Back to basics
In this article we go back to basics, looking at the essential principles behind drafting commercial contracts for the benefit of anyone who wants, or needs, an introduction or a refresher. But first, lets take a moment to reflect on some of the principles that underpin contract law.
Assuming that all parties can claim an appropriate legal capacity, there are four essential requirements for a contract to be formed: offer, acceptance, consideration and the intention to create legal relations. Once these four principles have been satisfied a contract has been made. The first three are always matters of fact; but the fourth is not.
Intention to create legal relations
Assuming that the other three elements of a contract are present the presumption in commercial contracts is that the parties intend their agreement to be legally binding. If that is not the case then during the course of negotiations they will (should) typically use terms such as "subject to contract" to make their position clear. That said, in the case of Somerfield Stores Limited v Skanska Rashleigh Weatherfoil (2006), in which an agreement was made "subject to contract" but was then acted on immediately even though the detailed contract was negotiated over a three-year period, it was decided that the agreement was still contractually binding for that period, notwithstanding the use of those words.
Does a contract have to be in writing?
Providing that the essential ingredients of a contract are present there are only a very limited number of circumstances in which a contract must be in writing. The most common are:
- a contract for the sale of land (section 2, Law of Property (Miscellaneous Provisions) Act 1989);
- the assignment of intellectual property rights (sections 90(3) and 222(3), Copyright Designs and Patents Act 1988);
- guarantees (section 4, Statute of Frauds Act 1677); and,
- the assignment of contractual rights (Section 136, Law and Property Act 1925).
It is also worth remembering that certain sorts of agreement not only need to be reduced to writing, but, in certain circumstances, must also be in the form of a deed. Examples of these are:
- land transfers (section 52, Law of Property Act 1925);
- leases (sections 52(2) and 54(2), Law of Property Act 1925);
- agreements which the parties intend to be binding but where there is insufficient consideration.
Leaving aside those situations in which a contract must be in writing there are obvious reasons why it is desirable for any form of commercial agreement to be written down, in particular, to provide certainty to the parties and to clearly apportion the risks and benefits arising from the contract.
But there are drawbacks too. Difficulties may arise in relation to longer-term contracts, such as a long-term supply agreement, where commercial relations may exist outside the contract and continue between the parties. The purpose of reducing a contract of this sort to writing is often to enable one party to force the other party to do something which for good commercial reasons it is reluctant so to do, as well as to provide a route to compensation for the claimant if the other party refuses point blank. Here the problem for the contract draftsman is to try to foresee all potential future scenarios; which is, of course, extremely difficult (exclamation of horror from lawyer!) and may well result in a lengthy and unwieldy document (exclamation of horror from client!).
It can also be claimed, with some justification, that the more detailed the contract, the more room there is for subsequent argument. Whereas, if a minimalist approach is taken to drafting, then the commercial imperatives of the relationship between the parties will dictate the resolution of any problems that arise. In effect this means that if either party can terminate the agreement on notice, and, if within this notice period a commercial agreement cannot be struck, then the parties can walk away.
But, whilst in certain limited circumstances a minimalist approach may be appropriate, for the majority of cases it is likely that the parties will prefer to have the certainty of a detailed agreement which will not, in the last resort, depend on the interpretation of the court or the importation of terms implied by law.
The opposite of minimalism (and the more usual approach) is to try to contain the details of the legal relations within a detailed document and to import an entire agreement clause with the intention of excluding from the contract any outside material which might otherwise vary it. This approach is supported by the "parol evidence" rule the rule that the courts will not normally allow oral terms to be imported into a written contract. But, as a contract can be oral as well as in writing, if it can be shown that the written contract did not capture the entire agreement between the parties then external evidence of this can be introduced.
So what, then, is a typical framework for a commercial contract? Lets look at the main elements.
The parties
The Companies Act 1985 significantly marginalised the doctrine of ultra vires so that for the most part the question of whether or not a company is acting ultra vires is not externally important. A limited liability partnership has a separate legal persona and is capable of entering into contracts and, as with a Companies Act company, the ultra vires position is not a concern here either.
