Commercial Contracts: Drafting Techniques and Precedents (Thorogood Reports)

THOROGOOD PROFESSIONAL INSIGHTS A SPECIALLY COMMISSIONED REPORT COMMERCIAL CONTRACTS DRAFTING TECHNIQUES AND PRECEDENT...

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THOROGOOD PROFESSIONAL INSIGHTS

A SPECIALLY COMMISSIONED REPORT

COMMERCIAL CONTRACTS DRAFTING TECHNIQUES AND PRECEDENTS

Robert Ribeiro PH.D BARRISTER

IFC


A SPECIALLY COMMISSIONED REPORT

COMMERCIAL CONTRACTS DRAFTING TECHNIQUES AND PRECEDENTS

Robert Ribeiro PH.D BARRISTER

Published in 2003, updated 2005

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The author Dr Robert Ribeiro, Barrister, has been an independent lawyer, public speaker and business consultant since 1989. His work includes the drafting and negotiation of commercial contracts and advising upon legal problems arising in commercial dealings. Robert’s work also includes the provision of public seminars and in-house training for commercial clients. He is author of the book ‘Engineering Contracts – A Management Guide’.


iii

Contents Introduction....................................................................................................1

1

THE COMMERCIAL AND LEGAL OBJECTIVES

3

Getting started: preliminary considerations.............................................4 Drafting precedents.....................................................................................4 The wishes and needs of the client ...........................................................4 Four philosophies of drafting.....................................................................6 Case study: the need to draft terms that create mutual understanding and expectations...................................................8 Rectification ...............................................................................................10 Mutual understanding: plain intelligible language ................................11 Obscure words ..........................................................................................12 The uses of formulae to clarify commercial objectives .........................15

2

STRATEGIC ENDS: SOME IMPORTANT DECISIONS TO BE MADE ABOUT THE TERMS OF THE CONTRACT

17

Time: is it to be or not to be of the essence?...........................................18 Positive obligations: firm undertakings or endeavours? ......................20 What is the distinction between ‘best endeavours’ and ‘reasonable endeavours’? ..................................................................20 Other cases distinguishing between reasonable endeavours and best endeavours ............................................................21 Are there any problems in enforcing endeavours clauses?..................22 Third party rights: should these be permitted, restricted or excluded?..............................................................................23 Controlling assignment.............................................................................23 The creation of a trust of the benefits arising from a contract.............25 The Contracts (Rights of Third Parties) Act 1999...................................27


iv

CONTENTS

Termination provisions: the choices to be made....................................30 Clauses providing for termination for breach of contract: the attitude of the courts ..........................................................31 Material breach; substantial breach; repudiation ..................................33 The nature of the breach...........................................................................33 Material breach ..........................................................................................35 Termination in relation to other remedies ..............................................36

3

STRUCTURING THE CONTRACT

37

The title and the description of the parties .............................................38 The recitals .................................................................................................39 Recitals and the matrix theory .................................................................40 The terms of the contract..........................................................................41 The signature: simple contract or execution as a deed? .......................41 Pre-contractual arrangements .................................................................42 Post-contractual arrangements................................................................44 What is the effect of an ‘entire agreement’ clause? ...............................45 The Court of Appeal cases........................................................................49 What is a framework agreement? ...........................................................51

4

HOW TO MANAGE THE RISKS

52

Risks ............................................................................................................53 Insurance ....................................................................................................54 Indemnities .................................................................................................55 Boilerplate clauses ....................................................................................57 Exclusions and limits of liability...............................................................63


v

CONTENTS

5

HOW THE COURTS WILL INTERPRET WHAT IS WRITTEN

64

Ambiguities, absurdities and technicalities ............................................65 The contra proferentem rule ....................................................................66 The interpretation of indemnities ............................................................68 ‘Consequential’ loss or damage ...............................................................69 The knock-on effect of amendments .......................................................72

6

CONTROL BY THE COURTS: VALID AND INVALID TERMS

74

The rule against penalties .........................................................................75 Unfair terms: some common law principles...........................................78 Unfair terms: the scope of the Unfair Contract Terms Act 1977 ..........80 Unfair terms: some cases on the test of reasonableness.......................83 Unfair terms in consumer contracts........................................................86 Other tests of validity under statute ........................................................87 The Human Rights Act 1998 .....................................................................88

APPENDICES

90

Appendix 1 List of cases cited .......................................................................................91 Appendix 2 List of statutes and other enactments mentioned in the text................95


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Introduction The ideas for this Report have been developing during the past decade and represent aspects of current drafting practice, as well as new legislation and case law. Among statutory developments, the one that immediately springs to mind is the Contracts (Rights of Third Parties) Act 1999, which will affect contract planning and risk management, not least because of its potential to catch people unaware of its full implications. Cases about this Act are already beginning to come on stream, and an important example is included in this Report. Among major areas of case law, we may single out judgments clarifying the law on agreements to agree and other related agreements, such as lock-out agreements; we would also count the steps taken by the courts towards the clarification of the law relating to indemnities as welcome additions to the vast body of contract law. Whereas, in the first edition of this Report, the law of misrepresentation was singled out as an area of potential difficulty, we can now say with some confidence that it is on the way to being clarified, and that certain simple steps can be taken to avoid unnecessary liability in this respect. Our understanding of clauses making time of the essence, and of their consequences, has become enhanced during the last few years, as has our appreciation of the fine distinction between exclusions of liability and limits of liability, and its consequences for the construction of terms. We have also become increasingly aware of the perils of using terms of art that are undefined, or expressions that are too uncertain in meaning to be valid. Other areas of law that are of increasing interest to those who draft contracts are the laws of restraint of trade, the Human Rights Act 1998, the Rome Convention 1980 and the Brussels Convention 1968, dealing with choice of law and jurisdiction, respectively. However, this Report was never intended to be another book on case law and statute. It is above all a work about how one sets about drafting a commercial contract, whether it is of an everyday type, such as a sale of a business or a purchase of goods, or whether it is a more unusual venture. Questions will always arise, such as what should one include; what should one be wary of; why should one form of words be better or worse than another; why does yet another form of words have (for those who are not familiar with the precedents) an entirely


1

INTRODUCTION

unexpected effect; what value is there in structuring contracts in certain ways, or in features such as recitals or entire agreement clauses, or in the many different kinds of ‘boilerplate’ clauses that exist? More than any other question, perhaps, the one that recurs is, ‘How do I begin to draft a commercial contract? Where do I start?’ That is where this Report begins.


2


Chapter 1 The commercial and legal objectives Getting started: preliminary considerations ......................................4 Drafting precedents...............................................................................4 The wishes and needs of the client .....................................................4 Four philosophies of drafting ..............................................................6 Case study: the need to draft terms that create mutual understanding and expectations.............................................8 Rectification .........................................................................................10 Mutual understanding: plain intelligible language..........................11 Obscure words ....................................................................................12 The uses of formulae to clarify commercial objectives ...................15

Chapter 1 The commercial and legal objectives

Getting started: preliminary considerations The simplest way to make a commercial contract might be to take out a precedent of the type of contract required and to complete a few details, and then to send it out for signature by each of the parties. But this is imperfect and not always desirable for a number of reasons: it may not accurately reflect the special nature of the particular venture; it may not meet the wishes and needs of the particular client; it may not necessarily pay heed to changes that have taken place in the law and could therefore place the client in a vulnerable position; and most important of all, it will be based upon the style and approach of the person who created it, which may not necessarily be what is required for the occasion.

Drafting precedents Drafting precedents are a useful sounding board for ideas, and for reminding us of things that may be included in contracts and of ways in which they may be written; but they should not be used as the first stage of drafting a commercial contract. It is at a later stage, after we have sketched out a preliminary draft or list of ideas, that precedents may be of value.

The wishes and needs of the client These should be a major consideration when one begins to create a commercial contract, and can be summarized by four headings, each of which will be a philosophical thread running the entire way through the contract. 1.

Planning

2.

Financial control


4

1 THE COMMERCIAL AND LEGAL OBJECTIVES

3.

Risk management

4.

Mutual understanding and expectations

The following are some notable cases in which the wishes and needs of the client became important issues.

Total Transport Corporation v Arcadia Petroleum Ltd (1998) CLC In this case a clause in a contract stated: ‘Owners shall be responsible for any time, costs, delays or loss suffered by charterers due to failure to comply fully with charterers’ voyage instructions...’ What the charterers needed was to be able to make the owners liable in damages for failure to comply with their instructions, whether or not the consequences of such failure had been in the contemplation of the owners at the time of the contract. But the clause did not contain precise words to this effect and a claim for a loss of a discount on the cost of petroleum, due to a loading of the cargo at the wrong time, failed because the owners of the ship had been unaware of the consequences.

Trafalgar House Construction (Regions) Ltd v General Surety and Guarantee Co Ltd (1995) 3 W.L.R. 204 What a contracting company needed in this case was a form of bond, from an insurance company in respect of work to be done by a sub-contractor, under which money was payable ‘on demand’. A bond of this kind has the characteristics of a promissory note, and as the sums are debts directly owed by the insurer to the holder of the bond, these sums are payable free from any set-off or counterclaim by the sub-contractor. But the precedent used for this occasion contained particularly obscure wording and did not make clear the terms on which the money was payable. It was held by the House of Lords that this was not an on-demand bond at all but only a conditional guarantee which, being dependent upon the precise state of accounts between the contractor and the sub-contractor, was subject to set-off and counterclaim.

Jervis v Harris (1996) Ch. 195 This case is an example of successful planning of contract terms. A landlord needed to be able to get reimbursement of money spent by him in carrying out repairs which a tenant should have carried out and failed, after notice, to carry


5


out. Such sums can be claimed as damages, but damages are subject to defences such as remoteness, failure to mitigate loss, the rule against penalties, and certain forms of statutory protection in favour of the tenant. Properly framed, however, the duty to reimburse will constitute a debt, not damages, and this will make the defences mentioned above inapplicable. In this case the landlord’s claim in debt was successful.

Four philosophies of drafting Planning The first of these ideas can be implemented at the beginning of, and throughout the drafting of a commercial contract. We might begin by asking ‘What are we trying to achieve?’ – in respect of the contract as a whole and also clause by clause. We will also be relating the contract, as written, to the commercial venture as planned, and will be trying to ensure that the contract mirrors the programme or sequence of events required, as well as the correct allocation of obligations and risks. At this stage the obligations of each party, programme and risks of each party, can be set out.

Financial control This is partly an extension of the obligations clauses, since the duties of each party in respect of payments to be made will be set out here. But it is more than simply a matter of price, consideration or payment. It will also involve the question of whether or not any security is required from either party, such as a bond or guarantee, or a deposit. It will also involve the question of when any refund or repayment may become due. It will also involve the question of whether or not deductions from monies owing (whether by way of set-off or counterclaim) are permitted. Another aspect of financial planning, which involves fine legal distinctions, has already been seen in the distinctions between a financial liability in damages and an obligation to pay a debt, or to reimburse a sum of money (which is a form of debt); this distinction is related to the distinctions between a warranty, an indemnity and a promise (or covenant) to pay an identified sum of money.


6


Risk management In many, but not all, contracts, this may account for a high percentage of the text of the document. Virtually all ‘boilerplate clauses’ (i.e. those clauses that are routinely used and not normally negotiated or customized for the particular contract) are put into a contract for purposes of risk management. The same is true of limits of liability. In Chapter four there will be details of boilerplate clauses dealing with matters such as force majeure, the right to assign or to sub-contract or sub-let, waiver, invalidity and severance, notices, choice of law and jurisdiction, and so on. One aspect of risk management which is likely to require negotiation, or clauses that are not merely routine, is that of insurance and indemnities which are related to the assumption of a risk. This topic is too great in scope to discuss in detail in these early paragraphs, but will be looked at in some depth in Chapters four and five.

Mutual understanding and expectations A moment’s thought will make one realize how many features of contracts are directed towards this end: the description given to the contract; the recitals; the definitions; schedules or appendices providing details which are not in the main body of the terms; as well as clarifications of meaning which are often put into individual terms of contracts for the avoidance of any doubt. The philosophy that a contract, or any term of it, should create a meeting of minds and not give rise to mis-understanding, should permeate every aspect of the drafting of commercial contracts. Those involved in drafting should remember that if misunderstandings or ambiguities arise, equitable remedies such as rectification or specific performance or the avoidance of forfeiture, are not easy to come by.


7


Case study: the need to draft terms that create mutual understanding and expectations Alghussein Establishment v Eton College (1991) 1 All.E.R. 267 This case involved a relatively simple contract for the development of a property near Primrose Hill, in London NW. However, many years after the contract was drawn up the case ended in the House of Lords on an appeal relating to two points of drafting. One of these involved a failure of those drafting the contract to clarify an open-ended time provision which contained the words ‘as soon as reasonably practicable’. The other involved specific obligations of the parties, but contained a proviso with a meaning that was far from clear, but which had a major bearing upon whether a project which had been delayed should be continued or discontinued. The clauses of the contract provided, as far as is material: ‘3a The tenant shall use its best endeavours to obtain all necessary licences, permissions, approvals and consents in respect of the development.’ ‘3b The tenant undertakes... as soon as is reasonably practicable following all necessary licences permissions consents and approvals having been obtained as aforesaid to use its best endeavours to commence and proceed diligently with the development in accordance with such licences permissions consents and approvals and complete the development to the reasonable satisfaction of the surveyors...’ ‘4

Upon the proper issue of the certificate of practical completion......the Landlords will forthwith grant and the Tenant shall forthwith accept and execute a counterpart of the Lease PROVIDED THAT if for any reason due to the willful default of the Tenant the development shall remain uncompleted on the 29th day of September 1983 the Lease shall forthwith be granted and completed as aforesaid but without prejudice to the provisions of Clause 3 hereof.’

(Italics have been added to the above text) The agreement was made in 1978, but by 1984 work had not started, and the respondents, the owners of the site, (referred to as the ‘Landlords’ in the agreement), claimed that the agreement was terminated by repudiation by the appellants (referred to as the ‘Tenant’). The appellants began the action,


8


arguing firstly that the expression ‘as soon as reasonably practicable’ allowed them to take into account economic factors (for example interest rates), so they were not in willful default. This part of the argument shows the importance of clarifying all matters relating to time obligations, even if, or especially if, they are in apparently plain language. The problem with time provisions is that words alone do not necessarily make plain their intended meaning. Or the parties may each read the words and intend to give them an entirely different meaning. The alternative argument put by the appellants was that even if they were in willful default, the terms of Clause 4 of the contract did not allow for termination, but provided just the opposite (see the italicized words). The problem for the courts was in trying to decide whether the contract had a word missing, or whether the parties intended it to be as drafted; and if they did, what they intended it to mean. The clause might have been intended as a default clause; but if so it was badly drafted. Or it might have been intended as a continuation of a programme, so that in any event, including willful default of the Tenant, the intended lease of the property intended for development would go ahead. This is a perfectly plausible explanation of Clause 4, but for the inelegant and ambiguous wording. It is always necessary to appreciate that if an important term of a contract is unclear in its meaning, litigation may result; and in the event of such litigation the courts may have to apply rules of construction to decide the outcome. There is indeed such a rule of construction, which can broadly be expressed as the principle that a contracting party will not normally be entitled to take advantage of his own breach as against the other party. Clear words in a contract are needed to give a contrary result, and the words of Clause 4 were not sufficient to displace the presumption to which the principle gave rise. We may draw two conclusions for drafting from this case. One is that time provisions need to be clearly defined, in this case either by putting an end date after the words ‘as soon as reasonably practicable’, or by defining the matters to be taken into account in deciding what is ‘reasonably practicable’. The other is that terms should not contain ambiguities or consequences that seem somewhat improbable or contrary to normal principles. If for some commercial reason terms do have to be drafted on an abnormal basis, then this should be clarified for the avoidance of any doubt. Above all, the parties to the contract need to know what has been stated and how it will work.


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Rectification This remedy should be understood by those who have to draft and negotiate contracts since it arises under the rules of equity and is subject to certain qualifications. It is not an all-purpose cure for incorrect drafting or poor proof-reading. In our case history above, the remedy of rectification was, perhaps surprisingly, not asked for when the case first appeared in the Chancery Division. The reason was probably that one party was in breach of the agreement, and equity will not usually assist a party in breach. The other reason is that the parties almost certainly did not know what the correct version of Clause 4 of the agreement was meant to be, and that, as we shall see, is an important requirement to obtain rectification. So the case had to be argued on other grounds. If rectification can be obtained, then it may in some circumstances be a quick and effective means of getting a contract to work in the manner intended. If, in the case history immediately above, the respondent could have produced a version of the contract showing that a word such as ‘not’ had been accidentally omitted, and showing where it had been intended to go, then the matter could have been put right at first instance instead of proceeding to the Court of Appeal and the House of Lords. But to obtain rectification one cannot merely assert that the wording appears to contain an error. One must know what the correct version was meant to be.

Grand Metropolitan plc v William Hill Group (1997) 1 B.C.L.C. 390 In this case rectification was granted in the following circumstances. The parties to a contract for the sale and purchase of companies had, at meetings and in correspondence, expressed an intention to proceed in accordance with certain accounting principles, but the contract as written and signed failed to reflect this intention. By the agreement two companies were purchased, and the agreement provided for a price reduction by reference to profits shown in the 1989 accounts of the two companies. Two methods of drawing up the accounts were possible, and advice of leading counsel was that the contract as actually written provided that the accounts of the two companies merely had to be aggregated without adjustment. But one of the parties argued that the parties had really intended that the accounts should be drawn up by a different method, in accordance with the principles of acquisition accounting, complying with GAAP. So the party taking this view sought rectification, which was granted by Arden J., since on the facts it was clear that the parties had intended that the 1989 accounts would be prepared on a consolidated basis.


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In granting rectification, Arden J. reiterated three requirements for rectification. These are: 1.

Proof that both parties had intended to include in the contract something which was not in fact reflected in the written agreement.

2.

Proof that the parties had a common intention which persisted throughout the negotiations.

3.

