compensate for the injured party’s loss. This blog does not cover “liquidated damages”, which are defined by the parties under the terms of the contract as specific amounts payable in the event of a party’s default.

Damages for breach of contract: the general rule for compensation

In English law, the purpose of an award of damages for breach of contract is to compensate the injured party for loss, rather than to punish the wrongdoer. The general rule is that damages should (so far as a monetary award can do it) place the claimant in the same position as if the contract had been performed (Robinson v Harman (1848) 1 Ex 850).

Damages for breach of contract are, therefore, essentially compensatory, measuring the loss caused by the breach. To put it another way, the damages enquiry involves comparing the position the claimant is in fact in, following the breach, and the position the claimant would have been in but for the breach. Accordingly, the awards are often called "expectation damages", because they seek to put the claimant in the position it expected. The net loss is calculated by quantifying all the harms caused by the breach and then deducting or crediting all the benefits caused by the breach.

Damages for monetary loss

The majority of damages for breach of contract award compensation for financial loss. This takes many forms, including costs or liability the claimant has incurred to a third party (but would not have incurred but for the breach), and profits the claimant has foregone (that is, would have earned but for the breach).

Difference in value or cost of cure

In many cases, even though the defendant has breached the contract, the claimant can pay for a third party to cure or reinstate so as to put the claimant in as good a position as if the defendant had performed. For example, the claimant might pay for repairs to rectify a breach of warranty of quality by a seller of goods, or a partial non-performance by a builder. Where already incurred by the time of trial, such a cost will be recoverable from the defendant providing it was not so unreasonable as to be a failure to mitigate and/or a break in the chain of causation. Where the cost of cure has not been incurred at the date of trial, it will only be recoverable where incurring the cost would be "reasonable" in all the circumstances. This is because a claimant will always have a choice not to cure the problem caused by the breach. A claimant may instead, either simply live with the consequences, or use the market to offload unwanted or defective property and replace it with better property.

The presumption of breaking even and "reliance loss"

In seeking to prove loss, the claimant benefits from a rebuttable presumption that but for the breach the claimant’s venture would have broken even. This means that if the claimant has already incurred costs but not yet had a chance to complete the venture, it is presumed that the breach which halts the venture caused the claimant to lose revenue equal in value to the expenditure already incurred.

This is important in cases where it is impractical for the claimant to prove the profits it would have made from a venture. For example, in Anglia Television v Reed [1972] 1 QB 60, a TV company entered into a contract with an actor to take part in a film, the actor broke the contract and the film could not be made. In that case the claimant was unable to say what the profit would have been had the actor performed the contract, but because of the presumption of breaking even, the claimant was able to recover the wasted expenditure it had incurred.

Damages for breach of contract: Lost management time

A particularly well-established application of the presumption of breaking even is the award of damages for lost management time. If, as a result of the defendant’s breach, the claimant’s staff are diverted from their usual tasks in order to investigate the breach or deal with the consequences of the breach, the claimant can recover its net cost of the staff (that is, their wages). This is not because that cost was itself caused by the breach. (Unless the staff were employed specifically to deal with the breach, their cost would have been incurred even but for the breach.) Rather, it is presumed that the claimant would have earned revenue from the staff at least equal to their cost to the claimant if they had not been diverted from revenue-producing activity but for the breach. In Azzurri Communications Ltd v International Telecommunications Equipment Ltd [2013] EWPCC 17 Birss J observed that: "if the breach can be said to have caused diversion of staff to an extent substantial enough to lead to a significant disruption of the business then it is reasonable to draw the inference of a loss of revenue equal to the cost of employing the staff."

Damages for breach of contract: Loss of profit

A claimant may prove that had the defendant’s breach not occurred, it would have earned greater revenue than its expenditure (that is, done better than broken even, and so has lost profits). Whenever a claimant is successful in a lost profits claim, it is because it proves exactly this. Alternatively, a defendant may prove that a claimant would not have broken even, or indeed that the claimant has suffered no loss because its venture or bargain was a bad one and the claimant would have made a loss but for the breach. For example, in Ampurius Nu Homes Holdings Ltd v Telford Homes (Creekside) Ltd [2012] EWHC 1820 (Ch), the defendant construction company avoided paying substantial damages by showing that the claimant would have suffered a loss from the development if it had gone ahead.

Damages for non-financial loss

The majority of damages for breach of contract provide compensation for financial loss or property damage. Recovery of damages for such losses is restricted by the ordinary rules of remoteness and causation. Non-pecuniary and non-property damage loss falling short of personal injury have traditionally been thought to be subject to a general bar to recovery to which narrow exceptions apply.

This traditional approach was applied by the House of Lords in the surveyor's negligence case of Farley v Skinner [2001] UKHL 49. In that case, the claimant specifically asked the surveyor whether the property he was intending to buy was affected by aircraft noise and the surveyor carelessly reported that it was not. Because "a major or important object of the contract was to give pleasure, relaxation or peace of mind", damages for non-pecuniary loss (of £10,000) were recoverable.