However, a statutory corporation must not act ultra vires. Though a local authority, for example, has a statutory power to do anything to facilitate, or which is conducive to, the discharge of any of its functions (s.111, Local Government Act 1972), the courts have interpreted this narrowly (Credit Suisse v Allerdale BC [1997]).
Clearly if there is any doubt about the capacity of parties, or indeed their financial viability, it is appropriate to consider the inclusion of a guarantee within the contract.
Privity of contract
The doctrine of privity means that only the original parties to a contract have an obligation (to each other) and that a third party has no right to enforce the contract. This basic tenet of English law has been altered by The Contracts (Rights of Third Parties) Act 1999 which enables a third party to enforce the contract if it expressly provides that he may, or if the relevant term purports to confer a benefit on him.
If it is intended that no third party should acquire rights under the contract it is important to ensure that the agreement includes a provision which expressly excludes them, including any that might arise under the Rights of Third Parties Act.
Recitals
Whilst the recitals in a contract (ie, the background to it) may seem of little importance, in fact there are a number of situations in which the reverse can be true.
If the recitals contain a clear intention for the parties to do something, then the courts will infer a covenant to do that thing just as if the contract itself had contained an express agreement to that effect (Aspdin v Austin (1844)).
A recital may well bring into the contract a representation that would otherwise be excluded e.g. because of an entire agreement clause.
Where a recital is intended to be a statement of all parties, then all parties are prevented from denying the truth of the recital. But where the recital is a statement of one party only, then only that party is so prevented.
And finally, when the words of an agreement are ambiguous, the recitals may be used to discover the intention of the parties (Rutter v Charles Sharpe & Co (1979)).
Main commercial terms
Consideration
For a contract to be legally enforceable there must be consideration. If there is none, or if the consideration has no value, the contract will be unenforceable unless exercised as a deed. In this regard particular care needs to be taken where the consideration exists only in the past. Past consideration is deemed to be no consideration: in other words, the discharge of an existing contract or obligation will be insufficient unless the relevant party does something more than he is already contractually obliged to do under an earlier obligation.
Duration
Care needs to be taken in drafting termination provisions. If the contract does not include a provision for termination, then the contract may either be terminable on reasonable notice (Marti Baker Aircraft Co Limited v Canadian Flight Equipment Limited (1955)) or in some cases not terminable at all (Harbinger UK Limited v GEI Information Services Limited (2001)).
Apart from termination by the passage of time it is usual to provide for the contract to be terminated if a party is in breach or becomes insolvent. In appropriate circumstances there may be additional rights to terminate (such as in the event of a change in control of either party).
Implied terms
Terms may be implied into a contract from a number of sources including statute (examples being: Sale of Goods Act 1979; Supply of Goods and Services Act 1982; Human Rights Act 1998) and common law (eg, terms may be implied to give effect to the intention of the parties or to give effect to the contract this is known as the Moorcock doctrine).
A contract can contain provisions that seek to exclude any implied terms, but a general disclaimer such as this may not be legally effective at all if it fails in any part and the contract would be better drafted using specific exclusions addressing terms that the courts might otherwise imply.
Limitation of liability
When it comes to drafting a limitation of liability clause one must be mindful of the over-arching general principles. Liability for death or personal injury cannot be excluded or restricted (s.2(1), Unfair Contract Terms Act 1977 (UCTA 1977)) and, as a matter of public policy, nor can liability for fraud.
As weve already seen, it is not uncommon for a contract to contain an entire agreement clause saying that any statements made prior to the construction of the contract will have no effect. It is worth remembering that any attempt to exclude previous misrepresentations will have effect only if it is reasonable to do so.
Furthermore, there are statutory limitations on restricting liability. UCTA 1977 sets out a test of "reasonableness" which will often apply even in a business-to-business context.
Well, that completes our introductory session on drafting commercial contracts. Articles looking at more detailed aspects of commercial contract drafting will be forthcoming the future and we will also be looking at them in our seminars.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