The party seeking rectification must show that the proposed rectification does not conflict with any of the other agreed terms of the contract.

Mutual understanding: plain intelligible language All commercial contracts should be intelligible. Language should be as plain as is compatible with accuracy of meaning. The question is how to achieve this. ‘Plain, intelligible language’ is compulsory in those contracts that fall within the ambit of the EC Directive on Unfair Terms in Consumer Contracts, 1993, and the UK Regulations, 1999, which give it effect. Under these rules, the Office of Fair Trading can require that terms be put into plain language and can enforce this, if necessary, by application for an injunction. In any case before the courts, if there is any doubt about the meaning of a term in a consumer contract falling within these rules, the interpretation most favourable to the consumer will prevail. In commercial contracts there is as yet no equivalent requirement, although the Unfair Contract Terms Act 1977 applies to many commercial contracts, and the knowledge of the customer of the extent of a term may in some cases be a relevant factor in deciding whether the term is reasonable or not.

How to make a term clearer 1.

Clear headings.

2.

Clear paragraphing to break up large blocks of text.

3.

Short sentences.

4.

Making it clear which party is to do what: if necessary by repeating a name instead of using a pronoun.

5.

Avoidance of obscure words (see below for some examples).


11


6.

Avoiding the passive tense: say, for example, ‘The Seller will deliver the Goods on or before the following date...’, rather than ‘The Goods will be delivered by the Seller on or before the following date...’

7.

Avoid unnecessary provisos (layers of provisos).

8.

Number and indent provisos or qualifications.

9.

Use good, well-chosen definitions.

10. Use recitals where appropriate to clarify the background to the contract. 11. Use schedules, appendices or annexes to set out details and to separate them from the main body of the contract 12

Use formulae where necessary, but check that they do exactly what is intended.

Obscure words A few examples will suffice to give the reader an idea of what to be wary of. For example, the word ‘forthwith’ is sometimes used in terms of contracts. Few people, however, have any precise knowledge of its meaning. Some readers will think that it means ‘at once’, or ‘without delay’; others will think that it means as soon as is reasonably practicable. Since at least two of the cases we will be looking at in the next chapter were about time provisions, and in one case turned upon a matter of minutes, meanings of expressions such as this can be of considerable importance.

Hillingdon London Borough v Cutler (1968) 1 QB The meaning of ‘forthwith’ was considered in this case. The owner of a house which was demolished under the Housing Act 1957 claimed that the demolition orders were not valid because they had not been made ‘forthwith’ as Section 17(1) of that Act required. The Act stated: •

‘17(1) If no such undertaking as is mentioned …is accepted by the Local Authority...then the Local Authority… shall forthwith make a demolition order....’

The argument of the owners was that this meant that a demolition order either had to be made immediately or not at all. The Court of Appeal disagreed and Harman LJ. stated: “Forthwith is not a precise time, and provided that no harm is done, forthwith means any reasonable time thereafter.”


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Re Cosslett (Contractors) Ltd (1998) 2 W.L.R. 131 The word ‘deemed’ is another obscure word. Everything in this case turns on the meaning of the words ‘deem’ or ‘deemed’. The words are common enough and have come to the aid of those drafting contracts on numerous occasions. For instance, there are terms under which a person is deemed, after a stated period of time to have accepted goods, or clauses under which certain property is deemed to belong to a party at a certain time. However, the precise meaning of the words can be obscure because it leads to a question of whether the state of affairs that is deemed to exist really exists, as a matter of fact or of law, or is merely treated for the time being as though it exists. If the latter is the case, this can lead to difficult questions as to how to classify this provisional state of affairs. In this case a contract for the separation of shale from coal by means of a coal washing plant provided by Clause 53(2) that all plant, goods and material owned by the contractor was, when on site, deemed to be the property of the council. By another clause of the same contract, the council could in certain circumstances, such as the liquidation of the contractor, retain the plant and sell it on completion of the works. In the event, the contractor got into financial difficulties and left the site leaving the plant there. The administrator applied for delivery of the plant, or payment for its use. In the Chancery Division and the Court of Appeal it was held that the terms of the contract did not have the effect of transferring legal ownership of the plant to the council. Millett L.J. stated that while ‘deeming’ provisions can in some cases pass legal ownership, the words were ambiguous, whereas words such as ‘shall be and become’ would have been adequate to pass legal title. What the council had in this case was a possessory right, together with a power of sale. But the power of sale was invalid in this case, since it required registration as a floating charge, under the Companies Act 1985, and this had not been done. The council had drafted terms which achieved some possessory rights, but these stopped short of what the council really wanted, and caused the litigation. What this case demonstrates is that an obscure word can give rise to extremely complicated legal relationships, and a failure to achieve commercial objectives.


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Cargill International SA v Bangladesh Sugar & Food Industries Corporation (1998) CLC Another obscure word is the word ‘forfeit’. In this case a term of a contract for the sale of sugar provided that a bond provided by the seller would be ‘liable to be forfeited’ if the seller failed to fulfil any terms or conditions of the contract. The normal law applicable to bonds is that if a purchaser holding a bond ‘calls’ the bond, i.e. demands and receives payment, there will be an accounting procedure at a later stage, so that the purchaser is neither over-compensated nor under-compensated. But the purchaser argued in this case that ‘liable to be forfeited’ meant that there was no right on the part of the seller to call for an account. This form of wording is not usual and the purchaser thought that it displaced the normal rules applicable to bonds. The Court of Appeal held that it was legitimate for a court to look at the context and the commercial background to the contract, in interpreting this provision, so as to avoid an unreasonable result, and accordingly they held that the purchaser was only entitled to retain sums equal to its actual loss. This conclusion seems entirely just, but the case again shows that a simple commercial device can be made unnecessarily contentious by the use of a few ambiguous words.

Days Medical Aids Ltd v Pihsiang Machinery Manufacturing Co Ltd and others (2004) 1 All.E.R. (Comm) Finally, it should be noted that simple and popular expressions can be obscure. Recently, in the above case, it was held by the Commercial Court that in relation to an agreement to supply a distributor exclusively with certain machines for use in the UK, the expression ‘for as long as is permitted by law’ was too uncertain to have effect. The expression related to rights of renewal of five year periods ‘for so long as permitted by law’. The parties had allowed the agreement to run for the initial five years and for one five year period of renewal. The judge decided that the basic five year period of the agreement, together with the five year period of renewal was reasonable for the protection of the distributor’s investment. But the words used were too uncertain to allow further renewals. If the words were construed so as to entitle the distributors to renew in perpetuity, this would be void as a restraint of trade.


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The uses of formulae to clarify commercial objectives We have been looking at contracts as a means of good commercial planning. In some cases it will be insufficient to set out a commercial plan, or part of it, merely as a verbal statement: it may involve numerical data, statistics, calculations, or comparisons or criteria. Formulae can be of great assistance in making these accessible, and particularly in making sure that only one outcome or interpretation is possible. This is not to say that a formula has to be a substitute for the words of a term; a formula should be a supplement, or alternative way of conveying the identical information to the words of the relevant term.

Martinez v Ellesse International SPA (1999) Court of Appeal A simple example of a commercial venture where the words used did not convey an accurate meaning, so that they later required interpretation by the courts, is Martinez v Ellesse International SPA (1999) Court of Appeal. In this case Ms Martinez, a former Wimbledon champion, entered into a five year sponsorship contract with Ellesse, a sportswear manufacturer, in 1995. She would be paid an annual retainer, which over the full contract period amounted to £1,945,000, together with an annual bonus of £900,000 if she reached number one in any month, or £550,000 if she reached number two in any one month. (The expressions ‘number one’ and ‘number two’ are, one would expect, terms that need a formula to calculate and explain them.) The contract stated that the ranking was to be based upon ‘the average of her best week’s ranking in each month’. The problem was that when this term was applied to the relevant period, and her best rankings were added together and divided by 12, the result was a figure of 2.5. This gave rise to the litigation in question. If the parties, at the time when the contract was drafted, had attempted to express the relevant terms as a detailed formula then the ambiguity would immediately have been spotted, and a suitable corrective formula or statement could have been put into the contract. In the event, the Court of Appeal held that the numerical figure arrived at was not sufficient on its own to qualify for a bonus, and that a comparative ranking with other players was the main criterion. There were other players, who by the same criteria ranked higher than the plaintiff, so she in fact ranked only fourth and did not qualify for the bonus.


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The term should have been set out to show that (for example), in the case of the number 2 ranking: •

2.0 (including any number between 2.0 and 2.5) qualifies for the £550,000 bonus;

•

2.5 (and numbers above 2.5) do not qualify.


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Chapter 2 Strategic ends: some important decisions to be made about the terms of the contract Time: is it to be or not to be of the essence?.....................................18 Positive obligations: firm undertakings or endeavours? ...............20 What is the distinction between ‘best endeavours’ and ‘reasonable endeavours’?............................................................20 Other cases distinguishing between reasonable endeavours and best endeavours ......................................................21 Are there any problems in enforcing endeavours clauses?............22 Third party rights: should these be permitted, restricted or excluded?........................................................................23 Controlling assignment.......................................................................23 The creation of a trust of the benefits arising from a contract.......25 The Contracts (Rights of Third Parties) Act 1999 ............................27 Termination provisions: the choices to be made..............................30 Clauses providing for termination for breach of contract: the attitude of the courts ....................................................31 Material breach; substantial breach; repudiation ............................33 The nature of the breach.....................................................................33 Material breach....................................................................................35 Termination in relation to other remedies ........................................36

Chapter 2 Strategic ends: some important decisions to be made about the terms of the contract

Time: is it to be or not to be of the essence? This is probably the most important question to be answered in approaching time obligations in a commercial contract. Whether the parties agree that time is to be of the essence or not will depend a great deal upon the overall commercial strategy that one or both of the parties will have in mind when negotiating the contract. With some commercial transactions, time is not critical and there will be no need to set particular deadlines. With others a delay amounting to a few minutes will be of commercial importance. It is in these latter instances that time is most likely to be of the essence. The fact that time is of the essence can sometimes be inferred from the nature and circumstances of the contract. However, there will be instances when either of the parties will wish to make it clear by the terms of the contract, one way or the other, whether or not time is of the essence. All that will be needed is a simple statement such as ‘time for the delivery of goods is of the essence’, or ‘time for the delivery of the goods is not of the essence’. These statements can also be put into ‘plain English’ versions and in consumer contracts it would not be advisable to use the words ‘of the essence’, unless one is prepared to add in ‘plain English’ details of what is meant, since otherwise the terms might not be sufficiently plain for a consumer to be capable of understanding their true meaning. We will deal with this point in more detail when we look at the ways in which the validity of a contract can be contested in Chapter six.


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2 S T R AT E G I C E N D S : S O M E I M P O R TA N T D E C I S I O N S T O B E M A D E …

The consequences of time being of the essence Where the contract makes time of the essence, time is a condition of the contract, that is, a major or fundamental term. This means that the smallest breach, and even an unintentional breach of the term, will entitle the other party to terminate or rescind the contract. These are harsh consequences, but two cases will demonstrate their application.

Lombard North Central plc v Butterworth (1984) 2 W.L.R. 7 In this case, involving the leasing of a computer, time for payment of each instalment due to the lender had been made ‘of the essence’. This meant that even an unintentional delay in making payment would permit the lender to exercise the same remedies against the borrower as if there had been a repudiation by the borrower. This had particularly harsh consequences for the borrower, who argued that what was being imposed upon him amounted to a penalty. However, the Court of Appeal held that to put into a contract a term making time for payment of the essence is to make a choice about the nature of a term, and this is not the same thing as stipulating damages (although it may affect the assessment of damages). So it did not amount to a penalty.

Union Eagle Ltd v Golden Achievement Ltd (1997) 2 All.E.R. In this important case there was a contract for the sale and purchase of a flat in Hong Kong. In the contract there was a clause which stated that time was of the essence ‘in every respect’. (This is somewhat unusual in ordinary domestic conveyancing, but may sometimes be a feature of a commercial conveyance of a particularly desirable property.) Further, the contract stated that if the purchaser failed to complete in time, the deposit would be ‘absolutely forfeited for liquidated damages (and not a penalty)’ to the vendor. There was the usual deposit of 10% of the purchase price. As it turned out, the cheque for the purchase price was delivered ten minutes too late, and the vendor rescinded the contract and claimed that the deposit was forfeited. The purchaser raised a number of arguments which were eventually heard in the Privy Council. One of these was based on waiver, but this argument was clearly unsustainable. Another argument was that the forfeiture clause amounted to a penalty. This argument was prompted by the unfortunate drafting of that particular term, which referred to ‘liquidated damages’. If the retention of the


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deposit had been a form of liquidated damages, then arguably it could indeed have been a penalty, since the sum may not have been a genuine pre-estimate of likely loss to the vendor. But the Judicial Committee of the Privy Council held that this was a deposit, and the forfeiture of a deposit is not the same thing as damages. The rule against penalties would only have applied in the circumstances if the deposit had been too large to be a genuine deposit. Finally, the appellant argued that equitable relief should be granted against the harsh consequences of time being of the essence. The Judicial Committee held that there was no general principle of equitable relief in this area, and that there were no specific grounds in this particular case. It was stated by Lord Hoffmann that if the court accepted the argument that ten minutes delay was not late enough for the normal rules of breach of an essential term to apply, then it would frequently be faced with arguments about how late was too late. So the usual rules applied.

Positive obligations: firm undertakings or endeavours? When we draft terms about the things that each party is to do for the other, it is important to appreciate that there is a significant choice to be made as regards each term of this kind. The term can be a definite promise to do something (for example, a promise to pay a specified sum at a specified time) or the term can consist of a promise by one party to use ‘best endeavours’ to do something, or a promise to use ‘reasonable endeavours’ to do something. Each of these expressions has a different shade of meaning.

What is the distinction between ‘best endeavours’ and ‘reasonable endeavours’? The difference between ‘reasonable endeavours’ and ‘best endeavours’ is that with best endeavours cost is not normally a material factor, whereas with ‘reasonable endeavours’ financial matters can be taken into account in deciding what is reasonable. There is an element of the subjective with reasonable endeavours, as the Phillips v Enron case shows. Every term has to be taken as a whole and in its context.


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Phillips Petroleum Co UK Ltd v Enron Europe Ltd (1997) CLC, 329 In this case there were long-term contracts that included the construction of facilities, as well as the sale and purchase of gas. The terms left certain terms to be agreed and stated that the parties were to use reasonable endeavours to agree as much in advance as possible, but in any case not less than 30 days in advance of the date on which the seller would commence deliveries of gas to the buyer (the commissioning date). The parties were also under an obligation to use reasonable endeavours to coordinate the construction of their facilities and to develop operationally necessary procedures. The buyer argued that it was entitled to take into account its own financial position when seeking to agree a commissioning date. The seller argued that the only criteria were technical and operationally practical criteria (i.e. financial criteria were not relevant). The Court of Appeal held by a majority that, when taken in their contractual setting, and in particularly in view of the fact that there was a fall-back date if the parties were unable to agree, the words used did not impose upon the buyer an obligation to disregard the financial effect upon the buyer of agreeing a commissioning date.

Other cases distinguishing between reasonable endeavours and best endeavours Sheffield District Railway Co v Great Central Railway Co (1911) ‘Best endeavours’ to develop through and local traffic meant ‘not second best’, and that the performing party should ‘leave no stone unturned’ and that there was ‘a duty to investigate alternative methods of performing the agreement’.

UBH (Mechanical Services) Ltd v Standard Life Assurance Co (1986) The Times, November 13 ‘Reasonable efforts’ meant that the duty to perform had to be balanced against the performing party’s own commercial interests, its own financial situation, costs, etc.


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P & O Property Holdings Ltd v Norwich Union Life Assurance Society (1994) EGCS A covenant by a developer to use reasonable endeavours to obtain a letting did not create an obligation to pay substantial reverse premiums to attract tenants.

Are there any problems in enforcing endeavours clauses? The answer to this is that it depends upon what it is that a party has to endeavour to do. If what has to be done is certain enough, such as delivery of goods, or commissioning of equipment, then a promise to use endeavours to carry out such functions will be enforceable. But if the thing promised is uncertain, such as endeavours to agree, or to negotiate, then the term may fail for lack of certainty.

Lambert v HTV Cymru (Wales) Ltd (1998) E.M.L.R. In this case a term of a contract between the plaintiff, an author and the defendant, the purchaser of the copyright of the author, provided: ‘The Purchaser shall… use all reasonable endeavours to obtain a right of first negotiation from any assignee of the Purchaser for the Author to draw or write ‘conceptual’ children’s books in connection with the Film on terms to be negotiated in good faith...’ This case, as we shall see in Chapter 3, is an important authority on the subject of agreements to negotiate, or related agreements. However, for present purposes we need only note that in the Court of Appeal it was held that this particular obligation to use reasonable endeavours was capable of being enforced. It was argued that the obligation in the clause quoted in this case was too uncertain to be enforceable. However, Lord Justice Morritt stated that it was reasonably clear and sufficiently certain what the contracting party was to do. So, unlike a contract to negotiate, a term that one party would use all reasonable endeavours to obtain a right of first negotiation (i.e. to procure that a third party does something) is certain enough for a court to enforce.


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Third party rights: should these be permitted, restricted or excluded? What this issue has in common with other issues in this chapter is the commercial importance of making an appropriate choice at the outset. There are a number of ways in which all or some of the terms of a contract may become enforceable by a third party. The two parties to the contract have a choice, when making their contract, as to how far third party rights should be permitted, and on what terms. Putting this into a commercial context, if a third party is permitted to take advantage of a contract, this could be potentially harmful to the commercial interests of one or the other of the two original contracting parties. To exclude, or control the rights of third parties, parties drafting a commercial contract need to bear in mind three concepts: 1.

Assignment of rights.

2.

The creation of a trust of benefits arising from a contract.

3.

The rights of third parties under the Contracts (Rights of Third Parties) Act 1999.