Professional negligence provides a range of examples in which an object of the contract was non-financial. Farley v Skinner is one example in the surveyor context. Solicitors’ negligence cases include that of a solicitor who failed to obtain a non-molestation order, another who failed to protect a mother’s custody of her children and one who mis-handled ancillary relief proceedings.

In contrast, damages for non-pecuniary loss will rarely be awarded in commercial cases. There will be no award where the object of the contract was "simply carrying on a commercial activity with a view to profit" (Hayes v Dodd [1990] 2 All ER 815, Staughton LJ). Similarly, "contract-breaking is treated as an incident of commercial life which players in the game are expected to meet with mental fortitude" (Johnson v Gore Wood & Co [2000] UKHL 65, Lord Bingham).

Personal injury and physical inconvenience

Where the non-pecuniary damage amounts to personal injury (whether physical or psychiatric), such damage is recoverable subject to the ordinary rules of damages. Such cases arise often in such varied contexts as employment, landlord and tenant, defective goods, or defective services (holidays, etc.). Moreover, damages are frequently awarded without reference to any special test in cases of physical inconvenience caused by defective construction, landlord failure to repair, and surveyor negligence, as well as services cases such as those of defective holidays.

Quantifying loss

Generally, there are no rigid rules for the quantification of damages for breach of contract. In the end the assessment of damages is a question of fact. However, there are various principles which delimit the damages that will be awarded. The quantification of damages in litigation is often complicated and requires specialist advice from forensic accountants.

Burden of proof

It is for the claimant to prove its loss. Where the claimant's proof of loss has been made more difficult by the defendant's wrong, there is authority for a rebuttable presumption in favour of the claimant that gives it the benefit of any relevant doubt (see Browning v Brachers [2005] EWCA Civ 753).

Factual causation

At the heart of the damages measure, which seeks to put the claimant in the position it would have been in but for the breach, is the question of factual causation, also known as the "but for" test. In other words, it is necessary to prove both the position the claimant is actually in post-breach, and the hypothetical position the claimant would have been in ‘but for’ the breach, and to compare the two. That is the measure of loss for breach of contract. A claimant cannot, therefore, look to recover losses that it would have sustained in any event (see Tiuta International Ltd (in liquidation) v De Villiers Surveyors Ltd [2017] UKSC 77).

Restrictions on recovery of damages

Not all losses that in fact flow from a breach of contract are recoverable. Just because a loss was in fact caused by the breach (that is, would not have occurred but for the breach) does not mean that the law holds the defendant responsible for it. The rules on mitigation, legal causation, remoteness and contributory negligence may restrict, and in some cases prevent, a damages award.

Damages for breach of contract: Legal causation

The first major principle at play here is that of legal causation. This principle (which is materially the same in contract and tort) holds that, even though some losses were factually caused by the breach (that is, but for the breach they would not have occurred), they are nevertheless treated legally as not having been caused by the breach. The essence of the rather fluid principle of legal causation is that it is not fair to hold the defendant responsible for these particular consequences of its breach. The courts adopt a common sense approach to what intervening acts or events "break the chain of causation" between the breach and the harm. As Lord Bingham explained in Corr v IBC Vehicles Ltd [2008] UKHL 13:

“The rationale of the principle that a novus actus interveniens [Latin for new intervening act] breaks the chain of causation is fairness. It is not fair to hold a [defendant] liable, however gross his breach of duty may be, for damage caused to the claimant not by the [defendant]'s breach of duty but by some independent, supervening cause for which the [defendant] is not responsible.”

Although separate from the principle of remoteness, the foreseeability of an intervening act or event, and whether it was something that the defendant’s duty aimed to protect against, will both be factors that point against a finding that the chain of causation was broken.

Damages for breach of contract: Mitigation

The essence of the principle is that if the claimant unreasonably fails to act to mitigate (avoid or reduce) its loss, or unreasonably acts so as to increase its loss, the law treats those actions as having broken the chain of causation and measures damages as if the claimant had instead acted reasonably. The claimant is said to have a "duty to mitigate" (although this is not a duty enforceable by anyone, rather it is a recognition that if the claimant fails to do so its damages recovery will be affected by that failure). (BPE Solicitors v Hughes-Holland [2017] UKSC 21).

The clearest application of this principle is in the sale of goods context. Thus where a defendant seller fails to deliver goods for which a market substitute is available, the claimant cannot simply claim against the defendant all the losses which result (for example, its lost profit on a sub-sale, or lost profit from the use to which it would have put the goods). This is the case even if it does suffer those losses, because the claimant should have acted reasonably to mitigate its losses by purchasing a replacement on the market.

Remoteness of damage

Remoteness of damage refers to a further important principle by which the law determines which consequences caused (in a factual/but for sense) by the defendant’s breach are within the scope of the defendant’s responsibility and should be brought into account. The traditional test of remoteness, which is in essence a test of foreseeability, is set out in Hadley v Baxendale [1854] EWHC Exch J70.

