Out-Law News 7 min. read

Rules governing the formation of a construction contract diverge

The rules governing the formation of a contract differ across jurisdictions. Parties engaged on construction projects need to understand how those rules might impact them to ensure they can protect their interests.

The importance of a valid contract

The importance of determining whether a contract has been formed or not can be illustrated in a couple of examples.

In the first example, a developer indicates to a construction company that it will award a ‘design and build’ contract to it. The construction company then undertakes a great deal of preparatory work of drawings, plans for planning permission applications and the like, and requests a ‘letter of intent’ from the developer to secure payment for this work pending the signing of the contract.

The developer writes to the construction company stating that the contract is to be awarded to it, “the whole to be subject to agreement on an acceptable contract”. Both parties are aware that the construction contractor requires to be paid for preparatory work, and on the strength of the letter it goes ahead and does the work. A contract is never executed because the developer in time abandons its plans for the project. The question that arises is whether the contractor can enforce a right to payment under a contract with the developer?

In the second example, an engineering contractor seeks payment for what it alleges was the balance due to it in respect of works done by it, its employees, and sub-contractors at the developer’s site and for materials supplied. The developer denies that they were liable to pay any further money to the contractor. The contractor’s claim is based on an ‘estimate’. The question arising here is whether this ‘estimate’ amounts to a binding offer and, if so, whether it was accepted by the developer, thereby binding the parties to a contractual price?

In both scenarios the interests of each party depend on whether or not they have formed a contract with each other before the contractor performed certain services or works for which it seeks payment. The law governing the parties’ dealings will be relevant to how each matter could be resolved. However, the rules of contractual formation, known also as ‘contract / no contract’, are not altogether harmonious across different legal systems. We have considered how the approaches of English law, French law and Spanish law compare, to illustrate this.

The English law approach to contractual formation

The rules of the law of England and Wales concerning the formation of a contract mainly originate from judge-made law, and they reflect a libertarian mercantile policy. Modern English law requires that:

  • there be an agreement concluded between the parties on certain essential terms;
  • all parties have an intention to enter into legal relations;
  • unless expressed as a deed, the agreement is supported by ‘consideration’ – i.e., reciprocal acts or forbearances of each party, or the promise thereof, that benefit the other party;
  • the persons entering into the contract have the necessary capacity to do so; and
  • in some cases, for example, in cases of a guarantee, certain formalities have been satisfied – for example, generally, in the case of a guarantee, it must be evidenced in writing.

In practice, the requirement for agreement on all essential terms, and the certainty of those agreed terms, probably represents the most active area of dispute in construction and engineering projects governed by English law. After a long period during which English case law indicated a requirement for certain minimum essential terms, the ‘unwritten’ law now recognises the freedom of negotiating parties to decide what terms are a pre-condition to a concluded and legally binding agreement, and in a contract for the supply of a good or service the price and time for the performance of obligations may be implied.  

The French law approach to contractual formation

On 1 October 2016, the French law of contract was subject to a significant reform. Prior to the entry into force of the current version of the Code Civil, Article 1108 stipulated four conditions for the formation of a contract: consent; capacity; a certain and determined subject-matter; and a lawful cause of the obligation.

Although long considered to be ambiguous, it was commonly acknowledged that the concept of cause had two aspects. On the one hand, the subjective ‘cause du contrat’, which refers to the motive of a party to enter into an obligation, and on the other hand, the objective ‘cause de l’obligation’, referring to the consideration expected in exchange for one's own obligation. In simple terms, the French cause was aimed at protecting the contractual balance.

With the 2016 reform, the formal positive requirement for a cause disappeared from the French code. Now, it sets out only three conditions for the validity of a contract: consent; capacity; and a lawful and certain content. However, the concept of cause lives on today albeit indirectly in the Code. For example, the notion of cause in its role akin to that of consideration resurfaces in Article 1169, which provides for a contract to be annulled where the consideration (contrepartie) is illusory or derisory.