Novation Since novation can be agreed upon at any time, or declined at any time, it is not usual to draft clauses in a contract either permitting it or restricting it. However, there may be cases where a contract is created between A and B in the knowledge that it will later be novated to a third party. In such cases a provision to this effect may be drafted into the original contract so that: •

the third party is identified,

•

a time-table is established, and

•

there is a clear commercial expectation that this will occur.

Controlling assignment Unless the contract contains terms restricting in some way the right of one or both of the parties to assign benefits of that contract, it is assumed as a matter of law that assignment is permitted. However, as Lord Browne-Wilkinson stated in one of the leading cases on this subject, “It is trite law that it is in any event impossible to assign the contract as a whole, including both burden and benefit.


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The burden of a contract can never be assigned without the consent of the other party to the contract, in which case such consent will give rise to a novation.” (Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd (1994) 1 AC 85, 103). The right to assign may be controlled in a number of ways: there may be a clause which states simply that neither of the parties may assign any part of the contract. Or the words ‘...without the prior written permission of the (other party)’ may be added. The clauses do not have to be bilateral: there are contracts in which one party, such as a major supplier or purchaser, restricts the right of the party it is dealing with to assign, while not mentioning its own rights to assign, which are assumed to have been preserved.

The Linden Gardens case (1994) In the case mentioned above, the issue before the House of Lords was whether or not a clause prohibiting assignment, or restricting it in such a way as to require prior permission, was valid in English law. It was argued that as a matter of policy such clauses should be ineffective. However, the House of Lords held that there was no such rule of public policy in English law and these controlling clauses mean exactly what they say, so that where permission is required and there is no permission to assign, a third party will not be able to take the assigned benefit(s). This raises some important issues of commercial planning. As we have already observed, there will be some instances in which parties actively want some form of restriction of the right to assign. In other cases, however, a restriction of the right to assign will be undesirable, since a purchaser of goods or services may wish to sell onwards, and to include the benefit of any term or contractual warranty relating to those goods or services. In the Linden Gardens case, a building had had decontamination work done to it and the question was whether claims relating to this could be enforced by any subsequent owner or lessee of the building, if the benefits of the contract had been assigned. The contract had a clause restricting assignment. The House of Lords held that claims could not be brought by any assignee. There will be cases when a purchaser of services or goods will need, for commercial reasons, to take steps to preserve third party rights. This could be done by negotiating some form of exception to any prohibition of assignment, or a clause stating that permission to assign, ‘may not unreasonably be withheld’, may improve the position of the party who may wish to assign rights.


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Hendry v Chartsearch (1998) CLC In this case there were data processing and computer services agreements in which there were clauses preventing assignment by one party without the consent of the other ‘not to be unreasonably withheld’. In an action concerning the validity of purported assignments it was held that if the relevant clause is drafted in this way, then there can be no valid assignment unless and until prior permission is sought. In this case, since no prior permission had been sought, the question of whether such permission could reasonably have been refused was not strictly necessary for the decision. Nevertheless, Lord Justice Evans did give some consideration to this question, and his view gives us an indication of how courts are likely to deal with this issue in the future. He was prepared to look at the facts of the case and at the differences between the assignor and the assignee. Chartsearch would presumably have refused to give permission to assign to Hendry, if such permission had been asked for. The original party to the contract with Chartsearch was a company and could have been made to give security for costs in litigation. The assignee, being an individual, and in any case entitled to seek legal aid, did not have to give security for costs. These were, in the opinion of Lord Justice Evans, grounds which would have made it reasonable for Chartsearch to have refused permission to assign.

The creation of a trust of the benefits arising from a contract This possibility was first thought of in the nineteenth century but was seldom used commercially. Only recently, as a result of the cases involving Don King Productions Inc v Frank Warren and others, have the possibilities of either expressly providing for the creation of a trust, or expressly excluding the creation of a trust of one or more of the benefits of a commercial contract been considered as a normal part of the planning of a commercial contract.

Don King Productions Inc v Frank Warren and others (1998) 2 Lloyds Law Reports In this series of cases the facts were as follows. A partnership agreement had been entered into by Mr King and Mr Warren, and there were purported assignments by Mr Warren and his company of boxing, promotion, management and


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associated agreements. However, the supposedly assigned contracts contained provisions expressly prohibiting assignment. On behalf of Mr Warren it was argued that this meant that no valid assignments had taken place. This would have greatly assisted Mr Warren in his contention that the contracts were not partnership property. The issues referred to the Chancery Division, and subsequently the Court of Appeal, as preliminary issues were whether, and with what effect, the purported assignment of non-assignable rights could be valid as a creation of a trust. To these questions Mr Justice Lightman, with whom the Court of Appeal agreed, gave the following answers: 1.

A trust may exist of a contract.

2.

A declaration of a trust in favour of a third party of the benefit of a contract or of the profits obtained from a contract is different in character from an assignment.

3.

A clause prohibiting assignment does not extend to declarations of trust of the benefits of a contract.

4.

There is no reason why the law should limit the parties’ freedom to create such trusts.

5.

If one party wished to protect himself against the other party declaring himself a trustee, and not merely against an assignment, he should expressly so provide. This had not been done in this case.

The immediate result of this case was that the parties reached a settlement on the basis that the contracts in question were indeed partnership property. The long-term result is that those who draft contracts might want to make it clear from the outset that they may wish to put into trust for one or more third parties some, or all, of the benefits arising from the contract. If they do this, then they must make sure that the wording of the contract is not inconsistent with this. If, on the other hand, a party to an intended contract does not wish the other party to be able to create such a trust, whether deliberately or unintentionally, then the clause which prohibits assignment will need to be improved and extended so that it also prohibits the creation of any form of trust.


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The Contracts (Rights of Third Parties) Act 1999 This Act is one of the most important and far-reaching changes to the law of contract in recent years. Although some of its provisions have now been tested in the courts, its full implications will take many years to become clear. One of its more obvious effects will be to extend to third parties the protection of clauses excluding or limiting liability. This will have powerful commercial effects in areas such as shipping, transport, construction and design, where one of the original contracting parties uses third parties to carry out all or part of the work. This change in the law will be looked at when we deal with limiting and excluding liability. Another important effect of the new Act will be to confer positive rights upon certain third parties, such as the right to enforce payment, or the right to enforce a warranty, or the right to enforce any terms about performance of duties. To this extent, the new Act will serve a similar purpose to that already served by the assignment of rights, or the assignment of debts. However, the difference will be that there will be no need for an assignment, so a term of a contract restricting or prohibiting assignment will not touch the rights conferred by the new Act. Moreover, the nature of the rights conferred upon third parties will be defined and structured by the Act itself, and not by the law of assignment. The new Act was passed on 11 November 1999 and came into force at once, but with a period of grace which meant that unless contracting parties expressly agreed to make use of the new Act at once, it would not affect any contracts made before 11 May 2000. Apart from this commencement provision, there are at least two main issues which have caused some apparent difficulty. These are: 1.

To what extent, if at all, could a third party acquire rights under a contract without the two original contracting parties intending this to happen?

2.

Once a third party has acquired such rights, to what extent does this tie the hands of the two original contracting parties and affect their ability to alter or to modify terms of the contract or to end the contract by agreement?

Section 1 (1) of the Act states that subject to the provisions of this Act, ‘a person who is not a party to a contract (a third party) may in his own right enforce a term of the contract if: a)

the contract expressly provides that he may, or

b)

subject to subsection (2), the term purports to confer a benefit on him.’


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Subsection (2) provides that subsection (1)(b) above does not apply if on a proper construction of the contract it appears that the parties did not intend the term to be enforceable by the third party. Several points of interest emerge from this text. Firstly, those who wish to make use of the new laws may expressly confer rights upon one or more third parties. The rights are to enforce terms rather than the contract as a whole, so one may select the particular terms to be enforced by the third party, and exclude others. Secondly, third parties can acquire the right to enforce terms by a rather more indirect method ‘if the term purports to confer a benefit on (them)’. This rather obscure provision contains potential dangers. If a third party can successfully claim that a term appears to confer a benefit on him, he can enforce it even though this might not have been contemplated by the parties to the contract. However, subsection (2) enables the parties to the contract to make their intentions clear in this respect if they so wish. As a result of these provisions it is expected that it will be fairly standard for contract terms to contain a clause stating either that the parties do not intend any term of the contract to be enforceable by a third party; or that the parties do not intend any term of the contract to be enforceable by any third party except where the parties have expressly stated that a named third party may enforce a particular term.

Nisshin Shipping Co Ltd v Cleaves & Co Ltd and others (2004) 1 Lloyd’s Law Reports 38 ‘This case is, I understand, the first time that the 1999 Act has been before the Courts.’ These are the words of Mr Justice Colman in a case in which shipbrokers sought to enforce terms of a contract made between owners of ships and the charterers of those ships. The terms provided that a commission of two per cent would be paid equally to two companies, one of which was Cleaves. But Cleaves was not a party to the contract. The Commercial Court held that since the relevant clause of the contract purported to confer a benefit upon Cleaves, Cleaves was entitled to enforce the term under Section 1 of the 1999 Act. Further, since the contracts provided for arbitration, Cleaves was entitled to refer the matters to arbitration, as this is provided for by Section 8 of the 1999 Act.


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This case is important not only because it is the first to apply the 1999 Act, but also because it touches upon the subject of the European Convention on Human Rights, a subject which we will look at in Chapter 6.

Identification Another of the problems posed by the new Act is that under Section 1 (3) a third party can acquire the right to enforce a term either by being named in the contract (as was the position in the above case), or by being identified in the contract as a member of a class, or by being identified in the contract as answering to a particular description. There need be no problem with named third parties. But the word ‘class’ is very wide, and could include large classes of people who were never intended to enforce terms. If a description is used to designate third parties who have rights under the contract, then it should be born in mind that even descriptions (or classes) such as ‘members of our group of companies’ can create uncertainties: does the expression refer only to members at the time the contract is made, or to members at the time that a claim may be made? This is the kind of issue that would need to be clarified in the contract.

Variation and rescission Section 2 of the Act creates further issues. It is headed with the words ‘variation and rescission of contract’, and its main point is to state that in certain circumstances a qualifying third party will be able to tie the hands of the original two parties if they wish by mutual consent to vary or to rescind the contract. A third party qualifies by having acquired rights under the contract and by making the promisor aware that he intends to rely upon those rights. The section is complex and its details will not be explored here. However, Section 2, subsection (3) provides that the parties are free to include an express term under which they may by agreement rescind or vary the contract without the consent of the third party. It is expected that this will become a standard term of commercial contracts if third party rights are not completely excluded.


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Termination provisions: the choices to be made All commercial contracts require provisions for their termination, either because without such provisions the duration of the contract would be unclear, or because one’s own client may wish to terminate the contract for good reasons concerning the position of the other party, or because events may have made the performance of the contract different from anything that the parties may have contemplated. In the last of these instances the common law principle of frustration may sometimes have a part to play, but in the absence of a clause providing for termination, the parties may have to resort to litigation to ascertain the true position. A person drafting the termination provisions for a commercial contract will have to make a number of choices: 1.

Should the clause state the termination rights of both parties? If a clause is drafted in this style, it will normally state that either of the parties may terminate the contract if any of the listed circumstances occurs. On the other hand, some lawyers would prefer to have a separate clause for each party, because the events would be different in each case.

2.

Should the clause provide only for breach and insolvency, or should it provide for other events, such as change of control, or the departure of or unavailability of key persons?

3.

Should the right to terminate be with immediate effect, or only after the expiry of a period of notice? The answer to this depends upon the ground for termination. Where insolvency is involved, it would be sensible to provide for termination by notice to take effect immediately. With breaches of contract, the position may require a distinction to be made between different terms of the contract, so that in the case of those breaches that are capable of being remedied, a stated period of notice would be provided for; while in the case of breaches that cannot be remedied, termination would be by notice to take effect immediately. Any right of either party to terminate by notice without giving reasons should of course provide for a commercially reasonable period of notice.

Apart from these points, it needs to be pointed out that there have been a great many important cases on the subjects of termination and notices. Almost invariably they have arisen out of ambiguities in the wording of the contracts concerned or unreasonableness of the provisions.


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Clauses providing for termination for breach of contract: the attitude of the courts Except in a few cases, such as consumer contracts and consumer credit agreements, clauses providing for the bringing to an end of a commercial contract are controlled by common law principles rather than by statute. The courts require clear language, particularly where the exercise of a right to terminate on account of breach by one of the parties could bring about harsh consequences. It is also essential that all provisions about termination should be free from ambiguity.

Wickman Tools Ltd v Schuler AG (1974) AC 235 This case is now much cited as an authority for the proposition that if one wishes to achieve an unusual effect by the wording of a term, very clear words are required. Lord Reid famously stated: “The more unreasonable the result, the more unlikely it is that the parties can have intended it, and if they do intend it, the more necessary it is that they should make that intention abundantly clear.” The case involved an agency and distribution agreement. It required Wickman Tools Ltd to observe a number of terms about promotion of the products of Schuler AG, and all of these terms were described as ‘conditions’. Wickman Tools Ltd also had to use its ‘best endeavours’ to promote and extend the sale of Schuler AG ‘s products in its territory. The agreement had only one clause that dealt with the subject of termination, and this was the clause headed ‘Duration of Agreement’. This clause provided for a party who had committed a material breach of the agreement to have 60 days in which to remedy the breach, after having been required to do so. These terms led to litigation. Schuler AG relied upon the status of the terms about the obligations of Wickman Tools Ltd, and argued that any breach of conditions could lead to immediate termination of the contract. Wickman Tools Ltd relied upon the express provision for 60 days’ notice. The House of Lords held that it would take very clear words to displace the natural meaning of the term providing for 60 days’ notice. The meaning of the word ‘condition’ is normally that the


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term is so strong that any breach, no matter how small, permits the non-defaulting party to terminate with immediate effect; a period of notice is not normally needed. But presumptive meanings can be displaced when they come into conflict with other terms which are so clear that their natural meaning simply cannot be disregarded. The clause providing for 60 days’ notice was simply too clear in its meaning to be disregarded.

Mannai Ltd v Eagle Star Assurance Co. Ltd (1997) AC This more recent example shows how important it is to be clear about dates or periods for notices to terminate contracts. In this case a clause in a lease provided that the tenant could determine the lease by serving not less than six months’ notice in writing on the landlord, ‘such notice to expire on the third anniversary of the term commencement date...’ Purporting to act under this clause, the tenant served notice on 24 June 1994, to end the lease on 12 January 1995. This was more than the required six months’ notice, but the landlord argued that the third anniversary of the commencement date was in fact 13 January 1995. The Court of Appeal held that as ‘12 January’ could not mean ‘13 January’, the notice was ineffective. The majority of the House of Lords held that when the tenant gave the notice he did in fact intend to terminate on the third anniversary, although the words that he used had misdescribed that anniversary. For practical purposes it becomes clear that if anniversaries are relevant to dates for termination (or indeed any other dates), it would be good practice to state what that anniversary is, as a calendar date. Not least of the problems in the above case is that the tenant may have thought that what was required was a notice to expire at the last moment of the day before the anniversary, or the first moment of the actual anniversary, that is, midnight on 12 January 1995. A good contract term would have left no doubt as to what was really required.

Harbinger UK Ltd v GE Information Services Ltd (1999) Masons C.L.R. 335 Ambiguities in clauses about duration or termination must be avoided. In this case the parties had entered into an agreement for the supply, support and maintenance of software by Harbinger. The terms of the agreement (as varied) provided for a supply of software for an initial period of three and a half years, and continuing thereafter for automatic renewal of terms of one year, unless


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and until terminated by either party upon one hundred and eighty days’ prior written notice. The problem with a term drafted in this way is that it is not clear whether this means that there is an entitlement to at least one year of automatic renewal, or whether the notice can be given in such a way as to take effect at the end of the initial term. The Court (QBD) opted for the latter interpretation. But it cannot be too strongly stated that a well drafted contract simply does not allow for these arguments.

Material breach; substantial breach; repudiation If a term provides for termination on grounds of breach by one of the parties, it is helpful to provide for: 1.

notice to remedy the breach (if it is capable of being remedied), and/ or

2.

notice of intention to terminate (either because the breach has not been remedied, or because it is not capable of being remedied).

It is also helpful to specify the nature of the breach that will give rise to the right of the party not in breach to terminate. As far as notice is concerned, the Wickman Tools case already cited shows that the courts are reluctant to construe a term so as to allow for termination with immediate effect (except in recognized cases such as where time is of the essence). But a carefully drafted term may allow for this in the case of breaches which are not capable of being remedied (such as breaches of confidentiality). If a breach is capable of being remedied, then it is sensible to provide for a period of notice in which to remedy the breach, and that if it is not remedied in that time, termination will take effect immediately.

The nature of the breach Rice v Great Yarmouth Borough Council (2000) TLR This case concerned contracts for the maintenance and management of sports facilities of the council, and for the maintenance of the council’s parks and gardens.


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The contracts were for four years. In the event, the council was not happy with the performance of the contractor, served default notices and eventually terminated the contracts. The relevant clause stated: “If the Contractor commits a breach of any of its obligations under the contract… the Council may, without prejudice to any accrued rights or remedies under the contract, terminate the Contractor’s employment under the contract by notice in writing having immediate effect.” This term has some useful features but it lacks any qualifications about the nature of the breach, and it lacks any need to give to the defaulting party an opportunity to remedy the breach. For these reasons the Court of Appeal took the view that the parties could only have intended the literal interpretation of this term to apply to extreme cases, which is to say, to repudiatory breaches. The court stated that single breaches, under this term, would have had to have been repudiatory, while multiple breaches would have had to have been cumulatively repudiatory, to justify termination by notice with immediate effect. Part of the reasoning behind this case is that with long-term contracts in which the contractor has made considerable investment, without clear words, one would not normally expect the contractor to have put himself at the risk of having the whole contract terminated for comparatively minor reasons. In this respect, the Court of Appeal was following the decision of the House of Lords in Antaios Compania SA v Salen Redeiera (1985) AC 191.