This test operates as follows:

  • A loss will only be recoverable if it was "in the contemplation of the parties", that is, foreseeable.
  • The loss must be foreseeable not merely as being possible, but as being "not unlikely", which is a more demanding test than in tort (Koufos v C Czarnikow Ltd (The Heron II) [1967] UKHL 4).
  • The loss must be foreseeable at the date of contracting, not the date of breach (Hadley v Baxendale, Jackson and another v Royal Bank of Scotland [2005] UKHL 3, Lord Hope at para 36).
  • It is not the precise circumstances that occur that must be foreseeable, but the type or kind of loss (H Parsons (Livestock) Ltd v Uttley Ingham & Co Ltd [1977] EWCA Civ 13).
  • The knowledge that is taken into account when assessing what is in the contemplation of the parties comes under two limbs: First, is the knowledge of what happens "in the ordinary course of things", which is imputed to the parties whether or not they knew it. Second, there is actual knowledge of special circumstances outside the ordinary course of things and that was communicated to the defendant or otherwise known by the parties.

Contributory negligence (but only in cases of breach of duty of care)

A defendant may seek to argue that the loss suffered by the claimant is partly due to the fault of the claimant. The Law Reform (Contributory Negligence) Act 1945 provides for apportionment of loss where a claimant has suffered loss "as the result partly of his own fault and partly of the fault of any other person" (section 1). "Fault" is defined as "negligence or other act or omission that gives rise to liability in tort or would, apart from this Act, give rise to the defence of contributory negligence" (section 4).

Here to help

Bringing or defending a breach of contract claim can be stressful, time consuming and complex. Unless it is a low value claim it is worth getting solicitors involved as early as possible. If you have any questions about damages for breach of contract or about contract law more generally or if you need help with resolving a dispute please contact Neil Williamson.


best endeavours

Best Endeavours And Other Endeavours Clauses

Best endeavours, reasonable endeavours, all reasonable endeavours - how are these terms used in a legal sense and what do they mean?

Contractual obligations are normally absolute and failure to satisfy an obligation will be a breach of contract. Endeavours clauses are therefore used when a party is only prepared to "try" to fulfil an obligation, rather than commit to it absolutely. For example, in the case Jet2.com v Blackpool Airport the clauses under scrutiny created an obligation for Blackpool Airport to use its “best endeavours to promote Jet2.com’s low cost services” and “all reasonable endeavours to provide a cost base that will facilitate Jet2.com’s low cost pricing”. We refer to this case in more detail below.

Best, reasonable or all reasonable endeavours

It is clear from cases such as Rhodia International Holdings Ltd v Huntsman International LLC [2007] EWHC 292 that there is a spectrum of endeavours clauses, with "best endeavours" being more stringent than "reasonable endeavours". Despite the fact they are widely used, there is some uncertainty as to what efforts each different endeavours clause requires in practice.

Best endeavours

The term best endeavours has received the greatest amount of consideration by the courts and the starting point is that the phrase "means what the words say; they do not mean second-best endeavours" (Sheffield District Railway Co v Great Central Railway Co [1911] 27 TLR 451).

This has been further refined by the Court of Appeal to require the obligor "to take all those steps in their power which are capable of producing the desired results … being steps which a prudent, determined and reasonable obligee, acting in his own interests and desiring to achieve that result, would take" (IBM United Kingdom Ltd v Rockware Glass Ltd [1980] FSR 335). In other words, the obligor must put himself in the shoes of the reasonable obligee.

Reasonable endeavours

Reasonable endeavours are less burdensome. One formulation involves the obligor balancing "the weight of their contractual obligation" to the other party against "all relevant commercial considerations" such as the obligor's relations with third parties, its reputation, and the cost of that course of action (UBH (Mechanical Services) Ltd v Standard Life Assurance Company, The Times, 13 November 1986).

This has been restated as a question of "what would a reasonable and prudent person acting properly in their own commercial interest and applying their minds to their contractual obligation have done to try" to achieve the objective (Minerva (Wandsworth) Ltd v Greenland Ram (London) Ltd [2017] EWHC 1457).

This suggests an objective approach based on the reasonable obligor (not obligee as is the case for best endeavours). However, it appears the assessment should still reflect the circumstances and position of the obligor. Crucially, the obligor is not normally required to sacrifice its own commercial interests and may be entitled to consider the impact on their own profitability (P&O Property Holdings Ltd v Norwich Union Life Insurance Society [1993] EGCS 69). This is one of the major differences between a reasonable and best endeavours obligation.

All reasonable endeavours

The third commonly used endeavours clause is "all reasonable endeavours". It is commonly adopted as a compromise between best and reasonable endeavours. However, it is difficult to decipher its meaning and an analysis of existing case law raises three interlinked questions:

  • Does it mean the same as best endeavours?
  • Is the obligor obliged to sacrifice its commercial interests?
  • Is the assessment based on the obligor's particular circumstances?

The answer seems to be that it depends on the context.

On the first question, the traditional orthodoxy is that all reasonable endeavours sits somewhere between best endeavours and reasonable endeavours. Courts have stated, obiter, that it is "probably a middle position somewhere between the two, implying something more than reasonable endeavours but less than best endeavours" (UBH v Standard Life). This reflects the natural and ordinary reading of the words.

