When no news is not good news: starting work without a signed contract (1)

This White Paper looks at a very common situation in the IT industry (and in other industries as well): starting work without a signed contract in place. What does the law say in these situations? Is this a desirable situation to put yourself in? What can you do about it?

Complex questions, all of them - this White Paper offers some general pointers and tries to draw out what we can learn from the decided cases, especially those in the IT industry.

Statement of the problem

There is a steady flow of cases dealing with the situation of where parties have started work against a letter of intent, or not even that - they just start work without any signed contract at all. It may be that they are negotiating the detailed terms of some proposed contract or it may be that they have not even got that far and have just agreed high-level "commercial" terms. It is a very common situation: but what does English Law say about it?

Just recently, there has been a rash of cases on this situation over the last year or two - and several have gone to the Court of Appeal. There, the line generally taken by the judges, often reversing the decisions of the trial judges, is that there is no contract at all. However, the recent decision of the Supreme Court in RTS Flexible Systems v Mueller (2) must throw that approach into some doubt: this was a case where the five judges of the Supreme Court unanimously overturned the Court of Appeal's decision and found that there was indeed a contract. It makes it very timely to look at these cases and try to determine exactly what the current law on this subject is.

The dynamics of a negotiation - important background

The practice of law is often about negotiations, and so it is just as important to be aware of these factors as well as the "black letter law".

Of course, there are many reasons why parties start work without a signed contract: maybe there just is not the time to finalise all the negotiations, or the proposed project is so important that the parties just cannot wait. It is not only the customer which may want the project to start early - the supplier may want to get some money in. However, there are other dynamics at play as well.

In terms of the negotiations, the dynamics of any negotiation have to be kept in the forefront of the parties' minds as well as the strict legal principles. The parties' positions and strengths do not stay the same as negotiations continue against a project which has already started. When a supplier has started work, it becomes harder and harder in practical terms the longer things go on for the customer to order a "down-tools" so that it can switch to a different supplier. In terms of the bargaining position, you can think of the parties' relative power as being like a pendulum: while the supplier is bidding for the work, the pendulum is swinging towards to the customer, which has much greater power in imposing its terms on a supplier which is keen to get the work. As the supplier moves to a favoured bidder status or even being the sole bidder, the pendulum is moving in the direction of the supplier. When work has begun, the pendulum has started to swing in favour of the supplier, and will normally continue to swing in the supplier's direction the longer the project continues, as it becomes harder for the customer to switch to a different supplier.

It is worth bearing this dynamic in mind as you negotiate. In fact, it is easy to lose sight of it - and customers sometimes find it hard to adapt to their weakening power as negotiations continue and the project starts. The different parties have completely different aims - the supplier wants to start work, get some cash rolling in and make it difficult in practical terms for the customer to move to a different supplier. The customer also wants the work to start as soon as possible - but also wants to secure favourable terms for that work - not just price and other commercial terms, but all the other elements that go to make up a contract, including SLA's, warranties and so on. The longer the customer waits, the less chance (in general) it has of securing these things against a supplier which is becoming increasingly confident. Of course, if the project gets off to a bad start, the pendulum may well move back towards the customer.

As the pendulum swings one way or another, suddenly negotiations become more and more protracted, and points which seemed more or less agreed at the outset become major stumbling-blocks. This changing dynamic can actually cause the situation to become more aggravated: if the project got off to a good start, it probably seemed an easy job to finalise the detailed terms; as work proceeds, getting anything agreed seems to move farther and farther into the future.

Turning to the legalities, what does English Law provide when this situation arises, and what can be done about it?

Preliminaries

The first point to make is that starting work without a contract inevitably leads to a situation where there is no clear legal answer: at best, you are left with a situation where the legal solution is more or less likely to be one thing rather than another according to all the circumstances. It really is like setting sail on a sea of uncertainties. As an example of this, a case has just been decided by the Supreme Court where the decision arrived at by each of the High Court, the Court of Appeal and the Supreme Court resulted in three different conclusions: three courts, a total of nine judges, and three different results. We will be looking at each of these decisions below as examples of some of the different results possible.