Antaios Compania SA v Salen Redeiera (1985) AC 191 In this case the relevant clause in a charterparty provided that ‘on any breach of this charterparty, the owners shall be at liberty to withdraw the vessel’. The owners tried to enforce this clause and bring a charter to an end on the grounds that inaccurate bills of lading had been issued. The House of Lords held that this was uncommercial and unreasonable and conflicted with the whole purpose of the NYPE charter form, and that the contract should not be interpreted so as to defeat the whole commercial purpose. From the point of view of a lawyer who may wish to give to his client an opportunity to terminate a contract on grounds of breach, it is desirable to avoid the effect of the above two cases, and to avoid the need to prove repudiation by the other party. Repudiation means one or more breaches that are so serious that either they show that the defaulting party has no real intention of performing his obligations, or they effectively deprive the non-defaulting party of a


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substantial part of the benefit of the contract. In the Rice case, above, it was not possible for the council to prove that the breaches amounted to repudiation.

Material breach The words ‘material breach’ are more likely to achieve the required effect of being credible and enforceable.

National Power plc v United Gas Company Ltd (1998) In this case each party had the right to terminate the agreement, which involved the sale of natural gas, with immediate effect, if the breach was ‘material’, and if the non-defaulting party had given seven days’ notice to the defaulting party, within which time the defaulting party could avoid termination by commencing to remedy the breach. National Power argued that by analogy with the Antaios case, if ‘any breach’ in a time charter meant ‘any repudiatory breach’, then ‘material breach’ must also mean ‘repudiatory breach’. Here it was held, however, that the term had a provision for notice and for remedying the breach. It was not solely about termination. So the approach taken by the judge was less stringent than in the two previous cases. He held in particular that in this context a material breach did not have to be as serious a breach as a repudiatory breach. When drafting such a term, some lawyers will leave ‘material breach’ undefined, on the basis that it is a breach of greater magnitude than a minor breach, but less than a repudiation. Other lawyers will attempt to define it. It can of course be simply defined in terms of whether it can or cannot be remedied within the period of notice. An expression best avoided at present is ‘substantial breach’, which has been held to equate to repudiation. The case in which this was said was Crane Co. v Wittenborg (1999), and one of the Court of Appeal judges thought that this would be the case even where there was an opportunity to remedy the breach.


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Termination in relation to other remedies Clauses providing for termination can, if the parties so wish, specify a remedial regime which is available to the non-defaulting party (or even the defaulting party in some instances). There is a presumption that even if such a regime is specified, a contracting party does not intend to abandon its common law remedies (although these may be affected by an arbitration clause).

Stocznia Gdanska SA v Latvian Shipping Co (1998) 1 W.L.R. 574 In, this case the House of Lords reversed the Court of Appeal and held that a clause allowing a shipbuilder to terminate and keep instalments of money paid, and to resell the ship if the buyer defaulted in its payment obligations, did not displace the seller’s right to sue for damages and unpaid debts. Only the clearest words would rebut the presumption that exists in favour of keeping one’s common law remedies.


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Chapter 3 Structuring the contract The title and the description of the parties.......................................38 The recitals ...........................................................................................39 Recitals and the matrix theory ...........................................................40 The terms of the contract....................................................................41 The signature: simple contract or execution as a deed? .................41 Pre-contractual arrangements ...........................................................42 Post-contractual arrangements..........................................................44 What is the effect of an ‘entire agreement’ clause? .........................45 The Court of Appeal cases..................................................................49 What is a framework agreement? .....................................................51

Chapter 3 Structuring the contract

The title and the description of the parties A contract is an instrument of commercial planning. Part of such planning is to be aware of the precise nature of the venture that is being entered into. The title of the contract will help to make clear from the start what the contract is about: for example, is it a contract for sale, or for leasing; is it a contract of agency or of distribution; is it a supply contract, or a design and supply contract; is it a software supply agreement or a software support agreement? A recent case which shows the difficulties that can arise if the parties are left in any doubt about the nature of the agreement they have entered into is Thames Tideway Properties Ltd v Serfaty & Partners (1999) 2 Lloyds Law Reports.

Thames Tideway Properties Ltd v Serfaty & Partners (1999) 2 Lloyds Law Reports. In this case an agreement was made by exchange of fax messages. It concerned shipment of wastepaper down the river Thames. One of the statements in the final fax before the first shipment was that this initial agreement was for 1993 and was renewable each December in the following year. The question before the court was what was the nature of this contract. If it was an annual shipping contract, then its terms would have governed all shipments during the year 1993 to the exclusion of any other standard terms of the parties. The alternative argument was that this contract was not an annual contract, but an exclusivity agreement which also provided for a trial shipment. This interpretation, which was the one accepted by the court, meant that subsequent shipments would be on other terms, depending upon how they had been formed. This finding was of considerable importance in the particular case, since in a later shipment there had been damage caused by fire, and the standard conditions of trading of Thames Tideway Properties contained a limit of liability, which in the event was held to be applicable to that particular shipment.


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3 STRUCTURING THE CONTRACT

The description of the parties is self-evidently an important feature of a contract, particularly when we bear in mind that many groups of companies may consist of companies with similar but different names. We must also bear in mind that one of the effects of mergers, demergers and takeovers is that two companies with similar names may belong to entirely different groups of companies. There is also the possibility that one may wish to make a claim against a company, which appears to be performing a contract, only to find that the real contracting party is a different company, which may, conceivably, become insolvent. An example of why the correct description of the parties is important is the law of set-off. Normally, and in the absence of any special terms of the contract, the right to set-off one debt against another only exists if all the debts are between the identical parties.

The recitals These are not essential for every commercial contract and it is a mistake to use them if they do not contribute anything. There are doubtless a number of differing views about the purposes to be served by recitals, but in this work the view that will be offered is that recitals are included to establish the following matters: 1.

One or more agreed facts, or an agreed state of affairs.

2.

Knowledge, awareness, or reliance on the part of one or both parties.

3.

The existing intentions of one or both parties to the contract.

Recitals are not the place to set out any of the promises, undertakings, warranties or assurances given by either of the parties, since all of these should be terms of the contract. Nor are they the place to set out the meaning of words, since these should be in the definitions clause. An example of a simple set of recitals would be the following, in relation to a design and consultancy agreement: ‘Whereas A)

The Designer is engaged in business providing design and consultancy services in relation to museums and galleries,and has considerable knowledge, skill and experience in this field.

B)

The Designer is willing to offer to the Client design and consultancy services in relation to the Project (as defined in this Agreement).


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C)

The Client is a public body created for the purposes of providing museum and picture gallery facilities to the public.

D)

The Client relies upon the knowledge, skill and expertise of the Designer in the Field of Activities (as described in this Agreement).

Now the Designer and the Client hereby agree:’

Recitals and the matrix theory The aim of a judge in interpreting a contract is to find out the intentions of the parties. The best guide to the intentions of the parties is the terms of the contract: what the parties say that they agree to do is what they intend. But, in some circumstances, the judges may look at the context or background of a contract, as well as at the words of the terms of it, to give it meaning. In Prenn v Simmonds (1971) 1 W.L.R. 1385, Lord Wilberforce coined the expression ‘matrix of fact’. There has been a certain amount of controversy ever since as to what exactly this amounts to. In Investors Compensation Scheme v West Bromwich Building Society (1997) CLC, Lord Hoffmann stated: “The background was famously referred to by Lord Wilberforce as the matrix of fact, but this phrase is, if anything, an understated description of what that background may include. Subject to the requirement that it should have been reasonably available to the parties… it includes absolutely everything which would have affected the way in which the language of the document would have been understood by a reasonable man.” Not every judge has agreed with this view. In Scottish Power Plc v Britoil (Exploration) Ltd (1997) Court of Appeal, Staughton L.J. stated that the ‘background’, or surrounding circumstances that a court should take into account, should be limited to those which would have been in the minds of the parties, with the knowledge of each party, at the relevant time. Whatever view one takes, it is clear that recitals can aid the process of understanding and interpreting contracts, since in many cases they will provide an agreed summary of the surrounding circumstances of the contract.


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The terms of the contract Every contract is different, but a logical order of presentation of terms of a contract might be as follows: •

Definitions

•

Entire agreement clause

•

Assignment

•

Rights of third parties

•

The consideration and terms of payment

•

The obligations of the parties

•

Secrecy

•

Ownership of goods and intellectual property

•

Risks and insurance

•

Liabilities and warranties

•

Indemnities

•

Boilerplate clauses: waiver, notices, force majeure, invalidity and severance

•

Duration and/or termination

•

Law, language, jurisdiction, arbitration

The signature: simple contract or execution as a deed? Simple contracts do not require signatures at all. A great many transactions (particularly in investment business, securities and insurance) are made by telephone or other electronic means. Telex contracts were unsigned but were always accepted as being valid. Internet contracts are valid provided that they contain the essential requirements of a valid contract. There are some exceptions to this rule, such as contracts of guarantee, contracts for regulated consumer credit and contracts for the disposal of land or any interest in land, which do require signed agreements. Apart from these points, the most important feature of a simple contract, in English law, is the requirement of consideration. If a contract is executed as a deed, it will of course be signed and expressed to be a deed, but although consideration may exist, there will be no requirement


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of consideration. This fact is of some importance where it is difficult to find a form of consideration (either because there is none, or because such consideration as there was was past consideration). A benefit, in some cases, of having a contract executed as a deed is that the period in which a party may claim for breach of contract, or for an unpaid contractual debt, is twelve years rather than six years. It is good practice on the part of the purchaser, in a contract for expensive items with a long life-cycle, to execute the contract of purchase as a deed.

Northern & Shell plc v John Laing (2002) 25 Con. Law Rep In this case a deed of warranty contained a statement that: ‘This Deed shall come into effect on the day following the date of issue of the Certificate of Practical Completion under the Building Contract for the Merchant’s House.’ The deed, under seal, therefore referred to a date which was in fact 25 August 1989, but the deed was executed on 16 January 1990. A claim was issued against John Laing on 14 January 2002, on the basis that if a deed was executed on 16 January 1990, there would still be two days left to run before claims under the deed were statute-barred. The question before the court was whether or not the words in the deed brought it into effect earlier than its date of execution and, if so, whether this operated retrospectively so as to make the claim statute-barred. The court held that the claim was indeed statute-barred because retrospective effect occurs if that is the intention of the parties, and the words in the deed to that effect meant that time began to run on 25 August 1989. The claim made on 14 January 2002 was outside the twelve year period running from 25 August 1989.

Pre-contractual arrangements Sometimes an agreement has to be entered into which is separate from the main agreement, and which precedes and facilitates the setting up of the main agreement. A secrecy, or confidentiality agreement is an example of this, since it may be needed so that two parties may communicate in confidence, as part of the process of negotiating the main contract.


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In some cases, pre-contractual arrangements take the form of agreements to agree or agreements to negotiate. In Walford v Miles (1992) 2 AC, it was established for the present and the foreseeable future that a positive agreement to agree, or to negotiate, is not enforceable. But the House of Lords accepted that a negative lock-out agreement would be enforceable, provided that it contained all the necessary features. The features for an enforceable agreement of this kind are that: 1.

It must be negative in form, that is an agreement not to negotiate with anyone other than a specified person.

2.

It must be made for good consideration.

3.

It must be for a specified period of time.

4.

It must be in relation to a specified subject-matter.

In the USA there had been a case in which it was held by the United States Court of Appeal that an agreement to negotiate in good faith is enforceable (Channel Home Centers v Grossman (1986) 795 F 2d). However, the House of Lords rejected this as a proposition of English law. Subsequent cases of interest have been the following:

Pitt v P.H.H. Asset Management Ltd (1994) 1 W.L.R. 327 In this case the Court of Appeal held that an exchange of letters containing a promise not to consider any other offers for a stated period was a valid lockout agreement. There was no explicit statement of consideration but the Court was prepared to find that consideration existed in the circumstances in which the promise was made, in particular a promise to refrain from taking alternative action detrimental to the promisor.

Lambert v HTV Cymru (Wales) Ltd (1998) EMLR In this case the Court of Appeal was prepared to enforce an agreement by the defendants that: ‘The Purchaser (HTV) shall use all reasonable endeavours to obtain a right of first negotiation from any assignee of the Purchaser for the Author to draw or write conceptual children’s books in connection with the Film on terms to be negotiated in good faith.’ The background to this was that Mr Lambert was an author who had produced certain characters and drawings and stories about them, and had assigned existing and future copyrights in the work to HTV. The above clause envisaged the possibility that HTV would assign its rights to an American company in antic-


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ipation of making a film. At first instance the judge dismissed the claim of Mr Lambert as showing no cause of action. The Court of Appeal held that this was not an agreement to agree or to negotiate, but an agreement to use all reasonable endeavours to procure that a third party did something. The Court held that there was sufficient certainty in this to be enforceable. Moreover, there was an element of negativity in it: a right of first negotiation excludes other parties from being first.

Countrywide Communications Ltd v ICL Pathway Ltd (2000) CLC By way of contrast, in this case it was held that a mere arrangement between the two parties that if Countrywide assisted the defendants (a consortium) in a complex bid for a computerisation project, and if the bid succeeded, Countrywide would be offered a contract on terms to be negotiated, was not an enforceable agreement. This was no more than an agreement to negotiate (although a remedy by way of quantum meruit was available to the claimant, on the basis of time spent with associated costs, because the claimant had been induced to provide its services on the basis of an assurance). The assurance did not amount to a contract but was sufficient to found a claim for a quantum meruit.

Post-contractual arrangements These may include matters such as guarantees and bonds. It is not uncommon for parties A and B to make a contract which provides that, within a certain number of days of the contract being made, party A will procure that party C provides a guarantee or bond in favour of party B. This is normal procedure in many commercial contracts for sale and purchase of major items or services. It is intended as security for the performance of the seller of its obligations. But a problem of structure may arise in so far as consideration must move from the promisee, and party B will not have been the one to give any consideration to the guarantor, party C. If there is any consideration at all, it will have come from party A, who will usually be a client of the guarantor (i.e. of a bank or of an insurance company). This difficulty is usually resolved in one of a number of ways. In some instances the law applicable to the guarantee or bond is a system of law that does not require any consideration. There is then no problem. In other cases, an artificial or nominal consideration may be stated. In other cases the bond or guarantee


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will be executed as a deed. In some cases the parties will want to state that the willingness of party B to make the main contract with party A is the consideration for the guarantee by party C to party B. While this is indeed possible, the problem will be that if the provision of the guarantee or bond is after the formation of the main contract, then the consideration will be past consideration, or the promise of something one is already bound to do. This will not be good consideration, so the order of formation of the contracts will need to be reversed.

What is the effect of an ‘entire agreement’ clause? The answer to the above question depends upon the way in which the clause is drafted. If it does no more than to describe the contents of a contract and then to state that this constitutes the entire agreement between the parties, the clause will hardly be controversial. It will be no more than a statement about where the parties are to look for the contract. In practice, a great many entire agreement clauses are drafted in more ambitious terms. They may well contain terms which exclude reliance upon representations or warranties (other than those expressly stated) or both. They may also contain exclusions or limits of liabilities or remedies. It is these additional features that have made these clauses controversial in recent years. A case that has dominated this area of the law for several years is Thomas Witter Ltd v TBP Industries Ltd (1996) 2 All.E.R.

Thomas Witter Ltd v TBP Industries Ltd (1996) 2 All.E.R In this case the contract was one for the sale and purchase of a company. It contained a provision that: ‘This Agreement sets forth the entire agreement and understanding between the parties… in connection with the Business and the sale and purchase described herein. In particular, but without prejudice to the generality of the foregoing, the Purchaser acknowledges that it has not been induced to enter this Agreement by any representation or warranty other than the statements contained or referred to in Schedule 6.’ This provision was combined with a limitation clause which stated that the sellers would not be liable for a breach of the agreement or a claim in respect of a warranty, unless written notice was given by 1st January 1992.


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The claim by Thomas Witter Ltd was for rescission and/or damages for misrepresentation or breach of contract. This was on the grounds that during negotiations there had been mis-statements about the basis of accounts of the company to be sold, and in particular an overstatement of a one-off expense. One of the statements became a term of the contract, while the others remained as representations. The defence was that firstly the entire agreement clause effectively excluded any liability for misrepresentation and, secondly, in respect of the warranty, notice of a breach had to be given in accordance with the required procedure, within the time limit stated. It was alleged that this had not been done. The Chancery Division of the High Court awarded damages for misrepresentation and for breach of warranty. In doing so, the judge made a number of findings and propositions of law: 1.

The notice did in fact contain all the formal requirements and had been given in time, and since there was no other restriction of claims for breach of warranty this part of the claim succeeded.

2.

The particular style of entire agreement clause did not state in so many words that liability for, or remedies in respect of, misrepresentation were excluded. It was a ‘no reliance’ clause, in which the draftsman was trying to prevent liability for misrepresentation from arising by stating that the party in question never relied upon any representation in the first place. In this case the judge thought that the wording of this particular clause was not adequate to exclude liability for misrepresentation.

3.

The judge went on to say, in a statement that has affected the way in which many lawyers have since drafted these kinds of clauses, that even if the exclusion of liability had been explicit, it would not have been fair or reasonable within the meaning of Section 3 of the Misrepresentation Act 1967. This was because the clause would have purported to exclude liability for all kinds of misrepresentation, including fraudulent misrepresentation.


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SALE OF A COMPANY

CONTRACT CONTAINS

COURT HELD

1. Time limit for notice of breach of warranty

1. Notice was in time: Damages for breach of warranty

2. An entire agreement clause… ‘No reliance on any representations’

2. Clause not sufficient to exclude liability

Inaccurate statements about accounts, made prior to contract

Some became warranties

Others remained as representations

3. Even if sufficient, term was not reasonable Damages awarded

Figure 1: Thomas Witter Ltd v TBP Industries Ltd (1996) 2 All.E.R


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MISREPRESENTATION

Fraudulent

Innocent

Rescission and/or

Recission and damages in tort for deceit

Damages under S.2 (1) of Misrepresentation Act 1967 if defendant unable to show reasonable grounds for belief that statement was true

Damages under S.2 (2) of the 1967 Act in lieu of rescission at discretion of Court, if rescission was available

Figure 2: Remedies for misrepresentation In the years following this case, many lawyers have added words to their entire agreement clauses to the effect that the clause in question does not purport to limit or exclude any liability for fraudulent misrepresentation.