By contrast, in Rhodia, the judge stated, obiter, that an "obligation to use reasonable endeavours to achieve the aim probably only requires a party to take one reasonable course, not all of them, whereas an obligation to use best endeavours probably requires a party to take all the reasonable courses he can. In that context, it may well be that an obligation to use all reasonable endeavours equates with using best endeavours". This passage is sometimes used to argue that all reasonable endeavours equates to best endeavours in all respects.

However, this comment may just relate to the number of courses of action a party needs to take and not to the other distinctions between these obligations, such as the extent to which a party might have to compromise its commercial position. Support for this approach comes from CPC Group Ltd v Qatari Diar Real Estate Investment Company [2010] EWHC 1535, which starts to touch on the second question. In that case, Vos J stated: "It seems to me, therefore, that an obligation to use all reasonable endeavours does not always require the obligor to sacrifice its commercial interests".

The question of whether a party can have regard to his own financial interests is likely to depend on the nature and terms of the contract in question. In Astor Management AG v Atalaya Mining Plc [2017] EWHC 425, Atalaya had to use "all reasonable endeavours" to obtain senior debt facilities, an event which would trigger the payment of substantial deferred consideration to Astor. Atalaya could not raise funds in a different way simply to avoid paying the deferred consideration as that would defeat the purpose of the contract. However, the financial considerations were not irrelevant and Atalaya did not have to raise funds through senior debt facilities if it would make their activities commercially unviable.

Certainty case study

A final factor to consider is whether the endeavours clause is enforceable at all. It is clear that if the underlying objective is unenforceable due to a lack of certainty, an obligation to endeavour to achieve that result will also fail. Similarly, the combination of a less stringent endeavours clause (such as reasonable endeavours) with a poorly defined objective may lead to a very weak obligation.

Jet2.com v Blackpool Airport is a useful example of these principles. Blackpool Airport was under an obligation to use both of the following endeavours obligations:

  • Best endeavours to "promote Jet2.com's low cost services".
  • All reasonable endeavours to "provide a cost base that will facilitate Jet2.com's low cost pricing".

The Court of Appeal found that the former obligation was enforceable there being "a difference between a clause whose content is so uncertain that it is incapable of creating a binding obligation and a clause which gives rise to a binding obligation, the precise limits of which are difficult to define in advance, but which can nonetheless be given practical content". However, the Court of Appeal suggested the latter obligation might not be enforceable. Whilst Jet2.com argued the all reasonable endeavours obligation required Blackpool Airport to help Jet2.com to keep its prices down, Moore-Bick LJ stated the words were "too opaque to enable me to give them that meaning with any confidence".

Practical steps

There is a degree of uncertainty as to what an endeavours clause may actually require in any given case, and these uncertainties are best dealt with expressly in the contract.

A more useful approach is to set out the steps the obligor should take to achieve that particular obligation. The approach will vary from case to case, but parties should have regard to factors such as:

  • Whether the obligor must bear any costs or incur any expenditure and, if so, how much.
  • The period for which the obligor should pursue that objective.
  • Whether the obligor must take legal action or appeal to achieve the objective.
  • Whether the obligor must inform the obligee of its progress in meeting the objective.
  • Whether the obligor must step aside if it is unsuccessful and allow, or even assist, the obligee to solve the problem itself.
  • The extent to which a party is entitled to protect its own interests, is required to act in the interests of the other party, or base its actions on its own particular circumstances. These issues are, in part, determined by the type of endeavours clause used but it may be useful to set them out expressly.
  • Specific steps that the obligor is or is not expected to carry out.

Finally, probably the most decisive factor is whether the obligor does in fact take steps to comply with the endeavours clause. In the majority of cases the debate is not over the nuances in the differing level of obligation imposed by such clauses, but whether any real endeavours were used at all. The prudent obligor will also record evidence of its efforts and inform the obligee should any difficulties arise.

Endeavouring to try our best

Endeavours clauses are a complex and continually debated area in contract law. It is very context dependent and requires those with or willing to impose obligations to think ahead. If you have any questions about endeavours clauses or about contract law more generally please contact Neil Williamson.


good faith

Good Faith In English Contracts

On 7 May 2020, the UK Cabinet Office published guidance that parties to contracts should act responsibly and fairly, support the response to Covid-19 and protect jobs and the economy. Being non-statutory it is unclear how the courts might apply this message. Such expectations call to mind the concept of good faith. The government is encouraging businesses to act in the interest of public health, the job market and other businesses rather than just their own. In contract law this roughly translates as a duty of good faith to the other party of a contract.

History of good faith

The concept of good faith can be introduced in a number of ways. For example, it can be a legal principle that would apply to all the commercial activity in a certain country or it could be written into a contract. Importantly, the way it operates is dependent on the legal system of the country in which it is raised. One thing that is universal about good faith is that it is subjective which creates this scope for different interpretations.