The best advice would be to start work only against a proper contract or at least a binding letter of intent which deals with the really important issues. Given the open-ended nature of situations which may result from not signing a contract before starting work, the following scenarios are not exhaustive, but they represent perhaps the commonest outcomes.

Scenario 1 - there is only an agreement to agree: this is not a contract at all and has no contractual legal status as such

The parties may well have "agreed" to seek to come to an agreement, but what they have "agreed" is really only an agreement to agree, or to try to agree. Such an agreement to agree is not enforceable as a contract and will not take effect as such.

Example

So in Walford v Miles the parties were negotiating the sale of a company and the sellers agreed not to talk to any third parties if the buyers could provide a comfort letter from their bank confirming that the bank would provide the money. The bank did so, and the sellers confirmed that they would sell the company for ?2m, subject to contract; however, five days later, the sellers wrote to say that they had decided to sell the company to a third party. The buyers sued. In the House of Lords, they failed to convince the judges that there was an enforceable contract. Any contract has to have the necessary element of certainty - and the House of Lords could not see how an open-ended commitment to negotiate could be said to be certain, even if you added an implied obligation to negotiate in good faith. The House of Lords saw the process of negotiation as an adversarial one, where each party pursued its own interests, and in theory each party reserved the right to walk away from the negotiations in order to persuade the other party to increase its offer.

Note in the case of Walford v Miles the parties had agreed some of the terms (such as the price) but this was all expressed to be subject to contract and in any case there was much still to be addressed between the parties.

Practical note

It is of course possible to enter into some sort of "lock-out" provision providing for one party to negotiate only with the other for an agreed period of time. What would be necessary is some sort of certainty - such as including a fixed period for the negotiations to take place.

Scenario 2 - the parties are negotiating, and may even be in agreement on all essential terms but have expressed their negotiations to be "subject to contract": this will normally prevent a contract coming into existence

It used to be said that solicitors' typewriters (or nowadays, their keyboards) had two extra keys: one for "without prejudice" and another for "subject to contract". They are certainly terms much used (and misused) by many, lawyers and non-lawyers alike.

In theory, using "subject to contract" will prevent a contract coming into existence but that rule is now riddled with exceptions and it is by no means guaranteed that using this term will have the effect of preventing a contract coming into existence.

The following case shows that the courts will not mechanically apply a phrase such as "subject to contract" without looking at all the surrounding circumstances - the actual result may be that there is a contract, even though the parties used such an expression.

Example

In RTS Flexible Systems v Mueller (2) the parties negotiated a complex project for the provision of an automated production line for use by the claimant, which produced pots of yoghurt. Negotiation of the terms took many months, but finally the parties had agreed the set of terms and conditions and most of the schedules. In any case, the urgency of the work meant that the parties had already started work. The terms and conditions included a "counterparts" provision which is very commonly found: it said that the agreement would not become effective until each party had executed a counterpart and exchanged it with the other. This was identical in effect to saying "subject to contract". This was the case where each court came to a different decision:

At first instance, the judge said that this clause prevented the terms and conditions coming into effect, but did not prevent a contract coming into effect based on what had been agreed so far in the schedules.

The Court of Appeal thought that this same clause prevented not only the terms and conditions having contractual effect, but prevented any contract coming into effect at all - in their view, the correct answer was that there was no contract.

However, the Supreme Court in the end held that the parties had impliedly waived the counterparts clause by their conduct in carrying on with the project. The result was that there was a contract, albeit unsigned, but comprising the agreed terms and conditions together with so much of the schedules as had also been agreed.

As was said above, this case just shows how indefinite any situation of an unsigned contract can be when starting work - three courts coming to three completely different decisions on the same facts. If any case demonstrated the need to be cautious in starting work without a contract, this one is it!