WRM Group Ltd v Wood (1998) CLC 189 However, the cases are in conflict as to whether such statements are strictly necessary. In this case the Court of Appeal took the view that it was fair and reasonable to limit the remedy of set-off to a specified sum in respect of any breaches of warranty or misrepresentations. No exception had been made for fraudulent misrepresentation, but the Court thought that this was not unreasonable in the context of set-off, and in the context of what would have been, at that stage, a mere claim in respect of fraud.


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Government of Zanzibar v British Aerospace (Lancaster House) Ltd (2000) CLC In this case, which was inconclusive, since it involved procedural issues, the judge differed from the Thomas Witter decision on a number of points. In particular he thought that a ‘no reliance’ clause could be effective. And, further, he thought that there was no need to make an express statement that an exclusion of liability was not intended to cover cases of fraudulent misrepresentation, since it would be understood as a matter of construction that an exclusion of liability was not in any case intended to exclude liability for fraud. So, in his view, failure to mention fraud as an exception did not invalidate the clause or make it unfair. On the other hand, in South West Water Services v International Computers Ltd (1999) BLR, the Thomas Witter case was followed.

The Court of Appeal cases To some extent the Court of Appeal has now clarified the position regarding entire agreement clauses. The issue of fraudulent misrepresentation is still not fully resolved, as it was not discussed in the cases that follow. On the other hand, a statement that one does not intend to exclude any liability in respect of fraudulent misrepresentation can do no harm. As regards ‘non-reliance’ clauses, the Witter case may have been decided correctly on its own facts, but the general proposition that non-reliance clauses are inadequate to prevent liability for misrepresentation from arising is not true. Just the opposite is the case. The following is an important statement from the judgment of Lord Justice Chadwick in the case of E A Grimstead & Son Ltd v McGarrigan, Court of Appeal 27 October 1999: “There are, it seems to me, at least two good reasons why courts should not refuse to give effect to an acknowledgment of non-reliance in a commercial contract between parties of equal bargaining power.... First it is reasonable to assume that the parties desire commercial certainty. They want to order their affairs on the basis that the bargain between them can be found within the document which they have signed. They want to avoid the uncertainty of litigation based on allegations as to the content of oral discussions at precontractual meetings. Second... it is legitimate and commercially desirable that both parties should be able to measure the risk, and agree the price, on the basis of the warranties which have been given and accepted.”


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This statement was repeated by Lord Justice Chadwick in Watford Electronics Ltd v Sanderson CFL Ltd (2001) BLR. From this we may conclude that for the time being, and barring a different approach being taken by the House of Lords (which has yet to decide a case about this point), clauses in which parties state that they do not rely upon warranties or representations made by the other party, other than those included in the written agreement, are effective to prevent liability from arising, other than under the written terms of the contract. In the above case, Lord Justice Chadwick stated that the requirement of reasonableness under Section 3 of the Misrepresentation Act 1967 (as amended by Section 8 of the Unfair Contract Terms Act 1977), does not apply to such a ‘nonreliance’ clause, because the clause does not exclude or limit liability for misrepresentation. What it does is to prevent the liability from arising in the first place. If this is the case, then the rules applying to ‘non-reliance’ clauses are more lenient to the person relying upon such clauses than the rules that would apply to an outright exclusion of liability for misrepresentation. This approach has in fact been accepted by the High Court, in the case of SAM Business Systems Ltd v Hedley & Co (2003), 1 All.E.R. (Comm) 465, in which Judge Bowsher QC noted than the particular entire agreement clause used by SAM Business Systems Ltd had not been drafted in the ‘non-reliance’ style, but instead as an exclusion of liability for misrepresentation. He said that such a term would have to satisfy the requirement of reasonableness, whereas the one used in Watford v Sanderson did not. So we can conclude that the statement in the Thomas Witter case, that non-reliance clauses are ineffective, is wrong as a general proposition, although it may have been a correct conclusion to come to on the facts of that particular case. The reason why the results of cases may occasionally differ on their own facts is that the effectiveness of a non-reliance clause, according to Lord Justice Chadwick, is based upon the law of estoppel. There may be cases where it is not fair or reasonable to allow a party to use a non-reliance clause to stop the other party from alleging misrepresentation. It may be that the Thomas Witter case was one of these.


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What is a framework agreement? These forms of agreement rely upon a number of the points that have been dealt with in this chapter. Their commercial use is to fix the terms and other matters, including prices where the parties so wish, in advance of separate subsequent transactions. The framework agreement often binds the supplier to supply goods or services on the terms agreed for an agreed period. The purchaser may agree a minimum take-up, or may in some cases not be bound to make any purchases at all. Commercially, time is saved and negotiations only need to be carried out once, at the beginning. Legally, these agreements often require a statement of consideration (for the option granted to the purchaser), and will often contain a statement of duration, or about termination, and an entire agreement clause.


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Chapter 4 How to manage the risks Risks ......................................................................................................53 Insurance ..............................................................................................54 Indemnities ...........................................................................................55 Boilerplate clauses ..............................................................................57 Exclusions and limits of liability.........................................................63

Chapter 4 How to manage the risks

Risks One of the most important aims of a commercial contract is to manage the risks. In reality a fine distinction can be made between risk avoidance, risk allocation and risk management. In the first case, one or both of the parties can see a risk, and it is then agreed in the contract that a term will be included which avoids or eliminates the risk. An obvious example would be to avoid an unreliable jurisdiction by opting for jurisdiction or arbitration in a territory with a good reputation in this field. With risk allocation, the risk will not have been eliminated, but the parties will have taken account, in the price and other terms, of the fact that the risk is to be placed upon one party rather than the other. Risk allocation is common in cases of delivery of goods, or in hazardous works, such as exploration. In contracts with an element of design, it is particularly important to deal with the matter of risk. The possibility of infringement of the intellectual property rights of a third party may also be a matter of risk allocation. Insurance and indemnities are a part of risk allocation. Risk management means that both parties have accepted that a risk exists, and steps have been taken, either in the terms of contract, or by other commercial means related to the contract, to manage the risk so as to make it commercially acceptable, without necessarily being able to eliminate it altogether. Financial controls, such as guarantees, are a form of risk management. So are limits and exclusions of liability. So are clauses providing for termination. Force majeure clauses are, above all, a form of risk management. The task of the commercial lawyer drafting or negotiating a contract is to foresee the risks and to make the necessary provisions in the contract. In the remainder of this chapter we will look at some of these provisions.


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4 HOW TO MANAGE THE RISKS

Insurance Other than Employer’s Liability insurance, there are few forms of insurance that are compulsory. So insurance is usually a matter for the parties to decide upon as a matter of risk allocation, and to be taken into account in the price. It is therefore up to the parties to set out, as terms of the contract, whether or not any of the following forms of insurance is required, and if so, which of the parties shall arrange it and at whose cost, and for what period of time. •

insurance of goods in transit

•

insurance of goods and materials on site

•

insurance of buildings and other property

•

public liability insurance

•

product liability insurance

•

professional indemnity insurance

•

insurance against pollution

This list is not necessarily exhaustive. Part of risk management is to provide, where relevant, that one party not only agrees to take out such insurance, but also agrees that it shall be with an insurer approved by the other party, and that the policy, or evidence of it, shall be made available to the other party for inspection. In some cases, and with some forms of insurance, the contract will provide that insurance of an item must be at full replacement value. In other cases, such as the last three examples above, a minimum amount for any one claim will be stipulated. However, it is not enough for one party simply to require the other to insure against certain risks. If this alone is done, the problem will be that the law of subrogation may apply in the event of a claim. Under the law of subrogation, the insurer of a party that has suffered a loss for which the insurer has paid, may borrow the claim of the party that has suffered the loss. So, it is not enough for two parties simply to state that materials on site shall be insured by the supplier. The supplier may still own the goods, and if the goods are lost or damaged due to the fault of the site owner or another party in control of the site, the insurer may pay the supplier in respect of the loss and then sue one or both of the other parties, borrowing the claim that the supplier would have had in contract or in tort. So the site owner and any other party may well require an indemnity to be contained in the respective contracts so that, once the insurer has paid, there will be no right of subrogation.


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Indemnities Many of the drafting faults with indemnities arise from a misunderstanding of what indemnities are intended to do, and are capable of doing. Further errors sometimes arise due to a failure to appreciate that indemnities are subject to well-established rules of interpretation, and will not be stretched by the courts to cover circumstances that are not in fact covered by express words or by necessary implication. An indemnity may be defined as a promise by one party to pay for or to keep another party harmless against certain types of loss, expense or damages. The scope of an indemnity needs to be carefully defined, since, as already stated, it will not cover any other types of loss, etc. The rules of construction regarding indemnities will be looked at along with other rules of construction in Chapter 5. Indemnities contain a positive aspect: that of undertaking to protect another party from loss, and of undertaking to pay for that loss if it arises. This can be seen in the words of Lord Goff in Firma-C Trade S.A. v Newcastle P & I Association (1991) 2 AC, when he stated that at common law a contract of indemnity gives rise to an action for unliquidated damages arising from the failure of the indemnifier to prevent the indemnified person from suffering damage.

Deepak v ICI (1999) 1 Lloyds Reports In this recent case, it was stated in the Court of Appeal that an agreement to indemnify and hold harmless contains within it by necessary implication an implied term not to sue. This is not new law but the law of indemnities has been, and remains, obscure and the courts find it necessary to shed light upon it from time to time. The value of the implied promise not to sue is that it can prevent subrogation from coming into play. In some cases the party receiving such an indemnity does not rely solely upon it, but also asks for the added protection of a waiver of subrogation given by the insurer. Strictly speaking this should not be necessary if the indemnity is effective, but there is always the possibility that the indemnity may be found not to cover the precise circumstances, so the waiver of the insurer’s rights of subrogation is sought as well. There are various options open to those drafting contracts, as far as indemnities are concerned. They may make them unilateral which is the normal style of many contracts. A unilateral indemnity is a classic form of risk allocation. The party giving an indemnity, for example against any claims by third parties for infringement of intellectual property rights, is taking on the risk of such claims


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being made by third parties. Sometimes the contract terms may require each party to give the other an indemnity of the same kind, depending upon who is responsible for the infringement. These are reciprocal indemnities. One is given in return for the other but they do not cover identical circumstances. The indemnity given by, for example an author to a publisher, covers the possibility that the author may be responsible for the infringement. The indemnity given by the publisher to the author covers the possibility that the publisher may be responsible for the infringement. A more unusual way of drafting indemnities is where each party indemnifies the other in the same circumstances. This we may call a mutual indemnity, although the courts sometimes refer to this as a knock for knock clause. Such clauses have caused a great deal of confusion in the past (and some poor drafting) because the parties have not always been entirely aware of their purpose. To understand this purpose we will sketch out a hypothetical case. We need to imagine two contracting parties, both employing a number of staff who are engaged in hazardous work and using expensive equipment. If there were a unilateral indemnity, as there is in many cases, then one party would bear all the risk. So instead the parties agree that in the event of an accident each party will bear its own losses to its own staff and its own equipment. At the same time, to reinforce this risk-sharing arrangement, the parties agree not to sue each other in the event of such an accident causing losses of these kinds. (They may retain the right to sue each other in other circumstances, or for other losses, but not for these.) In practice the words ‘indemnity’ and/or ‘indemnify’ are used because they cover the arrangement of the risks and the promise not to sue. So the clause will probably state that each party will indemnify the other against all of the specified kinds of loss or liability arising from the death or injury of any of its own employees, or arising from damage to or loss or destruction of its own equipment, resulting from the performance of the contract. Properly drafted, with the consent of the respective insurers, and with the necessary provisions covering possible negligence of either or both of the parties, these clauses are a valuable aspect of commercial planning and risk allocation. The main problem that arises is as regards mutual understanding and expectations. It is vital that such clauses should, if used, be drafted clearly and accurately, and vital that they should be properly explained to the client. There are other options open to the client, and no party should enter a mutual indemnity arrangement without being aware of its full implications.


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Boilerplate clauses These clauses are an important part of the structure of a commercial contract. They are also useful devices for risk management. The list below is of clauses that are typically regarded as boilerplate clauses, but perhaps they should only be regarded as such if the clauses are standard ones and not drafted to a particular client’s requirements or to serve a particular purpose in a specially negotiated contract. •

Entire agreement clauses

•

Clauses restricting the authority of persons to vary terms

•

Clauses providing that the parties may vary the contract or rescind it by agreement without the need for the consent of any third party

•

Clauses controlling the right to assign or to create a trust of benefits of the contract

•

Clauses preventing third party rights from arising under the Contracts (Rights of Third Parties) Act 1999

•

Force majeure clauses

•

Clauses about waiver

•

Clauses dealing with invalidity and severance

•

Clauses dealing with set-off and counterclaim

•

Clauses about termination of the contract

•

Clauses about notices

•

Clauses about the status of headings

•

Clauses about choice of law and jurisdiction and the language of the contract

Many of these boilerplate clauses will have been encountered earlier in this work, so no further discussion of them is required. Those that have not been looked at already will be examined now.

Clauses about waiver These clauses are aimed at controlling the possibility that a waiver may accidentally occur. This may be done by stating that any waiver must be made in writing. Under common law or equitable principles, a waiver could be made orally or even by conduct. A clause about waiver could also restrict the number


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of persons who would be able to give a waiver. The reason that this is important is that no consideration is required for a waiver and a once a waiver is granted and relied upon it cannot be retracted. The clause could also restrict the scope of the waiver and so help to avoid any ambiguity about what it is that has been waived. An example of a clause dealing with waiver might read as follows, although it must always be born in mind that whether or not a waiver has taken place is a matter of fact and evidence. ‘No failure or forbearance by us in enforcing any of our rights or your obligations under this contract shall be construed as a waiver. Any waiver given by us must be in writing, and must be expressly stated by an authorised employee of ours to be a waiver. Such a waiver will only apply to the specific events to which it is stated to relate, and not to any other events whether past or future.’

Clauses about invalidity and severance These clauses aim to deal with the problem that all or part of a clause of a contract may turn out to be invalid. Possible reasons for invalidity include: •

infringement of competition law,

•

penalties,

•

restraint of trade beyond what is permitted by law,

•

terms which infringe regulatory laws,

•

unfair contract terms, and

•

terms that fail on grounds of uncertainty.

A boilerplate clause about invalidity and severance aims at severing the invalid term from the contract and then agreeing what effect this has upon the contract. In some cases, if a term is invalid it may not be possible for the contract to continue at all, because the term is so fundamental. This would be true of terms about price or about what is to be performed. The boilerplate clause should be drafted so as to take account of this. In some cases the contract could be performed without the need to replace the invalid clause. In these cases the boilerplate clause is easy to draft: one simply states that the invalid term will be severed from the contract and the remainder of the contract will continue to be binding.


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For a recent case on severance, see Days Medical Aids Ltd v Pihsiang Machinery Manufacturing Co Ltd (2004) 1 All.E.R. 991, the facts of which are set out in Chapter 1 of this Report. But there is a third and more ambitious possibility, which is that the parties may wish to replace the invalid term. This is not easy because provisions for the replacement of invalid terms may involve agreements to agree new terms, or to negotiate new terms to replace the old. As long as it is understood that these will not be legally enforceable, they may still serve a practical or commercial purpose. If necessary, such provisions could always have a fall-back provision if the parties fail to reach agreement, such as arbitration or some other form of referral to a third party, which the parties agree to be bound by.

Clauses about notices These are a good practice in commercial contracts since there may be a number of things about which one party may have to give notice to the other, such as notices about intention to terminate the contract, or notices about complaints or defects or allegations of breach of any term, or notices about matters which have to be done as part of the contract programme. The important thing is that the clause must be drafted so as to give rise to mutual understanding rather than the reverse. It must clarify issues and not obscure them. There is no particular legal format for drafting clauses about the giving of notices: all that is needed is a plain statement about the means by which notice may be given, the address to which it must be given, any time limits that are applicable and any requirements as to the content of such notices. Among cases that we have seen in previous chapters, the Thomas Witter case and the Mannai case, are examples of how clauses about either the deadline for a notice or the content of a notice, can become an issue in litigation. This is what the person drafting such a clause is aiming to avoid.

Clauses about the status of headings These are useful in case the details of a particular clause become the subject of negotiations. An addition may be made to a certain clause, or a substitution, which may alter the content of the clause to the point where the heading may be a misdescription. For example, a force majeure clause may be the subject of an additional form of words which may not strictly be about force majeure, but may instead be about an act or omission of the customer (which is a different


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concept altogether, having different consequences). If the headings were to be read as part of the contract, then the contract would now contain an inconsistency. So the usual practice is to have a boilerplate clause which states that the headings to the clauses (or paragraphs or terms) are for reference only, and do not affect the interpretation of the contract.

Force majeure clauses At their simplest, these count as boilerplate clauses. They are one of the classic risk management devices, since they deal with all of the types of risk that are beyond the control of the parties and are either understood by the term force majeure, or more usually, are expressly defined as being examples of force majeure. Apart from consumer contracts, it is normal practice to leave the expression force majeure in French, since this has an international recognition value. As the expression is a term of art, and not ‘plain intelligible language’, it would not be good practice to leave it untranslated in any consumer contract. Where the expression is used, it may, if the parties so wish, be left undefined, in which case its meaning will simply be any circumstances beyond the reasonable control of the parties. However, because there are so many marginal or contentious circumstances that could arise, the standard practice is to provide a non-exclusive list of circumstances that amount to force majeure. These would include, but not be limited to, matters such as war or hostilities, terrorism and the effects of terrorism, denial of public utilities or means of transport, riot and civil commotion, earthquake, fire, flood and other natural disasters, and government intervention. Apart from these, the parties may wish to add other circumstances such as industrial action, epidemics, or shortages of materials. If the force majeure clause is simple and non-controversial, it can genuinely be called a boilerplate clause. If it contains unusual items it may be the subject of serious negotiation instead. Force majeure clauses are more than simply a list of circumstances. They also set out procedures for their use, such as the giving of notices containing certain details within certain time limits. They also set out the position that the parties will be in as a result of force majeure, for example whether the contract will continue after a period of suspension, or whether it will be terminated. It is not usual to provide for termination except where the force majeure lasts for longer than agreed maximum period.