English law has traditionally been averse to subjective clauses and has repeatedly rejected the adoption of good faith as a core concept of private law. There are several reasons for this hostility. English law embodies an ethos of individualism, so that parties are free to pursue their own self-interest. A general doctrine of good faith would also create too much uncertainty by creating obligations that are potentially vague and subjective. This could undermine the goal of contractual certainty, on which English law places great weight.Over the past thirty years, EU law has introduced the notion of “good faith” into confined areas of English private law. The majority of these interventions have concerned the protection of consumers in their interactions with businesses.

Good faith today

There is no general principle of good faith in English law unlike in other European legal systems (France and Germany significantly) and some US states. Therefore including a duty of good faith clause is the best way for a party operating under English law to make sure that the duty applies.

It was stated in a judgement in January 2020 by HHJ Pelling QC that ‘the circumstances in which… [good faith] can be implied into commercial agreements is an incrementally developing area of law’. Although there is no general doctrine of good faith in English contract law it can still affect commercial contracts in three ways:

  • Express duty.The parties can expressly agree that they will act in good faith. The question is whether the words chosen actually impose this duty and what it means in practice.
  • There is a well-recognised duty of rationality under which a party must exercise a contractual discretion in good faith and not arbitrarily or capriciously. This is often referred to as the "Braganza duty".
  • Implied duty.The courts might imply a general duty of good faith in a contract, or use the concept of good faith to imply other fact-specific duties. However, these duties are only likely to arise under a limited class of "relational" contracts.

Below is a more detailed look at these three avenues by which good faith is introduced into English law contracts.

Express obligations to act in good faith

Express duties of good faith, i.e. a clause stating that the parties should act in good faith, act with the utmost good faith, act in absolute faith, resolve disputes by friendly discussions, may achieve the following:

  • Prevent action that frustrates the purpose of the agreement.
  • Require the disclosure of material facts to the other party.
  • Prohibit knowingly lulling the other party into a false belief.
  • Prohibit asking for information under a pretence.
  • Prohibit knowingly providing false information on which the other party will rely.
  • Prohibit negotiating behind the other party's back.
  • Prohibit knowingly sustaining a groundless dispute.

The duty of rationality (the Braganza duty)

Another way to introduce good faith is through the principle known as the ‘duty of rationality’. This is an implied obligation in English contract law, in the absence of clear language to the contrary, to exercise a contractual discretion in good faith and not arbitrarily or capriciously (as stated in the case British Telecommunications plc v Telefónica O2 UK Ltd [2014] UKSC 42). This is often referred to as the "Braganza duty" after the leading case, Braganza v BP Shipping Ltd [2015] UKSC 17.

The duty of rationality is limited in scope. It is only likely to arise when one party, acting as decision-maker, makes a subjective decision on a matter that affects both parties giving rise to a potential conflict of interest between the parties. Any potential conflict of interest will be heightened where there is a significant imbalance of power between the parties. To simplify, the duty exists to stop the more powerful party to a contract from abusing that power.

The duty has been applied in a broad range of situations. Below are some examples:

  • Unilaterally setting or varying the charges or interest rate in a contract.
  • Valuing a portfolio of securities after the default of a counterparty.
  • Deciding whether to award an option to a service provider.
  • Deciding whether to award discretionary bonuses to employees.
  • Placing an employee on gardening leave.
  • Refusing to allow a tenant to keep a dog.
  • Deciding to carry out a valuation of premises.
  • Assessing and reclaiming overpayments.
  • Avoiding an insurance policy.

Implied obligations requiring good faith

It is well recognised that broad concepts of fair dealing may be reflected in the court's response to questions of construction and implication of terms: "A thread runs through our contract law that effect must be given to the reasonable expectations of honest men" (Lord Steyn, LQR 1997, 133 (Jul)). Almost all contracts would reasonably be understood as requiring honesty in their performance, reflecting the common assumption by the parties to this effect. For example, one of the principles of contract law is that no person may benefit from his or her own wrongdoing, which encourages honest performance. The court may also imply terms in fact that:

  • The parties will co-operate in the performance of a contract.
  • A party cannot insist on the performance of an obligation it has prevented the other from performing.

Although these obligations exist it would be incorrect to imply that they constitute the concept of good faith as defined in courts around the world. The concept of good faith should not be seen as a "general organising principle". To do so would risk undermining the express terms agreed between the parties in that, in English Law, the terms of a contract are the most important thing to assess before any subjective principles such as good faith (as stated in the case MSC Mediterranean Shipping Company SA v Cottonex Anstalt [2016] EWCA Civ 789.) However, where the contract is "relational", it may be possible to use the concept of good faith as an aid when interpreting a contract. This concept was first advocated by the High Court in Yam Seng. Some recent decisions support the concept of a relational contract and give a sense of ‘relational’ is defined:

  • The Court of Appeal commented, obiter, that a 25-year PFI contract could be classified as a relational contract. Given the "massive length" of the contract, the parties should not latch onto "infelicities and oddities" to disrupt the project and maximise their own gain. (Amey Birmingham v Birmingham City Council [2018] EWCA Civ 264.) Similarly, the High Court decided that a different 25-year PFI contract was a “paradigm example of a relational contract in which the law implies a duty of good faith(Essex County Council v UBB Waste (Essex) Ltd [2020] EWHC 1581 (TCC)).
  • In the High Court, Leggatt LJ decided that a long-term joint venture to develop hotels and an associated travel business was a relational contract subject to an implied duty of good faith (Al Nehayan v Kent).