Practice points on "subject to contract"

Using "subject to contract" on your documents or correspondence creates a presumption that you do not intend to be contractually bound - it is a presumption, perhaps a strong presumption, but not a fixed rule.

One tip is rather than mechanically using a set expression such as "subject to contract" at the top of your letter or email, it may be better to set out in ordinary words exactly what your intentions are. For example, you could say "this letter is not intended to be a legally binding offer and is not intended to be capable of acceptance" or "this document sets out a number of headline terms but is not intended to be a legally binding document between the parties, who will not be bound until there is a subsequent detailed legal document". Obviously, you would need to vary the words depending on the precise document and the exact circumstances.

Another tip is this: if you are in the course of negotiations and need to send out several documents or letters which you want to be "subject to contract", rather than just reproducing the selfsame words on each document, scratch draft different words with the same sense in each document to show any court that you really do not want that document to have any contractual effect.

Scenario 3 - the parties agree on the essential commercial terms but there is no finalised formal document: in this case, the parties might well be found to have entered into a contract on the basis of what they have managed to agree so far

Much will depend here on what it was that the parties were trying to agree - the more complex the deal, the less likely it is that a court will find a contract in the absence of very clear evidence. Evidence which might point to there being a contract in place is the fact that the parties have performed what they at least thought was the "contract" - the more the "contract" has been performed, the harder it becomes to argue that there was never a contract.

Example One

In DMA Financial Solutions v BaaN UK, BaaN decided to phase out its continuing support for a software product and sought a third party to provide continuing training for the product's remaining users. Negotiations began with DMA to provide this service which resulted in essential agreement on the commercial terms. This was in turn referred to BaaN's legal department in the US to draw up a "proper" legal agreement but they did not do so. Meanwhile, DMA started to provide training and BaaN ceased to do so. However, BaaN seemed to be changing its policy and the upshot was that it wanted to take back the provision of training. DMA sued. Nobody had used "subject to contract" or any similar expression.

The judge held that the parties had agreed everything they needed to agree to give rise to a legally enforceable contract: they had agreed on price and payment dates, duration, territory, use of BaaN's materials by DMA, access to and use of BaaN's staff and other principles as well. It was true that some "legal" points had yet to be agreed - so, for example, there was no choice of law clause. This was not relevant - all the commercial terms were there, the parties had started acting on it. The judge held that there was a binding contract based on the commercial elements which had been agreed, even though the parties had agreed to produce a "proper" legal agreement embodying all the terms so far agreed.

This outcome is not inevitable, as can be seen from the next example.

Example Two

In the case of Spectra International v Tiscali, the parties were negotiating at the beginning of the broadband explosion. Spectra wanted to exploit the convergence of television and internet access and was looking for a suitable ISP. A meeting took place at which commercial terms were discussed and headline terms agreed. In spite of the judge accepting that the claimant's witnesses were basically honest and that their records of the relevant meetings were accurate, the actual decision was that there was no contract.

The judge thought that this was not a simple agreement - it was more like a joint venture which of its very nature would require setting out in some detail each party's respective rights and liabilities. Furthermore, while some commercial factors were agreed, a lot of the technical matters in this emerging market had yet to be agreed. For example, the defendants had not seen a sample of the product and so could not gauge what technical problems lay ahead in developing a converged product.

Practice points on negotiating detailed commercial terms

The more complex the deal, the harder it will be to show that the parties "accidentally" entered into a contract without signing some form of contract. In the above two examples , a relatively simple contract for training could be entered into by meetings and exchanges of correspondence, whereas a complex joint-venture type of deal involving technical innovation required more before it became a binding contract. However, it will normally be in any party's interest to put the matter beyond doubt, by stating in clear English exactly what is and is not intended by way of contractual status. The fact that performance actually starts will incline a court to find a contract: the longer work proceeds, the more likely a court will be to find that a contract has come into existence. The RTS case above shows how easy it is to become subsumed in the project's problems and forget the commercial ones: again, don't let the negotiation of the contract slip off the bottom of the agenda.

