Contract was in place because companies behaved as if it was, says Supreme Court

Out-Law News | 11 Mar 2010 | 4:08 pm | 4 min. read

A deal was governed by a contract despite the two companies involved not actually signing and exchanging copies of it, the Supreme Court has ruled. The contract is in effect because the firms behaved as if it was, it said.

Molkerei Alois Müller (Müller) hired RTS Flexible Systems to provide and install a series of packaging machines in a deal worth about £1.7 million. The two companies negotiated a complex contract whose schedules covered issues such as limits of liability, testing, prices and payment structures and other details of the deal.

The companies agreed that work should begin based only on an outline deal covered by a letter of intent. When that ran out negotiations on the full contract proceeded, concluding on 5th July 2005 with some further amendments to the delivery timetable on 25th August.

One of the contract's clauses stated that the contract would not come into effect until copies of it had been signed and exchanged between the two companies. That never happened. A dispute as to the machines' performance followed, resulting in the current court proceedings. A preliminary issue for the court to settle was how much, if any, of the contract was in force.

The original court ruling said that the contract was partially in force. The Court of Appeal said that none of it was. The Supreme Court has now ruled that almost all of it was in force and that, by their behaviour, the companies had adhered to its demands and had effectively waived the requirement for an actual exchange of signed documents.

In his ruling Lord Clarke said that carrying on with a deal before a contract is finished is an all-too-common and potentially costly mistake.

"The different decisions in the courts below and the arguments in this court demonstrate the perils of beginning work without agreeing the precise basis upon which it is to be done," he said. "The moral of the story to is to agree first and to start work later."

He said that the lack of a formal execution of the contract meant that there were three possible ways to see the situation: that RTS's carrying out of its end of the deal was being done with no contract in place; that the contract was partially in place; and that almost all of it was in effect.

The Supreme Court rejected the first two positions, which were those taken by the two lower courts.

"The no contract solution is unconvincing," said Lord Clarke. "Moreover, it involves RTS agreeing to proceed with detailed work and to complete the whole contract on a non-contractual basis subject to no terms at all."

"It is unrealistic to suppose that the parties did not intend to create legal relations. This can be tested by asking whether the price of £1,682,000 was agreed. Both parties accept that it was. If it was, as we see it, it must have formed a part of a contract between the parties," he said.

The Supreme Court found that by 5th July, the contract was effectively in place, varied only by the conclusions of a meeting on 25th August.

Lord Clarke said that cases like this one had occurred frequently, but that this one was different to the others. He said that an important fact was that both companies behaved as if the full contract was in place.

"The striking feature of this case which makes it very different from many of the cases which the courts have considered is that essentially all the terms were agreed between the parties and that substantial works were then carried out and the agreement was subsequently varied in important respects," he said. "The parties treated the agreement of 25 August as a variation of the agreement that they had reached by 5 July. Nobody suggested in August that there was no contract and thus nothing to vary. It was not until November, by which time the parties were in dispute, that points were taken as to whether there was a contract."

The Court said that the idea that only some of the contract was in force makes no sense either. "It does not seem to us to make commercial sense to hold that the work was carried out on some but not all the terms agreed by 5 July," it said. "It is, in our judgment, inconceivable that the parties would have agreed only some of the terms."

"By 25 August there was in our judgment unequivocal conduct on the part of both parties which leads to the conclusion that it was agreed that the project would be carried out by RTS for the agreed price on the terms agreed by 5 July as varied on 25 August," said Lord Clarke.

Though the contract itself said that it would only come into force when the parties exchanged signed copies of it, the Court said that this clause had effectively been waived.

"The circumstances point to the fact that there was a binding agreement and that it was not on the limited terms held by the judge. The price had been agreed, a significant amount of work had been carried out, agreement had been reached on 5 July and the subsequent agreement to vary the Contract so that RTS agreed to provide Line 1 before Line 2 was reached without any suggestion that the variation was agreed subject to contract. The clear inference is that the parties had agreed to waive the subject to contract clause, viz clause 48. Any other conclusion makes no commercial sense.

Pinsent Masons, the law firm behind OUT-LAW.COM, acted for Muller on its successful appeal to the Supreme Court in this case.