Length can be seen as the main factor in recent statements when considering whether or not a contract is ‘relational’. As stated in the 2019 case Bates v Post Office, broadly speaking a relational contract exists when there is:

  • A long-term contract or a contract the parties intend to be long term, even if it lacks a fixed term and allows termination by notice.
  • The parties intend their roles to be performed with integrity and with fidelity to their bargain.
  • The parties will be committed to collaborating with one another.
  • The spirits and objectives of the venture cannot be expressed exhaustively in a written contract.
  • The parties each repose trust and confidence in one another.
  • The contract involves a high degree of communication, co-operation and predictable performance based on mutual trust and confidence, and expectations of loyalty.
  • One or both parties have made a significant investment.
  • The relationship is exclusive.

However, the law remains in flux and the circumstances in which a contract will be considered "relational" are limited.

Summary

Understanding the way the concept of good faith is constituted and used in the jurisdiction under which a contract is governed is the first step when considering to rely upon it. As has been mentioned, its subjective nature causes a wide variety of interpretations and not always the clearest picture of how it is used in practice. Taking the UK as our prime example (and specialism), the English courts have an austere, some would say draconian, approach to interpreting good faith into contracts because the written terms of a contract are seen as being precedent and therefore able to overrule any such principles. Therefore the surest way to make sure the obligation exists in English law (or does not) is by considering the inclusion (or non-inclusion) of a good faith clause.

Relying on the duty of rationality or the concept of a ‘relational’ contract, i.e. not an express clause, is ill-advised. In a recent case, TAQA v RockRose [2020], the court decided that just because a contract could be defined as a ‘relational contract’, it would not automatically lead to the conclusion that the parties owe each other a good faith obligation. It would depend on the terms of the particular contract. This is further indication that the UK courts are unlikely to imply a duty of good faith and even within the context of Covid-19 it is doubtful that its scope will increase.

If you have any questions about good faith clauses or about contract law more generally please contact Neil Williamson.


boilerplate clauses

Boilerplate clauses - what are they?

Boilerplate clauses are repeated in all kinds of contracts. They are not the commercial terms that vary from one transaction to another. They regulate the operation of the contract: its duration, interpretation, transferability and enforceability.

What are boilerplate clauses?

Boilerplate clauses are often standard, and most are not typically negotiated. But they are important. Many contract disputes depend on the drafting of boilerplate clauses such as termination, force majeure, and entire agreement.

Some heavily negotiated commercial terms routinely appear in so many contracts that they may also be classed with boilerplate. Examples are indemnities and limit of liability clauses.

Example: how boilerplate clauses may affect a dispute

Here’s an example from the case FoodCo UK LLP v Henry Boot Developments Ltd [2010] EWHC 358 (Ch). An entire agreement clause saved a developer from a series of claims for misrepresentation, brought by businesses that had leased units in the development. The clause agreed that no lessee had relied on any representation beyond those recorded in the contract. The effect was that one businessman, when confronted with the clause in the contract he had signed, admitted that he had not in fact relied on the alleged misrepresentations. That defeated his claim. The clause successfully excluded claims for innocent and negligent misrepresentation. That reduced the other five claimants to asserting fraud, which they failed to prove.

Some common boilerplate clauses:

  • Counterparts – Confirms the validity of counterparts or duplicates of the contract (and may delay contract formation).
  • Entire Agreement – identifies the express contract terms. Often contains terms limiting liability for misrepresentation.
  • Limiting liability for misrepresentation – Reduces the risk of liability for misrepresentation.
  • Severance - Agrees the contract will survive deletion of an unenforceable provision. May impose a duty to renegotiate.
  • Third party rights – Can limit non-parties’ rights to enforce contract terms and to veto variation and rescission.
  • Waiver - May help to prevent accidental loss of rights but cannot ensure their survival.

Counterparts

Parties to a contract may each execute a separate copy of the contract, each of which they will consider an original. A counterparts clause states this expressly. Even without a counterparts clause, a contract is valid if made in this way, under the common law. Land transactions are commonly executed in this way without a counterparts clause.

A counterparts clause may also be used where the parties execute multiple original contracts (duplicates), to confirm that each has the status of an original. Duplicates may be required for tax, regulatory, company administration or other reasons. In these cases, a counterparts clause may help stop a party (or an outside authority) objecting that a counterpart or duplicate contract is not binding or valid.