The Spanish approach to contractual formation

The Spanish Código Civil sets out the principles of the law obligations and contract law under Spanish Law. More specifically, Articles 1246 to 1259 of the code contain the basic rules on the formation of contracts. Three main elements are all essential to form a valid contract under Spanish law, as established in Article 1261– namely: consent, object, and ‘cause’.

Consent presupposes, as a minimum, that one of the parties entering into the contract offers something to the other party and that the latter accepts what is proposed. Hence, the consent must be evident. As per Article 1262, the decisive moment for examining the parties’ intention is at the point of formation of the putative contract. As provided by Article 1282, the intention of the parties is also interpreted through their acts both during the negotiations and subsequently. This is because the acts of the parties are expressions of their will.

If the intention of the parties is unclear, then the test that a judge would apply is to consider what reasonable person would have understood with the information available at the time of concluding the contract. Silence or inaction of the party to whom an offer is made does not constitute acceptance. However, there can be tacit consent by conduct.

‘Object’ is a concept of economic valuation that corresponds to an interest of the contracting parties. The object cannot be unlawful or in restraint of free trade.  Further, it must be possible, and it must be ascertainable.

As with the prior French law, ‘cause’ bears no fixed legal definition and has been likened to the purpose of achieving a certain result through the contract. There is a movement to similarly reform Spanish legal principles of contractual formation, as occurred in France, to not view cause as anything distinct from the other two required elements – namely, of consent and object. Advocates of this reform point out that eliminating ‘cause’ as a requirement of the contract does not mean, however, that the functions attributed to it cease to be fulfilled, even if in a different way. For instance, problems arising in contract formation such as a lack of cause can also be viewed from the perspective of error – i.e., lack of consent due to error. However, until such reform takes place, ‘cause’ remains as a positive prerequisite to the formation of a contract under the Spanish legal system.

Another concept of interest in contract formation under Spanish law is vitiated consent due to error. Consent, as an essential element of the contract, must be formed freely and spontaneously. It is vitiated when the will to form a contract is defective – this can occur for various reasons, one of which is error. Error is to be understood as a mental misrepresentation of reality that vitiates the formative process of the internal will. An error can affect the validity of a contract and render it null and void.

The diversity of approaches to contract / no contract

At the high conceptual level, the modern rules governing the formation of a contract are similar across the three sampled legal systems. For instance, where the question of terms is concerned, the approach to identifying what the parties regarded as essential to a binding contract seems to be similar. The concepts of cause and ‘consideration’ also share similarities. Both are necessary elements in the formation and enforceability of contracts. Under English law, a contract is binding only if valuable consideration is exchanged between the parties except in the case of certain forms of legal instrument. Both concepts – cause and consideration – demonstrate the intention to enter into a binding agreement and do not require an equal exchange of value.

So, when we return to our two examples above, very similar substantive issues are likely to arise for consideration, chief among them being the proper interpretation of the parties’ communications and other documents ‘crossing the line’ between them, and the degree of certainty reflected in the contractual terms that can be discerned from those dealings. English law appears to afford relatively greater latitude.

Under the English, French, and Spanish approaches to the contract / no contract question, it is doubtful that the first example would involve the formation of a binding contract due to the absence of certain contractual terms. As to the second example, modern English law, based on applicable precedent, might recognise the existence of a contract providing for a reasonable price to be paid for the works done. Perhaps under both French and Spanish law, the position might be less clear. 

General guidance

Parties should not assume that the same issues of law will arise in a contract / no contract scenario regardless of the applicable law. When negotiating over the terms of interim contractual documentation, depending on the commercial objective one is striving for, a recognition of the most likely applicable law, and the applicable principles pertaining to the formation of contracts, will serve to help a party avoid being subjected to another important law – namely, that of ‘unintended consequences.’

Co-written by Florian Quintard of Pinsent Masons.

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