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Clauses dealing with set-off and counterclaim These are not essential to every type of commercial contract but are a useful device for the control of financial matters. Under statute and under the rules of equity, parties to contracts have certain rights of set-off. In addition, there is always the procedural right of one party to make a counterclaim against the other, in the event that that other sues for a sum of money. There are two different types of boilerplate clause that can be used in this respect. One is a clause under which the parties agree provisions that enhance the rights of one or both of the parties to use rights of set-off. This is sometimes felt to be desirable because statutory rights of set-off require that debts be liquidated, although they need not arise from the same transaction. Equitable rights of set-off may be in respect of debts that are unliquidated, but they do have to arise from the same transaction or from closely connected transactions. Further, rights of set-off normally have to be between the identical parties. Terms of contract may to some extent modify these requirements and so improve rights of set-off.

Coca Cola Financial Corporation v Finsat International Ltd (1996) The Times, 1st May 1996 On the other hand, another type of boilerplate clause is one that excludes rights of set-off and counterclaim. In this case the Court of Appeal took the opportunity to review all the relevant principles and held that rights of set-off, whether legal or equitable, can be waived or excluded by agreement. There is clearly some freedom for the parties to contract as they wish in this area, although in UK contracts the Unfair Contract Terms Act 1977 is applicable. In this particular case the 1977 Act was not applied.

Stewart Gill Ltd v Horatio Meyer Ltd (1992) 2 All.E.R. However, in this case Court of Appeal did apply the Unfair Contract Terms Act to one such clause. This is because it went too far in not only excluding rights of set-off and counterclaim, but also providing that a buyer of goods could not withhold payment for ‘any other reason whatsoever’. The clause was struck out in its entirety by the court.


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Clauses about law and jurisdiction Although these may be thought of as boilerplate clauses, they do sometimes differ a great deal and present highly negotiable options. As the UK is a signatory of the Brussels Convention on Jurisdiction and the Enforcement of Judgments in Civil and Commercial Matters 1968, a choice of the parties about the jurisdiction of the courts will usually be effective, although there may be a question as to whether the choice should be exclusive or nonexclusive. If the parties fail to make a choice of jurisdiction, the rules under the Convention are very complex, an example of which is the case of Alfred Dunhill Ltd v Diffusion Internationale de Maroquinerie de Prestige SARL and others (2002) 1 All.E.R. (Comm) 950.

Alfred Dunhill Ltd v Diffusion Internationale de Maroquinerie de Prestige SARL and others (2002) 1 All.E.R. (Comm) 950 In this case it was held that a claim for damages for misrepresentation was a claim in tort, and fell under Articles 2 and 5(3) of the above convention, so that either the domicile of the defendant was the place of jurisdiction, or the place where the ‘harmful event occurred’.

Caterpillar Financial Services Corp. v SNC (2004) Lloyd’s Law Reports As regards any choice of law, the Rome Convention 1980 applies, and this choice will usually be valid, except where mandatory rules apply. In Caterpillar Financial Services Corp. v SNC (2004) Lloyd’s Law Reports, there was a loan agreement between the parties and Caterpillar was claiming sums due, alleging default by the borrower. The chosen law was English law, and the chosen jurisdiction was English, but the defendant argued that under Article 3.3 of the Rome Convention, the French rules about loans were ‘mandatory rules. Article 3.3 says that if all the elements relevant to the situation at the time of the choice are concerned with one country only, the parties’ choice of law cannot prejudice the application of that country’s mandatory rules. The High Court, in London, held that as the agreement had connections with several countries, other than France, the mandatory rules did not override the choice of law.


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Exclusions and limits of liability These are sometimes considered as forms of boilerplate clauses. Clearly, the question of whether or not this is a correct analysis depends upon the type of exclusion clause or limit of liability clause. We have already seen examples of these in the form of entire agreement clauses, and exclusions of set-off and counterclaim. But many types of clause limiting or excluding certain types of liability are subject to negotiation, or are used for a one-off purpose, and cannot for this reason be classified as true boilerplate clauses.

St Albans City and District Council v ICL Ltd (1996) 4 All.E.R This famous case may be considered as showing the dangers of treating exclusions or limits of liability as boilerplate clauses. In this case, one of the deciding factors in holding that the limit of liability imposed by ICL in respect of claims by their customers was not reasonable, was the fact that the limit of liability had been set unilaterally and was, in effect, a boilerplate clause. If the limit of liability had been a sum specifically agreed by the parties, there would have been a considerably higher chance that it would have been held to be reasonable.


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Chapter 5 How the Courts will interpret what is written Ambiguities, absurdities and technicalities ......................................65 The contra proferentem rule ..............................................................66 The interpretation of indemnities ......................................................68 ‘Consequential’ loss or damage .........................................................69 The knock-on effect of amendments .................................................72

Chapter 5 How the Courts will interpret what is written

Ambiguities, absurdities and technicalities The aim of a judge in interpreting a contract is to find out the intentions of the parties. To do this the judges must look at the contractual documents themselves: they may not hear subjective evidence from the parties as to their intentions. What the parties said is primarily what they intended. This rule of construction is important to all who draft contracts. If a term of a contract is ambiguous, or if a literal interpretation of it appears to give rise to an absurdity, or if the term contains a technical meaning which requires knowledge of the technical background, then the courts may look beyond the literal meaning of the words used. How far the judges may look and the nature of the materials at which they may look, is a matter for some controversy, and has given rise to the debate as to what is meant by the ‘matrix of fact’ and whether or not this is a helpful concept or an accurate reflection of the law. But at least there appears to be a consensus that the courts may look at the surrounding circumstances reasonably known to the parties at the time when the contract is made.

Segovia Compania Naviera S.A. v R. Pagnan & Fratelli (1977) 2 Lloyd’s Rep 343 In this case the courts had to interpret a term that the charterers of a ship could order it to any port in the United States ‘east of the Panama Canal’. This produced an absurdity since one has to go as far north as the state of Carolina in the USA to find a port that is to the east of the Panama Canal, and the whole of the Gulf of Mexico is excluded. Clearly, the person who had drafted the term had not looked at a map, and was trying in an inaccurate way to distinguish between the Pacific side of Panama and the Caribbean side. But the contract did not actually say this, so the court had to find an interpretation of the intention of the parties. This is an example of the ‘background’ principle: in this case the literal meaning of the words used was rejected by the High Court and Court of Appeal because


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5 H O W T H E C O U R T S W I L L I N T E R P R E T W H AT I S W R I T T E N

there was no apparent reason behind it. The alternative meaning, distinguishing between the Pacific and the Caribbean, made more sense.

Charter Reinsurance Co Ltd v Fagan (1997) AC 313 In this case there was a reinsurance contract which required the reinsurers to reimburse the reinsured in respect of their net loss in excess of a specified sum; ‘net loss’ was defined as ‘the sum actually paid by the reinsured in settlement of losses or liability’. The question before the courts was whether or not the expression ‘actually paid’ was to be taken literally, or meant something different, that is, ‘the sum actually payable’. All the courts in question, including the House of Lords, with one dissenting voice in the Court of Appeal, held that it meant ‘actually payable’, so that prior payment was not a condition of reimbursement. This case shows that even definitions in a contract do not necessarily solve all problems, and in this particular case can be the cause of the problem.

The contra proferentem rule This rule is of general application in the interpretation of contracts. It means that where the meaning of a term is in any doubt, the courts will construe it in favour of the party that did not draft it and against the interests of the party that did draft it or that is relying upon it. Examples of the contra proferentem rule are numerous.

Bramall and Ogden v Sheffield City Council (1983) Unreported In this case the local authority had attempted to charge liquidated damages in a contract for over 100 council houses. The builder argued that since the local authority was taking over the houses piecemeal, the scale of liquidated damages required some form of mechanism to reduce the liquidated damages in accordance with the number of houses taken over. The contract did not contain such a mechanism but, faced with the alternative, which was that the term was void as being a penalty, the local authority argued that a scaling down provision should be implied. This was something that the court was not prepared to do. The liquidated damages term was relied upon by the local authority and interpreting it contra proferentem, it could not be made to do something that it was not designed to do; so it was void.


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BHP Petroleum v British Steel (1999) 2 Lloyd’s Law Reports More recently, in this case the contra proferentem rule was discussed at great length. The case concerned a defective gas pipeline supplied by British Steel, but installed by other contractors. Cracks and leaks occurred, and a claim was made (in the region of £200,000,000) which included loss of production and gas. Liability was not admitted but, to shorten the proceedings, it was agreed that the interpretation of a crucial part of the contract should be tried as preliminary issues: 1.

The time limit: this provided for a rectification of defects within a period of eighteen months, after which ‘all liability of the supplier relating to the work shall terminate.’

2.

The cash limit: this provided for repair or replacement of defective items and went on to state, ‘The supplier’s liability hereunder shall not exceed 15% of the contract price by line item.’

If the strict contra proferentem rule had been applied, there may (although this point is arguable, since it is only hypothetical) have been weaknesses in these clauses which would have made them ineffective. The expression ‘relating to the work’ is uncertain in scope; the expression ‘hereunder’ is even more uncertain. So, applying the rule strictly a court might have given the clauses only the narrowest meaning, so that they only limited liability in contract, but not in tort. Even the scope of the contractual liability might have been arguable. But applying the statement of the House of Lords and of the Privy Council in the cases of Ailsa Craig Fishing Co Ltd v Malvern Fishing Co Ltd (1983) 1 W.L.R. and Canada Steamship Lines Ltd v The King (1952) AC, the court in the BHP case held that there is a distinction to be made between exclusions of liability and limits of liability. In the latter types of case, the contra proferentem is to be applied but not in the same strict sense as in the former cases. With limits of liability the courts can give the words actually used their natural meaning, and if this is clear and unambiguous it will be sufficient. So the answer to the preliminary issues raised in the case of the defective pipeline was that the time limit and the cash limit covered all the liabilities that might arise between the two parties in relation to that project. As the claim was outside the agreed time limit, this meant that it could not proceed. On the other hand, with exclusions of liability, as opposed to limits, and with indemnities, the contra proferentem rule applies in its full force. Nothing will be added and nothing will be implied unless the implication is unavoidable.


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The interpretation of indemnities The basic principle regarding the construction of an indemnity is that alluded to in the previous paragraph. In Walters v Whessoe and Shell Refining Co (1960), Unreported, but set out in a footnote to AMF v Magnet Bowling (1968) 2 All.E.R. 816, Lord Justice Devlin set out what is now regarded as the canonical statement: “It is now well established that if a person obtains an indemnity against the consequences of certain acts, the indemnity is not to be construed so as to include the consequences of his own negligence unless those consequences are covered either expressly or by necessary implication. They are covered by necessary implication if there is no other subject matter on which the indemnity could operate. Like most rules of construction, this one depends upon the presumed intention of the parties.” In this particular case, a clause under which Whessoe had agreed to indemnify Shell against all claims arising out of their operations was held not to entitle Shell to an indemnity in circumstances where the death of a person was caused partly by the negligence of Whessoe and partly by the negligence of Shell. The indemnity clause did not provide for this situation and there were other types of situation in which the indemnity could operate, such as where a third party might make a claim under statute, and not involving negligence, against Shell. One of the problems of applying this canon of construction was later on alluded to by Lord Devlin in Samples of Lawmaking, when he stated that canons of construction make things much easier for the judges but much more difficult for the parties who do not know the rules. It is, therefore, particularly important that the lawyer drafting the contract should alert the client to the choices that have to be made. An indemnity can either be drafted in such a way that the liability is split between the two parties in circumstances where both have been negligent or the indemnity can be drafted in such a way that the liability falls entirely upon one of the parties, even though both parties have been negligent. This is what Shell expected in the case discussed, but the clause did not clearly state this, so the indemnity failed altogether.

E.E. Caledonia v Orbit Valve Co Europe (1994) 1 W.L.R. A repeat of this situation occurred in this case in which the parties had entered into a knock for knock agreement, in which each of them indemnified the other against loss to its own property or death or personal injury to its own employees.


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If the clause had been correctly drafted, under this kind of agreement (which would require the consent of the insurers of each party), the parties would not base liability upon fault or blame but would simply ask whose property was damaged, or whose employee was injured. This would then determine which insurer paid for which loss. Properly understood, this kind of mutual indemnity is a non-litigation pact. It makes use of the principle that within an indemnity there is an implied promise not to sue. In the case in question, which involved the Piper Alpha accident, Lord Hobhouse said that there was no objection in principle to such provisions and a court should show no reluctance to give them effect. But the indemnity clause that the parties had used made no mention of negligence, so it was lacking in clarity. The principle that without clear words it would not operate to cover the negligence of the party seeking to be indemnified applied. E.E. Caledonia was the successor in title to the owners of Piper Alpha. It was seeking to be indemnified for making a settlement with the widow of an employee of Orbit Valve Co, following the accident which sank the Piper Alpha platform in the North Sea. If the indemnity had been properly drafted the position would have been that under the knock for knock agreement Orbit Valve should have born this liability to its own employees, so it should have indemnified E.E. Caledonia. But as the predecessor in title to E.E. Caledonia had been, in some respect at least, negligent and as the words did not provide for any indemnity in this situation, the court held that the indemnity did not apply. If the clause had had a few additional words stating that the indemnity would apply irrespective of any negligence on the part of the party seeking to be indemnified, this would have made a considerable difference, as the clause would now have the required clarity about the risk allocation. It cannot be too strongly stressed that there is a commercial choice to be made in these matters and full consultation with the client is needed.

‘Consequential’ loss or damage The above expression is a classic example of the dictionary meaning of a word being modified or displaced by canons of construction. The vast majority of commercial clients who have not received any legal training would be surprised to discover that ‘consequential’ loss or damages does not mean almost all loss or damages that are a consequence of a breach of contract. What it does


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mean is arcane and the result of precedent, and has shown itself liable to catch out the unwary even up to the present day.

Hotel Services Ltd v Hilton International Hotels (UK) Ltd (2000) Court of Appeal, March 15 In this recent case a contract for the supply of equipment to a well known hotel company contained an exclusion of liability for ‘consequential loss’. Precisely what the supplier had intended by this is a matter for conjecture. Commercial clients probably do not intend to exclude all liability, but they do intend to exclude financial liability over and above the cost of replacing the equipment or putting the defect right. However, this is based upon a complete misunderstanding of the law. We are back to the difference between a literal meaning and the special legal meaning given to the term. In this particular case, the claim was for the costs of removing and storing defective equipment, and for loss of profit which should have been earned by the equipment. The court held that in this contract, and in the absence of any definition, ‘consequential’ had been used as a synonym for ‘indirect’, and these were direct and natural losses arising from defects in the equipment.

Hadley v Baxendale (1854) 9 Exch. 341 The distinctions are based upon this case which appears to lay down two ways in which liability for a particular type of damages can be established. The formula laid down in this case is that damages that may be claimed are such as may fairly and reasonably be considered either arising naturally according to the usual course of things from such breach of contract itself, or such as may reasonably be supposed to have been in the contemplation of both parties at the time when they made the contract, as the probable result of a breach of it. Although neither the words ‘direct’, nor ‘indirect’, nor ‘consequential’ appear in this text, we have now reached the position where it seems to be accepted by the courts that ‘arising naturally’ means ‘direct’. So, by inference, the second part of the above formula refers to indirect or special damages. These are the damages that have come to be known as ‘consequential’. So, when a term of a contract excludes or limits liability for ‘consequential’ loss or damages, it only excludes those damages that do not arise naturally from the breach of contract. This in practice means that the value of such exclusions or limits of liability is far less than many commercial clients would like to imagine.


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LOSS OR DAMAGE DIRECT

INDIRECT OR CONSEQUENTIAL

Hadley v Baxendale Rule 1

Hadley v Baxendale Rule 2

damages arising naturally

unusual or more remote damages

Figure 3: The Hadley v Baxendale Formula

British Sugar Plc v NEI Power Projects Ltd (1997) BLR In this case the contract was for electrical installations and it contained a clause limiting liability for ‘consequential loss’ to the value of the contract, which was £106,000. The commercial thinking behind this clause was plainly to prevent all claims for economic losses over and above the contract value. But the word ‘consequential’ was undefined, and both the High Court and the Court of Appeal held that the relevant clause only served to limit those damages that were ‘indirect’. Damages that were ‘natural’ or ‘direct’, within the interpretation of Hadley v Baxendale, were not limited by the clause and could therefore rise above the ceiling of £106,000 in this particular case. Since British Sugar plc was claiming loss of profits (presumably of the direct and natural kind) in excess of £5 million, it will be understood that the clause did little to serve its intended purpose.

Pegler Ltd v Wang (UK) Ltd (2000) BLR In this case there was a term drafted for Wang which purported to exclude their liability for ‘indirect, special or consequential loss, howsoever arising, including but not limited to loss of anticipated profits or of data’. Wang probably thought that this term excluded all liability for loss of profits or of data, but it did not because of the circularity of the term as drafted. The profits


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and data referred to were covered by the words ‘indirect, special or consequential’, so that direct losses of profits or of data were not excluded. The lessons to be drawn from the recent cases are surely these: 1.

Ideally the words ‘indirect’ and ‘consequential’ should be avoided.

2.

If exclusions or limits of liability are needed other techniques, such as discrete categories of liability that are excluded, stated in plain English, should be used. These might include, where appropriate, loss of business, loss of profits, loss of data, loss of use, loss of opportunity, loss of contracts, or loss of goodwill, or money payable or paid to third parties on account of the delay caused by a breach of contract. At this point nothing will be said about whether or not such terms are fair or reasonable. That question will be addressed in the next chapter.

