The Dangers of Starting to Perform without a Contract in Place under UK Law

The purpose of commercial contracts is to define the elements of the deal, and to set out the rights, obligations and remedies available to the parties in case something goes wrong. However, it can be tempting for commercial organizations to get started on a new business relationship before the lawyers complete the paperwork.  In some cases, where time may be of the essence, commercial reality may well demand it.

Subject to Contract

In such circumstances, parties may use a temporary measure, such as a term sheet, Letter of Intent or Memorandum of Understanding which sets out the basics of a deal, leaving the finer detail of the agreement to be completed at a later date. These documents are usually expressed to be “subject to contract”, and may specifically state that the terms do not become legally binding until the full contract is agreed and signed.

The recent Supreme Court judgment in the RTS v. Muller has thrown significant doubt on the effectiveness of this approach. RTS was asked to supply Muller (a well known European yoghurt producer) with an automated packaging system for its products, and the parties agreed they would start work under a Letter of Intent (“LOI”). The LOI was only valid for four weeks, and expired before a full contract was put in place. Despite the lack of contractual cover, RTS carried on with the work and Muller continued to pay for it. A dispute subsequently arose over RTS’ performance.

The parties had a “subject to contract” clause (as described above) written in to the LOI. The Court of Appeal decided that the clause prevented a contract from being formed, but the Supreme Court disagreed with this decision, and held that the conduct of the parties, rather than the words in the LOI, was the deciding factor. By continuing to perform after the LOI had expired, RTS had waived its right to rely on the “subject to contract” clause to excuse its obligations to Muller.

Each case is decided on its own merits, but the RTS case is instructive, because it confirms that actual conduct, not words, will prevail if the parties end up in a dispute with no formal contract in place. In his judgment, Lord Clarke of the Supreme Court put it best: “The moral of the story is to agree first and stat work later”.

The Court also set out two principles to help parties decide whether a binding contact was in place: (a) would an “honest, sensible businessman”, acting objectively, reasonably conclude that the parties intended to create a binding contract; and (b) are enough of the essential terms agreed (i.e. goods and services, pricing, title and risk, governing law etc. clearly identified) to form a workable contract.

Agreement to Agree

In some cases, the parties may actually agree and sign a binding contract, but leave some of the finer detail to be completed at a later date. This is usually referred to as an “agreement to agree”. There are two dangers in taking this approach: (a) there is a risk that the detail is never filled in; and/or (b) the detail is agreed but not conclusively and clearly documented, leading to problems further down the line (as occurred in the Crest Nicholson v Akaria case in 2010).

The best way to deal with such issues is to agree the time period and the steps the parties need to take to fill in the blanks, ensure that there is a dispute resolution mechanism in the contract to deal with any disagreements, and document what is agreed as a formally signed and executed amendment or variation to the contract, which leaves no ambiguity as to what the parties have agreed.