Entire agreement

The entire agreement affects statements made in negotiations but not repeated in the contract. In the absence of an entire agreement statement, these could create a collateral warranty or side agreement, under the common law. For example, if a sales representative offers extra benefits as an inducement to sign a contract, the supplier could be contractually bound to provide those benefits, even if they were not written into the contract. An entire agreement statement prevents this by identifying the express contract terms, limiting them to the terms identified in the clause.

Limiting liability for misrepresentation

This part of the clause addresses the risk of claims if one party (usually the supplier, rarely the customer) induced another to enter the contract by a false statement. If that happens, even unintentionally, the other may claim damages for the loss caused by entering the contract, or occasionally undo (rescind) the contract. Depending on the facts, the claims arising may include misrepresentation, negligence, fraud and (if the false statement was also captured as a warranty) breach of contract.

To reduce this risk, an entire agreement clause may include a non-reliance statement and express limits on liability and remedies for misrepresentation. This kind of wording has defeated large claims for misrepresentation, as in the example described above. This limitation often appears in the entire agreement clause for historical reasons, but it could equally well go in the limitation clause, a remedies clause or a clause on representations.

Severance

This clause takes effect if a contract term is illegal or invalid. Examples of illegal or invalid term are:

  • Unfair exclusions of liability contrary to the Unfair Contract Terms Act 1977.
  • Non-compete and non-solicitation clauses that go beyond what is reasonable to protect a party's legitimate interests.
  • A duty to pay a banned person or organisation, contrary to anti-terrorism legislation.

Some severance clauses add nothing to what English law already provides. Under the common law doctrine of severance, the invalid provision is deleted and the rest of the contract survives if all these conditions are met:

  • Public policy allows it.
  • Nothing is added or rewritten. So, if an excessive restraint on competition or limit on liability is deleted, a reasonable and valid provision is not substituted.
  • The basic nature of the contract is unchanged. (But contracts routinely survive the deletion of an unfair limit on liability.)

Third party rights

The Contracts (Rights of Third Parties) Act 1999 introduced a new pitfall in contract drafting: the risk of accidentally giving a non-party (i.e. third party) the right to:

  • Enforce a contract term. Any express or implied benefit to a non-party may be directly enforceable by that non-party against the parties.
  • Prevent variation and rescission. Once a contract creates a directly enforceable third party right, the parties may need the non-party's consent before they can change that right by agreeing to vary or rescind the contract.

A clause dealing with third party rights can prevent direct enforcement by a non-party or restrict it to third party rights created expressly or remove the need for a non-party's consent to variation or rescission. Some clauses on third party rights go further, excluding non-party rights arising in other ways and preserving other rights of the parties. The need for these provisions and their effect on the contract are often unclear.

Waiver

A party can lose a right by waiting too long to exercise it or by taking action inconsistent with the right, under the common law of waiver. Expressly reserving the right during the delay or while taking the inconsistent action can prevent waiver, at least for a while.

A "no waiver" clause tries to preserve all rights from being waived, especially by delay. However, the clause may not prevail over the later words and actions of the party seeking to rely on it.

Worth checking

Boilerplate clauses can have sweeping effects in the event of a breakdown of contractual relations. Making sure the correct ones are included is therefore essential. But the idea that they can be applied equally in every contract is false. Making your lawyer away of the idiosyncrasies of your contractual dealings when considering boilerplate clauses is therefore advisable.

If you have any questions about boilerplate clauses or about contract law more generally please contact Neil Williamson.


resale price maintenance

Resale Price Maintenance – Korg Fined

On 9 July 2020, the Competition and Markets Authority (CMA) published the full text of its infringement decision finding that Korg (UK) Limited had breached the Chapter I prohibition of the Competition Act 1998 and Article 101 of the Treaty on the Functioning of the European Union by engaging in resale price maintenance in relation to the online retail prices of Korg's synthesizers and hi-tech equipment.

Background

In April 2018, the CMA launched an investigation related to alleged anti-competitive agreements and/or concerted practices in relation to the distribution of musical instruments and equipment by Korg (UK) Limited (Korg UK). On 24 March 2020, the CMA issued a statement of objections alleging that Korg UK had breached Article 101 of the TFEU and the Chapter I prohibition by restricting retailer freedom to discount the online retail prices of synthesizers and hi-tech equipment supplied by Korg UK, in other words, that Korg were guilty of resale price maintenance.

Korg UK subsequently reached a settlement agreement with the CMA and, on 29 June 2020, the CMA announced that it had issued an infringement decision, fining Korg UK £1.5 million for engaging in resale price maintenance designed to restrict retailer freedom to set prices online by requiring their musical instruments to be sold at or above a minimum price. The CMA has now published the full text of the infringement decision.

The facts

Korg UK is active in the distribution of musical instruments and music-making equipment (MI) including electronic MI in the UK and Republic of Ireland. The CMA's investigation was limited to the supply of Korg synthesizers and hi-tech equipment (including DJ equipment, electronic percussion, stage pianos, and controllers) (Relevant Products).