3.

If the client insists upon the use of the word ‘consequential’, or if indeed the lawyer drafting the contract feels that there is any value left in the word, then it can be given an express definition in the contract which, if properly drafted, may succeed in widening its meaning. But the important thing is not to make such a definition ‘circular’, since this will achieve very little.

The knock-on effect of amendments If the parties to a contract use a standard form of contract and then amend it or add to it during the negotiations, the courts may have to interpret the effect of these changes. A contra proferentem approach will frequently be taken, and those drafting the contract should be aware that the amendment may be interpreted as having deeper significance than they had expected. To give an example, the parties may have set out their respective obligations, and then may have set out a risk allocation. An amendment may then have been made to the terms, producing a different layout of the tasks to be performed by the parties. What those drafting the contract may fail to appreciate, however, is that this may lead a court to take a strict view of the risk allocation. The court may indeed decide that the alteration to the tasks to be performed by the parties must have meant that they intended to rearrange the risk allocation. And the contract will be interpreted in light of this. The case set out below is a good illustration of this.


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The Visurgis (1999) Lloyds Law Reports In this case the charterers of a ship were the plaintiffs, who were claiming in respect of some major parts of a crane weighing 1400 tonnes, which fell from the port side of the ship as a consequence of negligent lashing. The owners of the ship were the defendants and they relied upon the terms of the charter, which was an amended Gencon form and provided, among other things, that the owners were to be responsible for loss of or damage to the goods ‘only in case the loss of or damage to the goods has been caused by the improper or negligent stowage of the goods’. This term was intended to restrict the liability of the owners to cases where they had performed their task negligently. A further term stated that the owners were not responsible for any other loss or damage arising from any other cause whatsoever, even from the neglect or default of the captain or the crew. But a new clause was typed into the contract during the negotiations and this stated that ‘all lashing/securing/dunnaging at loading port...will be performed by vessel’s crew… in owner’s time using materials as on board free of charge to charterers’. It will be noted that this clause has altered the tasks to be performed by the owners or by persons under their control: lashing, securing and dunnaging are different tasks from, and additional to, stowage. The Queen’s Bench (Admiralty Court) held that, firstly, the cause of the loss was the incorrect lashing of the main item, a rear machinery bed (RMB), and that this negligent lashing, which had been carried out by the crew under the master’s direction, was the sole cause of the loss.Secondly, the new clause had introduced a new division of performance. Thirdly, the effect of this new typed clause was that the owners undertook to perform the lashing operation with due care. The owners were therefore liable for the negligent lashing, and the term excluding their liability was not applicable.


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Chapter 6 Control by the courts: valid and invalid terms The rule against penalties ...................................................................75 Unfair terms: some common law principles.....................................78 Unfair terms: the scope of the Unfair Contract Terms Act 1977....80 Unfair terms: some cases on the test of reasonableness.................83 Unfair terms in consumer contracts..................................................86 Other tests of validity under statute ..................................................87 The Human Rights Act 1998...............................................................88

Chapter 6 Control by the courts: valid and invalid terms In this chapter we will be taking a fresh look at various reasons, common law, equitable and statutory, why some terms of commercial contracts may be held by courts to be invalid. Such rules do not stand still and have been added to in recent years, as well as being reinterpreted from time to time.

The rule against penalties This rule derives from the rules of equity and has been in existence for upwards of two centuries. It exists in many common law systems around the world but has no exact equivalent in civil law (continental law) systems. The rule is that if a sum is fixed by the contract as being payable in the event of a breach of any term of that contract, that sum may be valid as liquidated damages (that is, a genuine pre-estimate of the likely loss to the injured party), or it may be void as being a penalty. A penalty is a sum which is not a genuine pre-estimate of likely loss and which has been put into the contract for other reasons, such as a threat to the party in breach, or an attempt to recover excessive sums. Lord Diplock delivered what is probably the definitive text on this subject in the case of Photoproduction Ltd v Securicor Ltd (1980) AC 827. “Parties are free to agree to whatever exclusion or modification of all types of obligations as they please, within the limits that the agreement must retain the legal characteristics of a contract and must not offend against the equitable rule against penalties; that is to say it must not impose upon the breaker of a primary obligation a general secondary obligation to pay to the other party a sum of money which is manifestly intended to be in excess of the amount which would fully compensate the other party for the loss sustained by him in consequence of the breach of the primary obligation.” The question of whether or not any term amounts to a penalty is a rule of construction. Then, once the rule of construction has determined that a term amounts to a penalty, another, and this time a strict rule, comes into play, which is that the term classified as a penalty is void. It is deleted from the contract, and the


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6 C O N T R O L B Y T H E C O U R T S : VA L I D A N D I N VA L I D T E R M S

contract continues in being without it. This means that a party claiming to have suffered damages from a breach of contract will still be able to sue for damages; but any damages awarded will be assessed according to general principles for the assessment of damages and will not be liquidated damages.

Bramall & Ogden Ltd v Sheffield City Council (1983) This case has already been discussed in the previous chapter as an example of the contra proferentem rule. In this case there was a liquidated damages clause in a standard form of contract. But the clause was designed to provide for liquidated damages only where work was to be completed and handed over to the buyer at one time. Then, if there was a delay, a single rate of liquidated damages applied. But in fact the contract was intended for a situation in which houses were to be built and handed over to the buyer piecemeal. In such a situation, a single rate of liquidated damages is inappropriate, since it takes no account of the fact that the loss to the buyer from any delay must reduce as houses are handed over, one by one. So the scale should have been one with a provision for reduction to take account of these matters (a ‘sectional completion’ scale). Failure to take account of this meant that the liquidated damages clause could not have been a genuine pre-estimate of likely loss. So, the clause was void and the only remedy for the buyer was to attempt to prove actual loss, in a claim for damages to be assessed. (It will be readily understood that a buyer that does not have evidence of loss to hand will fail in such a claim.) This case illustrates the canon of construction that, in general, if the same sum of liquidated damages is payable for different events, there is a presumption that the sum is a penalty. It is only a presumption and not a hard and fast rule. A question frequently asked is whether or not the parties to a commercial contract are free to agree that a term amounts to liquidated damages, and is not a penalty. In short, is a penalty a matter of the wishes of the parties, or is it a matter for the courts? The answer is that if the parties state that a term is liquidated damages, this is evidence of its status, but it is not conclusive. It is still open for a court to make a finding that the term is a penalty. A case that illustrates this is Duffen v Fra Bo SpA (1998) The Times, June 15.

Duffen v Fra Bo SpA (1998) The Times, June 15 In this case the Court of Appeal had to consider, among other things, a clause in an agency agreement, which was designed to compensate the agent in the event of a breach by the principal resulting in termination by the agent. The term stated that on such termination the principal would become liable to the agent


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for and would pay to the agent the sum of £100,000 ‘by way of liquidated damages, which sum is agreed by the parties to be a reasonable pre-estimate of the loss and damage which the agent will suffer on termination of this agreement’. The Court of Appeal held that this could not be a genuine pre-estimate because the sum stated was not graduated. It was payable irrespective of the unexpired duration of the term and did not bear any reasonable relationship to the agent’s loss. This was therefore a penalty. The rule against penalties only applies to sums payable as a consequence of a breach. The rule does not apply to a debt which is fixed by agreement and payable for the performance of a specified obligation or on a specified event: see Jervis v Harris (1996) Ch. 195. This rule is of particular importance in deciding whether or not interest is capable of being a penalty. Interest that is payable as part of a contractual obligation to repay money clearly falls outside the rule against penalties. The reason is that it is not payable as a consequence of a breach of contract, but payable as part of the method of performance of the contract. On the other hand, default interest could in certain cases be classified as a penalty. This point arose in the case of Lordsvale Finance plc v Bank of Zambia (1996) 3 W.L.R. 688.

Lordsvale Finance plc v Bank of Zambia (1996) 3 W.L.R. 688 In this case the Bank of Zambia had entered into a facility agreement with the plaintiff. The agreement contained a normal interest provision and a further provision for additional interest in the event of default by the borrower. It was later argued that this additional interest was a penalty. Mr Justice Colman held that it was not a penalty, although in some cases interest uplift could be a penalty. Relevant factors were whether or not the sum was retrospective, whether or not it was reasonable, whether or not it was commercially justified by increased risk to the lender after the default, and whether or not it was consistent with international banking practice (for example in New York). It was held that in this case the interest uplift satisfied all these tests.

Cargill International SA v Bangladesh Sugar & Food Industries Corp (1998) Finally, to show that arguments as to what is capable of being a penalty are never closed, we may look again at Cargill International SA v Bangladesh Sugar & Food Industries Corp (1998), which we have already looked at as an authority that the word ‘forfeit’ does not bear its literal meaning in relation to bonds, and that sums obtained by calling on the bond may have to be repaid if they exceed the true


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loss. The case was decided as a matter of construction of the term. But at first instance Mr Justice Morison stated that if he had been persuaded that there was a term of the contract which enabled the buyer to call on the bond and to retain the money when he had suffered no damage, he would have held the provision to be penal. The comment is not part of the actual decision and raises a point that may have to be finally decided at some date in the future.

Unfair terms: some common law principles As we shall see later on in this chapter, many of the most important rules about unfair terms are contained in statutes and regulations. But the scope of these may be restricted, whereas common law or equitable principles are capable of far wider application. Under common law, one of the more significant rules in this area is that a person putting forward terms of any contract needs to bring them to the attention of the other party if they are to be effective. The more unusual or onerous the term, the more important it will be to bring the existence of the term to the attention of the other party before the contract is made. Notices that are given too late will be of no value. Mere receipts will be inadequate to incorporate terms into a contract. Delivery notes could be the terms of a contract, if the contract was concluded at the moment of delivery, but in Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd (1989) QB, the Court of Appeal held that the more onerous terms of a lending contract could not be incorporated into the contract by this method, so the contract would be read without them.

AEG (UK) Ltd v Logic Resources Ltd (1995) Court of Appeal, unreported In this case a similar conclusion was reached with regard to the terms of a warranty in a contract of sale. The seller had drawn attention to the existence of its terms of sale before the contract was made and had stated that the full text was available on request. The full text excluded conditions 13-15 of the Sale of Goods Act 1979 and substituted a more limited warranty, under which the buyer would have the burden of transporting any defective goods back to the seller. The buyer had not requested the full text and was unaware of the details of this term.


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The proceedings were commenced by the seller in the form of an action for the price, or the outstanding part of it. The buyer argued by way of set-off and counterclaim that the buyer had the right to deduct the cost of transporting the defective items (by air from Iran) from the invoiced price. The seller argued that the warranty in the conditions of contract was binding upon the buyer. The buyer argued that this part of the conditions of sale either had not been incorporated into the contract or else was unreasonable under the Unfair Contract Terms Act 1977. The interesting thing about this argument is that the test of validity of the term is similar under both common law and statute: if the term is not properly brought to the attention of the buyer it will not be part of the contract under common law principles, and it may not satisfy the requirement of reasonableness under Section 11 of UCTA 1977. The buyer won on both grounds. In other cases it may be important to be aware that two distinct grounds for contesting the validity of a term may exist, since UCTA will not always be applicable – as for example in an international supply contract.

Amiri Flight Authority v BAE (2004) 1 All.E.R. (Comm) 385 Most recently, the same issue arose in Amiri Flight Authority v BAE (2004) 1 All.E.R. (Comm) 385, in which the validity of an exclusion of liability contained in a oneyear warranty was disputed. This case contains many valuable arguments, some of which will be explored later in this chapter, but for the moment we may note that the problem was that the term in question had been included in a schedule to the contract and not in the main body of the contract. There will undoubtedly be cases where to put a limit or exclusion of liability in such a place will mean that it has not fairly been drawn to the attention of the other party. In this particular case, which involved a multi-million pound contract and in which both parties would have been advised by lawyers, it was held that in the context of the particular structure of obligations under the contract, this was not unfair.


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Unfair terms: the scope of the Unfair Contract Terms Act 1977 The title of this statute is a misnomer, since it does not (unlike the EC Directive on Unfair Terms in Consumer Contracts 1993) purport to address all types of unfair terms in contracts. It is highly selective, being mainly about the misuse of exclusions and limits of liability in certain contexts. To understand its detailed effects is like picking one’s way through a labyrinth without the guidance of a unifying thread. The 1977 Act is capable of applying to both business contracts and consumer contracts, but in different circumstances. It applies to all United Kingdom contracts, but not where a foreign system of law has been chosen, unless the choice of a foreign system of law is not bona fide, or a UK resident consumer is involved. It does not apply to ‘international supply contracts’, as defined in Section 26, nor does it apply where one of the UK systems of law is the law applicable only by choice of the parties.

Amiri Flight Authority v BAE Systems plc (2004) 1 All.E.R. (Comm) This case is a recent authority on what may become an increasingly difficult problem of deciding what is an ‘international supply contract’. The definition included in Section 26 of the 1977 Act is comprehensive, but does not necessarily deal with every possibility in a complex commercial world. In the above case, an aircraft was to be built in Hatfield and was without doubt intended for an international supply to the buyer in Abu Dhabi. But delivery, in accordance with the terms of the contract, took place in Hatfield to a representative of the buyer, who then flew the aircraft to Abu Dhabi. The Court of Appeal held that this did not qualify as an international supply contract and, as it was a sale of goods, albeit non-standard, within the UK, UCTA applied, and it was therefore subject to the requirement of reasonableness. The main Section of the 1977 Act is Section 3, and this prevents unreasonable exclusions or contracting out of liability. But to qualify for protection under this section, a party to a contract must either be a consumer, or else must contract upon the written standard terms of business of the other party. No other section of the Act has the identical qualification requirements, but as this is the section that arises most frequently, there have been a number of occasions to consider the meaning of ‘written standard terms’.


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St Albans City and District Council v ICL (1996) 4 All.E.R. In this case the Court of Appeal had to deal with a claim for damages for failure of software to compute accurately. The defence relied upon a clause limiting liability to £100,000. The question was whether Section 3 of the 1977 Act was applicable in this case. The local authority, even when defending the interests of its inhabitants, was not a consumer. So did it contract upon the written standard terms of ICL? Counsel for ICL argued that if, as was the case, there were negotiations about the terms, then the terms were not standard. This argument was rejected by the court, which stated that the issue was one of fact for the trial judge. The Court of Appeal noted that the trial judge had found that the conditions of ICL remained virtually untouched by the negotiations, and agreed with his finding that they were standard terms.

Salvage Association v Cap Financial Services (1995) F.S.R. 654 In this case there were two contracts for computer accounting software, and the court made a distinction between the two contracts. One had been drafted in advance and there was no attempt to negotiate; this was definitely ‘written standard terms’. In the case of the other contract, the standard draft only formed the starting point for negotiations. Legal advice had been sought by the buyer, and amendments were accepted by the seller. It was held that the second contract did not fall within Section 3 of UCTA 1977, (although it did fall within Section 2 of that Act, which does not impose the same qualifications).

British Fermentation Products Ltd v Compair Reavell Ltd (1999) 2 All.E.R (Comm) 389 In this case the question arose as to whether or not ‘model forms’ of contract supplied by public institutions are ‘standard terms’ within the meaning of Section 3. These terms often contain exclusions or limits of liability. The court held that in this case the form in question was not habitually used by the seller, so it did not constitute the seller’s standard terms.

Overseas Medical Supplies Ltd v Orient Transport Services (1999) 2 All.E.R (Comm) In this case the defendants used a standard form of contract produced by the British International Freight Association. This did amount to the written standard terms of OTS, presumably because they had adopted it as their own.


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We must now look at some other sections of UCTA 1977. Section 2 of UCTA 1977 is about liability for negligence: it cannot be contracted out of or avoided by notice, at all, in the case of death or personal injury. As regards other types of loss or damage, under Section 2(2) the term or notice must satisfy the requirement of reasonableness. There is an important link between this Section and the new Contracts (Rights of Third Parties) Act 1999. By Section 7(2) of the 1999 Act, Section 2(2) of UCTA 1977 does not apply where the negligence consists of the breach of an obligation arising from a term of a contract and the person seeking to enforce it is a third party acting in reliance on Section 1 of the 1999 Act. Other Sections of UCTA 1977 are different again: Sections 6 and 7 are specific to sales of goods and hire purchase, or contracts of hire, or work and materials, and prevent contracting out of statutory rights altogether in some cases, while in other cases it has to satisfy the requirement of reasonableness. But these sections do not require that the contracts be made upon standard terms of business. Section 13 of the 1977 Act confronts us with yet another difficulty. It is intended primarily as an anti-avoidance section, to prevent elaborate ways of restricting liability, by reference to remedies or rules of evidence or procedure, from being used as a means of evading the Act. But it begins with the words: ‘To the extent that this Part of this Act prevents the exclusion or restriction of any liability it also prevents…’. A question that has seldom been aired in the courts is whether or not Section 13 requires either a contract with a consumer or written standard terms of business, as does Section 3 of the Act, but not Sections 2 or 6 or 7.

Stewart Gill Ltd v Horatio Meyer & Co Ltd (1992) 2 All.E.R. 257 In this case Section 13 was applied to render ineffective a term of a standard contract of a seller which purported to make it impossible for a buyer to withhold any part of the price in respect of defective goods, whether by way of set-off or counterclaim or allegation of defective goods, or for any other reason whatsoever. This offended against Section 13, since rights of set-off and other statutory rights to withhold money would normally have been available to the buyer. What the case does not do, however, is state whether or not Section 13 would have been applicable if the terms had been negotiated terms rather than standard terms.


