Understanding Commercial Contracts from formation to execution
WHAT IS A CONTRACT?
A contract comprises a “legally enforceable agreement containing terms and conditions, defining the rights, duties and obligations of the parties”.
HOW IS A CONTRACT CREATED?
For a contract to exist the following four basic elements must be satisfied:
1. An offer.
An offer is defined as a promise by one party to enter into a contract with another party on certain terms. The offer must be complete, specific, capable of being accepted and made with the intention of being bound by acceptance.
2. There must be an acceptance.
An acceptance is a final and unqualified assent to an offer.
The acceptance must be made in response to the offer, must correspond with the terms of the offer and must be communicated to the person making the offer.
3. There must be consideration.
Consideration means some right, interest, profit or benefit accruing to the one party or some forbearance, detriment, loss or responsibility given, suffered or undertaken by the other at his request.
In simple terms it means the price that one party is paying the other.
As a general rule a court will not concern itself with the adequacy of the consideration. That is, a court will make no attempt to audit the bargain made by the parties to see if it is a fair one.
4. Intention to create legal relations.
An “agreement” will not be enforceable unless there is an intention to create legal relations.
In most cases involving commercial parties it will be clear that there is an intention to create legal relations.
Notwithstanding these apparent complicated rules, it is very easy to satisfy the requirements of offer, acceptance, consideration and intention to create legal relations. Note therefore that:
- contracts do not have to be in writing;
- contracts can be created by email;
- contracts can be created by correspondence;
- contracts can be created by issue of an purchase order which a supplier accepts in writing or by conduct, ie performance of order.
- contracts can be created over the telephone; and
- contracts can be created by face-to-face meetings.
There are some exceptions to this. For example, the following have to be in writing:
- contracts for the sale of real property/land.
- A transfer of copyright.
- guarantees, that is a promise by a third party who is not a party to a particular contract, guaranteeing the liability of a party to that contract.
Sale of Goods Act 1979
In contracts for the sale of goods, where the seller sells the goods in the course of business, the Sale of Goods Act 1979 implies a number of terms relating to the goods:
Section 8- where price is not agreed, a buyer of goods must pay a reasonable price for them.
Section 12 – A condition that the seller has the right to sell the goods and warranties that:
- no third party has any rights over the goods which the seller has not disclosed to the buyer; and
- the buyer will have quiet possession of the goods.
Section 13 – A condition that the goods conform to their description.
Section 14(2)(A) – A condition that the goods are of satisfactory quality. This means that the goods must meet the standard that a reasonable person would regard as satisfactory taking into account description, price, appearance, finish, freedom from minor defects, safety, durability and fitness for all normal purposes.
Section 14(3) – A condition that the goods will be reasonably fit for any purpose expressly or impliedly made known to the seller.
Section 28 – If no time for payment is stated, it is implied that the buyer must pay cash on delivery.
Section 29 – If no place for delivery is agreed, it takes place at the seller’s place of business.
NB – Sale of Goods Act is favourable to Buyers/Customers.
Supply of Goods and Services Act 1983
The Supply of Goods and Services Act 1983 applies to contracts for works and materials. With regard to the work element, section 13 provides that the services will be carried out with reasonable care and skill.
OTHER USUAL TERMS
The terms implied by sections 13 and 14 of the Sale of Goods Act 1979 and by section 13 of the Supply of Goods and Services Act 1983 can be a little imprecise and uncertain. It is therefore common to include a more precise definition of the quality of goods that the buyer can expect from a seller. For example a seller may warrant that the goods will be without defect for a period of sale 12 months from the date of delivery.
Unless there is agreement to the contrary, it will be implied that goods will be paid for on delivery.
Consideration should be given in the case of a seller to payment in advance or a deposit or for interest in the event of late payment. Under the Late Payment of Commercial Debts (Interest) Act 1998 unpaid creditors are entitled to claim interest at 8% above the Bank of England base rate. This rate applies if the contract does not specify a rate which parties agree should apply instead.
Consideration should be given to as to which party is responsible for delivery and what happens if goods are damaged in transit.
Limitation of liability
It is usual for a seller to seek to exclude or limit its liability for breach of contract. For example, in the case of a sale of goods, typically a seller will normally seek to limit its liability to an obligation to replace defective goods. Provided that it replaces those defective goods it would wish to ensure it had no further liability. If the contract is silent the seller will have unlimited liability.
Retention of Title
Typically a seller will seek to retain ownership of goods until it has been paid. A customer will want ownership to transfer as early as possible so it can resell the goods it has purchased in the ordinary course of business.
USUAL TERMS IN A LONG-TERM GOODS OR SERVICES SUPPLY AGREEMENT
Length of contract
The main distinction between a one-off supply or order by order basis from a long-term supply agreement is the duration and therefore this should be clearly stated. Typically, a customer will want the duration to be subject to a three or six month without cause right of exit so any contract be ended easily and supply sourced elsewhere if need be.
Minimum purchase requirements
A seller will normally push for some additional commitment from the buyer to make the long-term contract worthwhile.
This long-term commitment can either be achieved by way of minimum purchase requirements or exclusivity (see below).