The CMA concluded that during the relevant period (9 June 2015 to 17 April 2018), Korg UK operated and enforced a wide-ranging pricing policy, the purpose of which was to ensure that MI Resellers would not advertise or sell the Relevant Products online below a certain minimum price specified by Korg UK from time to time, for example in Korg UK’s price lists. The CMA found that the nature of the Korg Pricing Policy was such that Korg UK rarely needed to contact MI Resellers about it (in writing or otherwise), when MI Resellers were complying with it because the Minimum Price was, in general, clearly displayed on Korg’s UK’s price lists relating to the relevant products.

This generally limited the need for verbal and written communications concerning the Korg Pricing Policy, and therefore limited the amount of written records related to the Korg Pricing Policy. Despite this, the CMA obtained evidence which, in the CMA’s view, demonstrated the existence of the Korg Pricing Policy. Relevant contemporaneous documentary evidence was corroborated by certain witness evidence describing verbal and/or written communications that took place between Korg UK and its MI Resellers during the relevant period.

Resale price maintenance – Korg evidence

The commercial aims, content and communication and scope and duration

Korg UK’s commercial aims for introducing the Korg Pricing Policy were as follows:

  • It was designed to enable Korg UK’s MI Resellers to achieve attractive margins through the maintenance of high and stable pricing, so increasing the attractiveness of the Korg brand and encouraging MI Resellers to stock and sell the Relevant Products (and the Korg brand more generally).
  • In doing so, it aimed to help Korg UK secure, maintain and/or improve its UK market position in the relevant products relative to its competitors, in particular, by maintaining the brand value of the relevant products.

Resale price maintenance – Korg’s monitoring and enforcement

The evidence showed that Korg UK sought to monitor and enforce the Korg Pricing Policy by contacting MI Resellers in advance of Korg UK issuing a new price list or immediately after issue to ensure early compliance with the Korg Pricing Policy.

Korg UK’s awareness of competition law and potential illegality, and culture of concealment

The evidence shows that Korg UK staff were very familiar with competition law and appeared to know what conduct would constitute a breach of it. Korg had introduced a compliance code in 2015 and senior employees took an active role in giving competition compliance training as part of the induction for new Korg UK staff. The CMA further concluded that “Korg UK staff operated under a culture of concealment and tried to avoid generating an evidence trail of potentially incriminating written records.”

CMA’s legal assessment of resale price maintenance

The decision sets out CMA’s legal assessment of Korg UK’s agreement and/or concerted practice with Reseller 1, one of its MI Resellers, that Reseller 1 would not advertise or sell online synthesizers or hi-tech equipment supplied to it by Korg UK below a certain Minimum Price specified by Korg UK from time to time, in accordance with the Korg Pricing Policy.

The CMA had reasonable grounds for suspecting that more than 20 MI Resellers of the relevant producers were subject to the Korg Pricing Policy, and that MI Resellers generally complied with Korg UK’s requests to adhere to the Minimum Price.

The CMA, therefore, concluded that throughout the relevant period:

  • Reseller 1 generally complied with the Korg Pricing Policy, due to a credible fear of sanctions for non-compliance.
  • Korg UK monitored Reseller 1’s pricing and requested Reseller 1 on numerous occasions to follow the Korg Pricing Policy with regard to Reseller 1’s advertising and selling online of the Relevant Products (this tended to happen when Korg UK issued a new price list or when Reseller 1 had been caught matching another MI Reseller’s lower prices, at least temporarily).
  • On numerous occasions Reseller 1 increased its pricing (albeit not always immediately) to at least the Minimum Price, on Korg UK’s request.
  • On numerous occasions Reseller 1 reported to Korg UK other MI Resellers advertising or selling the Relevant Products online at prices below the Minimum Price.

Decision to impose penalties

The CMA concludes that there is strong evidence that Korg UK must have been aware, or could not have been unaware, that its conduct had the object or would have the effect of restricting competition. In particular, there was evidence that staff were aware that resale price maintenance was illegal and that there was a culture of concealment to hide evidence. The CMA therefore found that Korg UK committed resale price maintenance intentionally.

Case study

The CMA has published a case study explaining the facts of this case. It notes that there are a number of lessons that businesses can learn from this case, including an understanding that:

  • It is illegal for a supplier to interfere with a reseller’s ability to independently set their own price.
  • The CMA has sophisticated means of gathering evidence and uncovering evidence even where the companies have tried to hide their actions by deleting communications.
  • If you are ever asked not to put something down in writing, you should be suspicious as it could relate to something illegal. If so, you should seek legal advice and seriously consider whether to report the matter to the CMA.
  • Directors and senior staff have a special responsibility to be well informed on competition law and make sure their companies are behaving legally and ethically.
  • Attending compliance training alone is not sufficient to be compliant – you must actively comply with the law.
  • As a reseller you can also be investigated for breaking the law if you are found to have co-operated with a minimum pricing policy. If a supplier tries to make you comply with a minimum pricing policy, you should refuse and point them to our guidance. The CMA would also urge you to report them. Resellers may also face enforcement action such as fines if they have gone along with the supplier’s resale price policy.

EM Law help a wide range of clients with compliance and structuring around their operations. Please contact us if you have any questions on the issues raised in this article.