Scenario 4 - the parties agree on some matters but are silent on other matters: if what they have agreed so far is precise enough to be a contract, the court may well find that one has come into existence, even though some implied terms are necessary or even a later contract is needed to fill in some gaps

In this case, it is necessary to be able to show that what the parties have so far agreed is enough to constitute a contract. If what has been so far agreed misses some elements necessary to make a legally binding contract, there will still not be a contract.

Example

In Bear Stearns Bank v Forum Global Equity Forum wanted to sell distressed debt loan notes to Bear Stearns. Negotiations concentrated on the price, while the parties agreed that their respective lawyers would draw up a formal agreement on standard terms: there were in fact several different sets of standard terms that could have been used. The Loan Market Association's terms were the ones exchanged by the parties' lawyers, but nothing was ever signed. Moreover, some matters were not finalised at all: there was no agreement on the legal structure of the deal, or on the settlement date, or on the representations and warranties. The court did not think that any of these matters was essential to the existence of a contract. The missing gaps were either supplied by the actual standard terms exchanged by the lawyers or the court could find implied terms where necessary.

Scenario 5 - the parties have agreed on some points, but there are some points on which they are still apart: the court is likely to say that the terms do not apply, as the parties have failed to agree on points which they regard as essential

Possibly the best example of this in the IT sector is the case of Co-op v ICL (7) although the actual decision was set aside by the Court of Appeal on the grounds that the judge had failed to appear objective. The facts are still a good illustration of a common situation. The parties already had a contract for the provision of IT services for a range of services including discounted prices. If the contract was terminated before the completion of certain services, uplifted prices would be payable by Co-op to ICL. The parties negotiated for some months over a draft contract while the project commenced, but the parties could not come to terms as ICL was unwilling to enter into a contract containing some terms including liquidated damages. The judge found that ICL's reservations about certain of the contract terms prevented a contract coming into existence: as ICL did not want such terms in its contract, then they could not be forced on ICL, and the parties could not be found to have entered into a contract without such terms.

Example

In GHSP Inc v AB Electronics Ltd (8) the purchaser (GHSP) requested a quotation from the supplier (AB Electronics) for some electronic parts to be used in cars made by Ford and attached to its request its terms and conditions. These provided for unlimited liability on the supplier's part. The supplier objected to this and other terms, but the parties never got together to talk through their differences and seek to come to a negotiated conclusion. Each party made it clear that they would not accept the other's terms and conditions. Discussions drifted on over some months but things picked up pace when the ultimate purchaser demanded tight deadlines. The supplier requisitioned materials and lined up its suppliers, and the parties entered into a month of intensive discussions to refine the specification and agree a delivery schedule. The purchaser emailed to ask if the supplier would agree to the latest specifications and delivery schedule, and the purchaser indicated its agreement. Later that day it sent an acknowledgement of order by courier, that acknowledgement of course including the supplier's own terms, which included limitations and exclusions of liability.

In fact, the parts were defective and could cause problems with engines decelerating or loss of power. Ford threatened to claim for its costs in checking and replacing the defective parts.

The judge held that neither party's terms applied, as they each objected to the other's terms and they were apart on major issues including any limitation or exclusion of liability. There was a contract - it was to be found in the supplier's final assent to the specifications and delivery schedule - but that contract was without any terms and conditions, leaving the supplier with unlimited liability.

Scenario 6 - the parties agree on some terms in some sort of letter of intent but expressly anticipate that a further agreement will be executed based on what has been agreed so far: a court might still find that the terms agreed are not binding and that the parties have not yet entered into any binding agreement

A court is not obliged to find a contract and there are some indicators in recent cases that the court will not strain to find a contract and force it on the parties. This is particularly so where the court cannot be sure what the commercial terms should be for the contract in question: if the parties were negotiating a long-term contract but only got as far as agreeing short-term prices, it is less likely that a court will impose such terms on the parties - it is up to the parties to negotiate in freedom.