A customer will seek to resist such commitments.
Alongside the minimum purchase requirement a seller may push to require a buyer under a long-term purchase agreement to purchase exclusively from the seller. A customer will usually require all contracts to be non-exclusive. If there is a better opportunity or a better price elsewhere, or the customer is not satisfied with supply, it will want to go elsewhere, which the customer cannot do if it has agreed to an exclusive purchase obligation.
Under a long-term supply agreement a seller may want the right to vary the prices during the term of the agreement but a customer will want pricing fixed for as long as possible. Price rise mechanisms should be agreed with caution and ideally be non-binding. These could be inflationary rises although careful consideration should be given to which index to use, eg. RPI/RPIX. Alternatively, a more complicated price review could be based upon changes in the cost to the seller, eg open book.
Termination and its consequences
Consideration should be given to what events should trigger termination and which party buyer/seller both has termination rights. Typical events of termination will include a serious breach of contract, and insolvency.
The Transfer of Undertakings (Protection of Employment) Regulations 2006 (“TUPE”).
This is a very complicated topic. Alarm bells should be ringing where services are outsourced or there is a long-term supply of services agreement.
Essentially under TUPE where the services of a company are outsourced, those employees of the outsourcing company who are dedicated to the function being outsourced will transfer to the new service provider under their existing terms and conditions of employment.
Where a supplier of services has a dedicated workforce (which may be one employee) who provides services wholly or mainly for a particular customer, on termination of that contract, that employee will transfer either to that customer (if that customer brings those services in-house) or to a new service provider.
BATTLE OF THE FORMS
Where both the seller and the buyer purport to impose their own standard terms into a contract, difficulties can arise in determining which terms prevail. This is known as the ‘battle of the forms’.
Where the seller offers to contract on its own terms and the buyer purports to accept these but at the same time seeks to impose the buyer’s own terms, there is no acceptance at all. Instead this is a counter offer which is open to acceptance by the seller either expressly or by performance.
In practical terms, this means that the last set of terms despatched prior to acceptance or performance (ie the last shot fired in the battle of the forms) will prevail.
In the face of a battle of the forms, the other party can decide to deal with the conflict of terms directly by discussing and agreeing terms with the other side. This of course involves negotiation and consequently incurs time and expense which the use of standard terms is designed to avoid.
However, in high value or risk contracts or where there is the possibility of significant repeat business, the time and effort involved may be justified.
The alternative solution is to try to include your own standard terms in as many pre-contractual documents as possible in the hope that you will fire the last shot. This is always a risky strategy in that the other party may succeed in firing the last shot.
1. Incorporation of terms and conditions
Standard terms and conditions will only take effect if they have been incorporated into the agreement between the buyer and the seller. Standard terms and conditions must therefore form part of the offer. Sellers must ensure that their terms and conditions of sale are brought to the attention of the customers at the earliest possible opportunity and certainly before the contract is made.
This means that terms should be set out:
- on websites;
- in brochures;
- on quotation forms;
- on acknowledgement of confirmation of order of seller;
- on invoices.
Invoices are post contractual documents so that it would not normally be brought to the attention of a buyer before the contract is made. However, if the terms and conditions regularly appear on the back of invoices, it is possible to imply prior knowledge by way of a course of dealings.
Care should be taken that where terms appear on the reverse of a document, that reverse is drawn to the buyer’s attention.
Misrepresentation is an untrue statement of fact or law made by Party A (or his agent for the purposes of passing on the representation acting within the scope of his authority) to Party B which induces Party B to enter the contract thereby causing Party B loss.
It is usual to try to exclude liability for misrepresentation under an exclusion or limitation clause.
There are three types of misrepresentation:
- fraudulent misrepresentation;
- negligent misrepresentation; and
- innocent misrepresentation.
The remedies for each are different.
Whether misrepresentation is fraudulent or negligent, the claimant can rescind the agreement and claim damages. However where the misrepresentation is innocent the court can order damages in lieu of rescission or just rescind the contract. The court cannot award both damages and rescission in the case of innocent misrepresentation.
Rescission means that the contract is set aside and the parties are put back in the position they would have been in before the contract was made.
Therefore if a buyer is buying goods, the seller will get the goods back and the buyer will get the buyer’s money back. Rescission is not available where it is no longer possible for the parties to be restored to their original position.
Also the right to rescind is lost if the contract is affirmed. This means that once a buyer becomes aware of the misrepresentation but does an act implying that he continues to be bound by the contract, the right to rescind is lost. An act of affirmation will include payment of any monies after becoming aware of the misrepresentation.
3. Limitation and exclusion clauses.
Most sellers or providers of services will wish to exclude or limit.
Under the Unfair Contract Terms Act 1977 (“UCTA”) a business cannot exclude or restrict liability for death or personal injury caused by its negligence. Also it cannot exclude liability for breach of the condition in section 12 of the Sale of Goods Act 1979 that a seller has good title to the goods.
Other exclusions of liability are possible. However, where parties are dealing on standard written terms, exclusion of liability for negligence (other than the way death or personal injury is caused), breach of any of the statutory implied terms such as satisfactory quality or fit for purpose, breach of contract or misrepresentation is subject to a reasonableness test under UCTA.
