Terms such as “letter of intent”, “memorandum of understanding” and “heads of agreement” are often bandied about in business on documents which are intended somehow to fall short of a “full” contract, but what exactly are they and, in particular, what effect do they have if the parties subsequently fall out?
Unfortunately there is no magic to any of these terms in English law – the documents themselves can mean whatever the parties intend them to mean, and the courts will decide on their legal effect by what the documents say, not what they are called. Worse still, recent case law suggests that what the courts decide in such cases will not always be the most obvious conclusion.
To bind or not to bind
It’s a big part of Contract Law 101 that a binding contract comes into force when one party makes an offer that the other party accepts. Acceptance can be in the form of a signed document, but it does not have to be; if the parties take steps to perform the contract then courts for centuries have held that this can be good enough to form a binding contract.
In one case last year the makers of Muller yoghurt entered into discussions with an equipment manufacturer for the supply of a number of automated packing machines. The discussions went on for years, with the manufacturer producing no less than 10 quotations over time, with terms and prices changing as the discussions went on. The manufacturer eventually supplied 2 production lines, and subsequently was told by Muller over the telephone that the manufacturer had won the contract. The parties agreed a price of £1.6 million. Muller then sent the manufacturer a “letter of intent” stating that full contractual terms would be based on a specified standard industry format known as MF/1 and full terms and technical specifications would be agreed within 4 weeks. The manufacturer agreed to this, subject to 2 points of detail.
Negotiations continued for some time afterwards, with the 4 week period being extended by agreement several times, but although all of the major points were settled the parties could not agree on final terms.
The judge in the High Court held that, after the 4 week period and by no later than 29 June 2005, a new contract came into existence because the parties had agreed all of the main contractual points and proceeded, largely, to perform it. However, the Court of Appeal saw things differently. Clause 48 of MF/1 stated “the Contract… shall not become effective until each party has executed a counterpart and exchanged it with the other.” The effect of these words was that, whilst the letter of intent had been binding during the initial 4 weeks and then as extended, no contract after that could come into force at all unless it was signed and exchanged by both parties.
The Court of Appeal decision was something of a surprise, and Muller appealed. On 10 March 2010 the Supreme Court confirmed that in a case where a contract is being negotiated subject to contract and work begins before the formal contract is executed, it cannot be said that there will always or even usually be a contract on the terms that were agreed subject to contract.
However, the Supreme Court went on to say that English law did recognise that in some cases, although certain terms of economic significance to the parties might not be agreed, neither party intends agreement of those terms to be a precondition to a concluded agreement. The parties regard them as relatively minor details which can be sorted out without difficulty once a bargain is struck. The parties agree to bind themselves to agreed terms, leaving certain subsidiary and legally inessential terms to be decided later. This was the case here. The parties had effectively reached a binding agreement on or about 25 August (which incorprated more details than the initial judge had thought applicable) and, by acting as they did and proceeding with the work, the parties had waived the requirement set out in clause 48 for the contract to be in writing.
“Subject to contract” – does it always work? No.
If it is the intention of the parties that a letter of intent or similar is not to be contractually binding then applying the words “subject to contract” will usually do the trick. However, even here the position is not crystal clear. In the recent case of Jirehouse Capital v Beller a trial of a previous dispute between the parties was due to commence on 29 June. On 23 June lawyers on both sides started to discuss a settlement using “subject to contract” in their correspondence. A deal in principle was agreed, and on 30 June one side’s lawyer sent out final documents to the other side marked “subject to contract” stating that “draft settlements are attached for your final consideration. All terms have been agreed”.
The parties subsequently fell out again, and the question was raised whether the settlement reached had been binding or whether the use of the words “subject to contract” had prevented this. The High Court held that the use of the words on 30 June was not effective; the parties had done the deal, it was binding, and the lawyers did not by then intend to use the expression.
“Subject to contract” – should you bother to use it? Yes.
In Whittle Movers v Hollywood Express a provider of distribution services (H) decided to use W as its subcontractor, and sent W a letter of intent that was expressed to be subject to negotiation and execution of a mutually satisfactory and legally binding documentation; the letter was not binding on either party, and any work done in anticipation of the contract was at that party’s risk and cost. In the event, whilst an interim agreement was entered into, no full contract was ever agreed, but nonetheless W started doing work for H and invoiced H accordingly. Subsequently the owners of H decided to sell the business and H gave W six months to terminate any contract there might be.
The High Court decided that there was a binding contract between the parties and that this was based on the interim agreement together with the circumstances of the performance of the contract. The Court of Appeal, however, said that there was no contract at all – the parties had never finished their negotiations, and the courts should be slow to overturn the effectiveness of the use of “subject to contract”.
The dangers of letters of intent
It is alarming that the Muller case came before three courts (the High Court, Court of Appeal and Supreme Court) and three different judgements were handed down. To avoid this kind of nightmare letters of intent need particularly careful drafting so that a situation does not arise where one party thinks it has a binding commitment from the other, whereas the other thinks it remains free to walk away at any time because no binding contract has been reached. By their nature such documents are intended to be relatively brief outlines of the deal as a whole which will be contained in a later, more comprehensive document, and sometimes there is a temptation to avoid using clear language for fear of delaying the negotiation process. Those who succumb to that temptation can face a very uncertain ride in front of the English courts at the moment.
Lord Clarke, when giving the judgement of the Supreme Court in the Muller case, said “the moral of the story is to agree first and to start work later”. Which of course is easy for a judge to say – he’s not trying to run a business…
© Taveners March 2010