Example

The recent case of Whittle Movers v Hollywood Express (9) demonstrates the complexity of the situation where work begins against a background of different documents and negotiations. Hollywood was to provide distribution services to national cinema and film rental chains and required a sub-contractor to provide certain services. It launched a competitive tender which stated that the process was subject to contract and that Hollywood was under no obligation to enter into any contract. Whittle emerged as the prospective sub-contractor.

Hollywood sent a letter of intent to Whittle, which stated explicitly that a full legal agreement was to be drawn up based on the draft terms provided during the tender but incorporating such commercial terms as had been agreed. It further stated that it was not legally binding and any work done by either party was at its own risk and cost. There was an interim agreement to cover the fact that Hollywood was losing an existing sub-contractor for some of the sites that Whittle was to service, but the parties in fact started work shortly afterwards on the whole project. Whittle performed services, invoiced Hollywood, which in turn paid Whittle, while all the time, there was no formal signed contract, despite Whittle chasing for one. The formal documents were not provided by Hollywood, whose owners had in fact decided to sell the company. They gave Whittle six months notice of termination of any contract.

The Court of Appeal agreed with the trial judge that there was certainly no long-term contract to be found from these facts. Moreover, they held that the correct answer in this case was that there was no contract at all. One point which had influenced the Court of Appeal was that Hollywood was receiving a real benefit in that it was getting the prices appropriate to a long-term contract, while it was only taking the services for a short period. The court could not impose a short-term contract on the parties where one party would be receiving such a benefit - one which the parties would not in reality have ever agreed in practice. Of course, Whittle could recover for the value of the services it had in fact provided by an action for unjust enrichment (or, as it is still called, quantum meruit), but such an action does not depend on there being a contract.

Conclusions

As can easily be seen from the above, the law does not and cannot provide a neat answer to all the various situations which can arise in commercial practice. In theory, you should not start work without a proper contract in place; if you are happy to accept the risks, and appreciate the effect it may have on your negotiating position, then a legally binding letter of intent may be the next best option.

Trying to draw the various strings together, these sorts of factors incline a court to find that there is no contract:

• The parties have just agreed to agree and not really come to any sort of actual agreement at all
• At least one of the parties has made it clear in its communications that it does not intend to enter into contractual relations with the other
• The parties have failed to reach agreement on some terms and have shown that they do not intend to contract unless agreement is reached on those terms
• The more complex the commercial arrangements envisaged, the less likely it is that the court will find that there is a contract without a proper signed document

On the other hand, these sorts of factors incline a court to find that the parties have in fact entered into a contract:

• The more the parties have appeared to be acting in accordance with some sort of contract, the more likely a court is to find that they indeed entered into a contract - so the longer a project has gone on, the fact that the parties apparently complied with payment provisions in the draft document or that they executed variations of the draft - these things make it more likely that there was a contract
• The parties may have expressly agreed to enter into some sort of "temporary" contract, or letter of intent, or heads of terms and expressly or impliedly envisage that they will keep negotiating to reach further terms
• Without expressly saying so, the parties may be taken to have waived any "subject to contract" reservations and in fact have entered into a contract

The short advice would have to have to be: do not allow the situation to develop where you are working on a project without some form of express contract providing the necessary protection for your business. Failing to do so could mean a trip to the Supreme Court via the High Court and the Court of Appeal to find out what the reality of the situation is.

Notes

(1) Copyright Richard Stephens 2010. The law is stated as at 17 August 2010.

This note is intended to provide general information about legal developments in England & Wales and you should not apply any of the advice or information contained in it to specific situations without seeking professional advice first.

(2) [2008] EWHC 1087 (TCC); [2009] EWCA Civ 26; [2010] UKSC 14

(3) [1992] 2 AC 128 (HL)

(4) 28 March 2000, High Court

(5) [2002] EWHC 2084 (Com)

(6) [2007] EWHC 1576 (Comm)

(7) [2003] EWHC 1 (TCC)

(8) [2010] EWHC 1828 (Comm)

(9) [2009] EWCA Civ 1189