Where dealing with consumers, it is very difficult to exclude any liability.
When considering the reasonableness test, a court will pay attention to the resources available to the supplier and in particular the insurance cover that is available.
Trading on the internet can bring about its own special problems, for example pricing errors for goods sold online.
The problem can be overcome by having appropriately worded terms and conditions of sale which means that the acknowledgement is not actually an acceptance of the customer’s offer to buy and a contract is only formed after payment for and dispatch of goods.
There are special rules applicable to online selling to consumers which online traders have to comply with and are enforced by trading standards.
5. Overseas contracts
When contracting overseas a number of additional considerations need to be considered. For example:
- which law applies to the contract? Do not leave it to chance but agree the governing law;
- agree which courts have a jurisdiction to hear any disputes;
- seek local law advice where possible. For example, will a retention of title clause be enforceable in the jurisdiction?
- are there any special rules applicable in that jurisdiction? For example, in certain European jurisdictions on termination of distribution agreements, the distributor is entitled to compensation;
- do not assume that English law principles will apply. For example, many European jurisdictions have a civil code which will overwrite anything agreed under the contract.
- Execution – under English law contracts have to be executed by overseas companies in accordance with the laws in which they are incorporated/their constitutions
6. Competition law issues
As a starting point, businesses should be wary of any agreement between undertakings that may affect trade in the UK or between member states of the European Union and which have the object or effect of restricting competition within the UK, part of the UK or the European Union.
Breach of these provisions means that an agreement is void and the parties may be liable to substantial fines. In addition, third parties harmed by such agreements have a claim to damages.
Common restrictions which are anti-competitive and therefore unenforceable include:
- any restriction on the buyer’s ability to determine its sale price. It is possible to impose a maximum re-sale price (over which the buyer cannot sell the goods) or set recommended resale price but a seller cannot impose a minimum resale price;
- a seller cannot restrict the territories into which or customers to whom its buyer may sell goods. However, a seller can restrict active sales into the exclusive territory or to an exclusive customer group reserved to the supplier or allocated by the supplier to another buyer. It is not permitted to restrict passive sales. An active sale means actually approaching individual customers inside another distributor’s exclusive territory or exclusive customer group. Passive sales are sales made to unsolicited requests from customers.
If you submit a tender then that tender is likely to be an offer which the customer can accept thereby creating binding contract without the need for any further documentation to be signed. The difficulty for bidders/tenderers is that the rules of the tender normally prevent the giving of conditional tenders. By including any provisions to the effect that the tender is not an unconditional offer, the tenderer may be excluded from the tender process.
8. The small print
Whilst there are numerous items of small print that parties should be aware of, here are two common issues:
8.1 A contract may be expressed to be, say, a three or five year term. The seller believes that the buyer is entering into a long term commitment with the seller because the buyer has agreed to such a three or five year contract. However in the “small print” it is often the case that the buyer has the right to terminate on, say, three months’ notice. Therefore the agreement is really no more than a three month agreement except that the seller is committed to supply for the full term of the agreement, ie three or five years. The buyer however has a get-out by giving three months’ notice.
8.2 Reasonable endeavours. Sometimes obligations are not obligations at all. For example, in many maintenance contracts the maintainer does not guarantee to fix a problem but merely agrees to use reasonable endeavours to fix that problem. Accordingly the maintainer’s obligation is to try to fix the problem. Accordingly if the problem is not resolved, the customer has no comeback against the maintainer if the maintainer has used reasonable endeavours to try to fix that problem.
9. Other statutory rules
The basic position under English law is that parties are free to agree whatever terms they like and that a court will not normally interfere with that bargain. However, there are exceptions. See Unfair Contract Terms Act 1977 above. Other common exceptions include:
9.1 Consumer protection rules for contract terms used to trade with consumers- for example the Consumer Rights Act 2015.
9.2 Consumer credit and consumer hire agreements. There are strict formalities for entering into consumer credit and consumer hire agreements which, if they are not followed, can result in the whole agreement being unenforceable.
9.3 Intellectual Property agreements. There are some special rules that apply to transfers or licensing of intellectual property.
9.4 GDPR clauses – GDPR may require certain clauses to be included such as data processing clauses or model data transfer clauses.
9.5 The Commercial Agents (Council Directive) Regulations 1993. These apply where a principal appoints a self-employed intermediary who has continuing authority to negotiate the sale or purchase of goods on behalf of that principal or can negotiate including the sale or purchase of goods on behalf of or in the name of that principal. There are various provisions of the Commercial Agents Regulations which cannot be contracted out of. By way of example, the Regulations:
- set out minimum notice periods in respect of termination of the agency agreement; and
- provide for the payment of a lump sum on termination of the agency agreement.
The only circumstances in which a lump sum is not payable is where the principal terminates because of a breach by the agent which would justify summary termination.
Disclaimer: This article is for general information only and is not intended to be a substitute for specific legal advice. You should obtain specific legal advice before taking or refraining from any action. Nothing in this article constitutes legal advice
©Mark Cowling 200920 All rights reserved.