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WRM Group Ltd v Wood (1998) CLC 189 In this case there was a term in a contract for the sale of two companies which restricted the purchaser’s rights of set-off to £300,000 in respect of any claims for breach of warranties given in the contract; set-off was particularly relevant in this case, since the companies were being paid for by way of loan notes. The purchaser wanted to set off sums in the region of £5 million, on grounds of breach of warranty and misrepresentation. Since the expression ‘warranty’ was defined in this particular contract as including ‘the representations and warranties set out in the sixth schedule’, the main argument in this particular case was about whether or not the limit of rights of set-off satisfied the Misrepresentation Act 1967. It was held that it did satisfy the requirement of reasonableness under this Act. At page 196 of the report of this case, Lord Justice Morritt stated in a brief aside: “Counsel for WRM accepts that Section 13 (of UCTA 1977) is not relevant for the purposes of this case”. No explanation of this is given, nor are the arguments preceding this statement given in this report. But presumably it means that whereas the Misrepresentation Act 1967 does not require written standard terms, a claim under Section 13 of UCTA 1977 may require written standard terms (unless, possibly, it is a contract for sale of goods, etc.). This particular contract was not one which involved goods, and contracts for the sale of companies are invariably negotiated and not on standard terms, so Section 13 of the 1977 Act was perhaps not relevant.

Unfair terms: some cases on the test of reasonableness The requirement of reasonableness is imposed by Sections 2, 3, 4, 6, 7 and 13 of UCTA 1977, as well as Section 8 which substitutes a new Section 3 into the Misrepresentation Act 1967. Section 11 of UCTA 1977 sets out the test of reasonableness generally, and Schedule 2 of UCTA sets out further tests in relation to contracts involving goods, falling within Sections 6 and 7. Details of these tests need not be set out here, but a survey of some recent cases on this subject may be found useful.

St Albans v ICL (1996) In this case the limit of liability in the standard terms of ICL was held not to satisfy the test of reasonableness. This decision does not mean that all limits of liability expressed as agreed sums are necessarily invalid. What it does mean is that such


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limits, if unilaterally imposed, may be unreasonable due to the lack of bargaining power of the party upon whom the limit is imposed or due to the fact that the party relying upon such a limit could have obtained sufficient insurance to be able to afford a higher limit of liability.

British Fermentation Products Ltd v Compair Reavell Ltd (1999) In this case it was held that conditions compiled by a public institution were not the standard terms of the seller, but even if they had been they satisfied the test of reasonableness. In this case the conditions in question provided for a term about making good defects in machinery, or replacing it, and stated that this was instead of any warranty or condition implied by law. This case demonstrates that where ‘neutral’ conditions are compiled by an institution, which usually represents buyers as well as sellers, and where a remedial regime is agreed upon for either of the parties, the courts will be reluctant to interfere with it on grounds of fairness.

Overland Shoes Ltd v Schenkers Ltd (1998) Court of Appeal A similar view was taken in this case where Lord Justice Pill stated in relation to BIFA conditions of carriage that they were the product of the combined efforts of nearly all those associated with the shipping industry, and that they sought to balance the interest of all parties, and had long been accepted as reasonable and fair. On the other hand, a different clause in these very same conditions was held not to be reasonable in the later case of Overseas Medical Supplies Ltd v Orient Transport Services (1999) All.E.R. Comm.

Overseas Medical Supplies Ltd v Orient Transport Services (1999) All.E.R. Comm In this case the Court of Appeal had to consider a clause which provided that if the carrier arranged insurance for the customer it did so only as agent for the customer, and that if there was a failure to insure as requested there was a limit of liability of £600. It was held that these clauses were not sufficiently clear to make it obvious that the limit of liability applied not only where goods were lost but also where there was a failure to insure altogether. In Sovereign Finance Ltd v Silver Crest Furniture Ltd (1997) C.C.L.R., it was held, in a hire purchase case, that a clause purporting to exclude all liability was prima facie unreasonable.


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Watford Electronics Ltd v Sanderson CFL Ltd (2001) BLR This case is of considerable value in helping us to decide what is needed to satisfy the requirements of reasonableness under UCTA 1977. In this case the buyer, Watford Electronics Ltd, made three contracts with the seller Sanderson CFL Ltd. These were a sales contract, a software licence agreement, and a software modification licence agreement. All three contracts were according to the written standard terms of the supplier but, at the request of Watford, a term had been added to clarify the warranty commitment of the supplier. It read: ‘In addition… Sanderson commit to their best endeavours in allocating appropriate resources to the project to minimise any losses that may arise from the contract.’ The system apparently did not work in a satisfactory way, and Watford decided to replace it. They brought a claim for damages of 5,000,000 for breach of contract or alternatively for negligence and misrepresentation. The misrepresentation point was dealt with by the entire agreement clause (see Chapter 3 ) which was of the non-reliance type, and was effective to prevent misrepresentation from arising. The main point of the Court of Appeal case was a term containing a limit of liability to ‘the price of the equipment connected with any claim’. In the Technology and Construction Court, the judge, following the decision in the St Albans case, held that this limit of liability was not reasonable. The Court of Appeal held that this limit of liability was reasonable and therefore effective. The reasons were: 1.

There had been an element of bargaining in the negotiations, about price and other matters. The added ‘endeavours clause’ was a significant factor in helping to make the limit of liability reasonable.

2.

The parties were of equal bargaining power and the individual managers who conducted the negotiations were both experienced. The terms had been fully discussed and Watford had themselves traded on similar terms


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Unfair terms in consumer contracts There have been laws that have distinguished between consumer contracts and business contracts for a generation or two; UCTA 1977 makes such distinctions, although it regulates both types of contract. More recently, the EC Directive on Unfair Terms in Consumer Contracts 1993 has provided a framework which regulates only those contracts which are classified as consumer contracts. These contracts may be defined as those between a natural person not acting for the purposes of his trade, business or profession (a consumer), and a person (whether natural or legal) who is acting for the purposes of his trade or business or profession. In the United Kingdom, the above Directive was implemented by Regulations in 1994, and these have now become the Unfair Terms in Consumer Contracts Regulations 1999. These apply to virtually every type of consumer contract and impose a uniform standard of fairness which is: ‘A contractual term which has not been individually negotiated shall be regarded as unfair if, contrary to the requirement of good faith, it causes a significant imbalance in the parties’ rights and obligations arising under the contract, to the detriment of the consumer.’ The Regulations also require that a seller or supplier shall ensure that any written term of a consumer contract is expressed in plain, intelligible language. If a term is unfair within the meaning of these Regulations, it will not bind the consumer. So a consumer will be able to use the Regulations as a defence. But the Regulations go further than previous legislation since they allow the Office of Fair Trading, and the qualifying bodies specified in the regulations, to consider complaints and to apply for injunctions to prevent the continued use of unfair terms. What this means for those who draft contracts which are capable of being consumer contracts, is that the terms must be in plain language and must comply with the test of fairness laid down, or else there is a risk of one or more terms being ineffective. There is also the risk that complaints may be made to the Director General, or to any of the qualifying bodies. If such complaints are made, the normal action taken is to ask for the offending term(s) to be revised or discontinued. If the user of the terms fails to comply then injunctions may be sought.


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Director of Fair Trading v First National Bank Plc (2001) In this case a contract term, intended for consumer contracts made with the above bank, not only provided that time for repayment was ‘of the essence’, but also that interest on sums unpaid would continue after, as well as before, any judgment ‘such obligation to be independent of and not to merge with the judgment’. At first sight, this term would appear to contravene the Directive and Regulations by using language that is not plain and intelligible. In court it was argued that it created a significant imbalance and was contrary to the requirements of good faith. The Court of Appeal accepted the argument of the Director General of Fair Trading but the House of Lords reversed this decision, and held on balance that the term only provided for the consequences that a customer of the bank might reasonably have expected. What the case shows is that the arguments can be very close, and careful drafting is essential.

Other tests of validity under statute Various statutes exist which may affect the validity of contract terms. Only a few examples will be given here since they tend to be of specialised application. Under the Housing Grants, Construction and Regeneration Act 1996, Section 113(1), if a contract is a construction contract as defined, a provision making payment conditional on the payer receiving payment from a third person is ineffective, unless that third person is insolvent. This is intended to outlaw ‘pay when paid’ clauses in construction contracts, except under certain defined circumstances. Under the Late Payment of Commercial Debts (Interest) Act 1998, interest may be charged by businesses on sums that are overdue from their commercial customers. As of August 7 2002, all businesses and the public sector have been able to use the Act to charge interest to all businesses and the public sector. It is possible to draft into a contract a term which will exclude this statutory interest, but only if the contract between the parties makes its own provision for a ‘substantial contractual remedy’. As well as interest at a statutory rate, these new laws also provide for fixed statutory sums which may be added by the creditor in respect of unpaid sums.


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It is not possible to make a choice of a law of another country to evade these new laws if, but for the choice of law, the law would have been that of a part of the United Kingdom.

The Human Rights Act 1998 The Human Rights Act 1998 raises considerable debate as to whether or not it is capable of affecting commercial contracts between persons or bodies other than the public sector. The Act provides by Section 6 that: ‘It is unlawful for a public authority to act in a way which is incompatible with a Convention right’. Public authority includes courts and tribunals. So the argument is that if a court or tribunal has to decide a case about a contract, it must decide it in accordance with the Convention on Human Rights. Extrapolating this argument, it would seem that if any term of a contract is incompatible with any part of the Convention, then the court or tribunal would be bound to hold the term to be invalid, or at least to construe it in a way which is compatible with the Convention. Articles of the Convention that come to mind are: ARTICLE 1

•

This entitles every person to peaceful enjoyment of his possessions.

•

This includes land.

•

Possibly this could be relevant in interpreting forfeiture clauses in contracts and, in particular, in leases.

ARTICLE 10

•

Everyone has a right to freedom of expression.

•

This may be relevant to any terms restricting a person’s right to communicate with other persons. Confidentiality clauses are allowed. But there may be other terms which go too far. It is possible that this Article may be relevant also to matters such as dress codes of employees, or any matters relating to personal appearance.

ARTICLE 11

•

Everyone has the right to freedom of peaceful assembly and to freedom of association. This may be relevant to terms in contracts which seek to restrict the whereabouts of persons (such as employees), or people with whom they may associate.


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This brief summary is by no means intended to be exhaustive: the aim is simply to point out examples of a possible new dimension in the assessment of terms of commercial contracts to see whether they are valid or not, or whether a court will give them their intended meaning or not.

Nisshin Shipping Co Ltd v Cleaves & Co Ltd (2004) 1 Lloyd’s Law Reports 38 This case is mainly about the Contracts (Rights of Third Parties) Act 1999 (see Chapter 2 of this Report). But counsel for the defence also raised the question of the European Convention on Human Rights. The argument was about whether a third party could use an arbitration clause in shipping contracts made by other persons. The argument put by the defence was that Section 8 of the Contracts (Rights of Third Parties) Act 1999 should be construed restrictively, since it could be seen as shutting out the parties from the courts, which could be contrary to Article 6 of the European Convention on Human Rights. This argument failed, and perhaps this is not surprising, since the defence was invoking the claimant’s supposed human rights in order to try to deny the claimant’s right to arbitrate. As the judge said, the arbitration clause did not take away a right of the claimant, but instead provided a remedy which would not otherwise have been unavailable to him. However, what this case does show is that human rights have been, and no doubt will continue to be, invoked even in purely commercial cases.


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Appendices Appendix 1 List of cases cited .................................................................................91 Appendix 2 List of statutes and other enactments mentioned in the text..........95

Appendices

Appendix 1 List of cases cited AEG (UK)Ltd v Logic Resources Ltd (1995) Court of Appeal, unreported. Alfred Dunhill Ltd v Diffusion Internationale de Maroquinerie de Prestige SARL and Others (2002) 1 All.E.R. (Comm) 950. Alghussein v Eton College (1991) 1 All.E.R. 267. AMF Ltd v Magnet Bowling Ltd (1968) 2 All.E.R. Amiri Flight Authority v BAE Systems plc (2004) 1 All.E.R. (Comm) 385.

BHP Petroleum v British Steel (1999) 2 Lloyds Rep. Bramall & Ogden v Sheffield City Council (1983) unreported. British Fermentation Products Ltd v Compair Reavell Ltd (1999) 2 All.E.R. British Steel v Cleveland Bridge and Engineering Co Ltd (1984) British Sugar v NEI Power Projects (1997) BLR

Cargill Int. SA v Bangladesh Sugar and Food Industries Corp (1998) CLC. Caterpillar Financial Services Corp. v SNC (2004) Lloyd’s Law Reports Charter Reinsurance Co v Fagan (1997) AC 313 Coca Cola Financial Corp’n v Finsat International Ltd (1996) The Times, 1 May. Cosslett Re (1998) 2 WLR 131 Countrywide Communications v ICL Pathway Ltd (2000) CLC


91

APPENDICES

Days Medical Aids Ltd v Pihsiang Machinery Manufacturing Co Ltd (2004) 1 All.E.R. (Comm) 991 Don King Productions Inc v Frank Warren (1998) 2 Lloyd’s Rep. Duffen v Fra Bo Spa (1998) The Times, June 15.

E.E. Caledonia v Orbit Valve Co Europe (1994) 1 WLR 221.

Firma C-Trade SA v Newcastle P&I Assoc’n (1991) 2 AC.

Government of Zanzibar v BAE (Lancaster House) Ltd (2000) CLC 735. Grand Metropolitan plc v William Hill Group (1997) 1 B.C.L.C. 390.

Hadley v Baxendale (1854) 9 Exch 341. Harbinger UK Ltd v GE Information Services Ltd (1999) Masons CLR 335. Hendry v Chartsearch (1998) CLC Hillingdon (LB) v Cutler (1968) 1 QB Hotel Services Ltd v Hilton International Hotels (UK) Ltd (2000) Court of Appeal.

Interfoto Picture Library v Stiletto Visual Programmes Ltd (1989) QB. Investors Compensation Scheme v West Bromwich Building Society (1997) CLC.

Jervis v Harris (1996) Ch 195.

Lambert v HTV (Cymru) (1998) E.M.L.R. Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd (1994) 1 AC 85. Lombard North Central plc v Butterworth (1984) 2 WLR 7. Lordsvale Finance plc v Bank of Zambia (1996) 3 WLR 688.


92

APPENDICES

Martinez v Ellesse International Spa (1999) Court of Appeal Mannai Ltd v Eagle Star Assurance Co Ltd (1997) AC

Nisshin Shipping Co Ltd v Cleaves & Company Ltd (2004) 1 Lloyds Law Reports 38 Northern & Shell plc v John Laing (2002) 25 Con. Law Rep.

Overland Shoes Ltd v Schenkers Ltd (1998) Court of Appeal, February 12 Overseas Medical Supplies Ltd v Orient Transport Services (1999) All.E.R. Comm.

P & O Property Holdings Ltd v Norwich Union Life Assurance Society (1994) EGCS Pegler Ltd v Wang (UK) Ltd (2000) BLR Phillips Petroleum Co UK Ltd v Enron Europe Ltd (1997) CLC 329. Photoproduction Ltd v Securicor Ltd (1980) AC 827. Pitt v P.H.H. Asset Management Ltd (1994) 1 WLR 327 Prenn v Simmonds (1971) 1 WLR 1385.

Salvage Association v Cap Financial Services (1995) F.S.R. 654. SAM Business Systems Ltd v Hedley & Co (2003) 1 All.E.R. (Comm) 465 Scottish Power plc v Britoil (Exploration) Ltd (1997) Court of Appeal. Segovia Compania Naviera SA v R. Pagnan & Fratelli (1997) 2 Lloyd’s Rep. Sheffield District Railway co v Great Central Railway Co (1911) South West Water Services Ltd v ICL (1999) BLR. Sovereign Finance Ltd v Silver Crest Furniture Ltd (1997) CCLR. St Albans City & District Council v ICL Ltd (1996) 4 All.E.R. 481. Stewart Gill Ltd v Horatio Meyer Ltd (1992) 2 All.E.R. 257. Stocznia Gdanska SA v Latvian Shipping Co (1998) 1 WLR 574.


93

APPENDICES

Terrell v Mabie todd & Co (1983) The Times, July 2. Thames Tideway Properties Ltd v Serfaty & Partners (1999) 2 Lloyd’s Rep. Total Transport Corp’n v Arcadia Petroleum Ltd (1998) CLC. Trafalgar House Construction Ltd v General Surety & Guarantee Co (1995)3 WLR

UBH (Mechanical Services) Ltd v Standard Life Assurance Co (1986) The Times Union Eagle Ltd v Golden Achievement Ltd (1997) 2 All.E.R.

The Visurgis (1999) Lloyd’s Rep. 218.

Walford v Miles (1992) AC 128. Walters v Whessoe and Shell Refining Co (1960) Unreported, but set out in a footnote to AMF Ltd v Magnet Bowling Ltd (1968) 2 All.E.R. Watford Electronics Ltd v Sanderson CFL Ltd (2001) BLR Wickman Tools Ltd v Schuler AG (1974) AC 235. Witter (Thomas) Ltd v TBP Industries Ltd (1996) 2 All.E.R. 573. WRM Group Ltd v Wood (1998) CLC 189.


94

APPENDICES

Appendix 2 List of statutes and other enactments mentioned in the text Misrepresentation Act 1967 Brussels Convention on Jurisdiction and the Enforcement of Judgments in Civil and Commercial Matters 1968 Unfair Contract Terms Act 1977 Sale of Goods Act 1979 Rome Convention 1980 EC Directive on Unfair Terms in Consumer Contracts 1993 Housing Grants,Construction and Regeneration Act 1996 Human Rights Act 1998 Late Payment of Commercial Debts (Interest) Act 1998 Contracts (Rights of Third Parties) Act 1999 Unfair Terms in Consumer Contracts Regulations 1999 (SI 1999/2083)


95

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The commercial exploitation of intellectual property rights by licensing

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1 85418 296 X • 2003 The Employment Act 2002 has raised the stakes. Imperfect understanding of the law and poor drafting will now be very costly.

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Applying the Employment Act 2002 – crucial developments for employers and employees AUDREY WILLIAMS

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Insights into understanding the financial media – an insider’s view SIMON SCOTT

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European lobbying guide £129.00

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ENRON, WORLDCOM… who next?

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Tips and techniques to aid you in a new approach to campaign planning.

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MANAGEMENT AND PERSONAL DEVELOPMENT

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