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The phrase “subject to contract” should be used when you are negotiating what you expect may in the future become a binding contract, but not yet. So when negotiating a letter of intent or heads of terms, it is a useful way of making it clear that, although the key terms of the transaction are being put in writing, you don’t intend to be legally bound unless and until those terms are then confirmed in a more formal, detailed agreement. And anyone who has bought or sold a house in the UK will be familiar with offers being “subject to contract” (or “STC”), making it clear that, although an offer to purchase a property may have been accepted by the seller, there is no commitment to proceed with the transaction until the parties exchange contracts.
So far, so straightforward. But it should be borne in mind that using the “subject to contract” phrase is not conclusive, but creates a presumption that the parties do not intend to create legal relations (ie enter into a binding contract), and that the behaviour of the parties may result in the protection offered by the “subject to contract” to be lost. So, for example, in the case of RTS Flexible Systems Ltd v Molkerei Alois Müller1, Müller had sent a letter of intent to RTS, together with a draft contract which included a clause limiting RTS’s liability in the case of certain disputes. The draft contract also included a clause stating that the contract would not be binding unless it was signed and executed by the parties, ie that it was subject to contract. The contract was never signed, but RTS proceeded with its supply obligations with the consent of Müller. A dispute arose which included a claim by Müller against RTS for failing to supply equipment of the correct specification. Müller argued that the draft contract (with the clause limiting RTS’s liability) did not apply since the draft included the clause confirming that it was not binding unless signed and executed. The Supreme Court disagreed, and decided that the parties had proceeded with the project as if the draft contract did apply, and they had therefore, by their conduct, waived the clause in the contract that stated it would not take effect unless signed.
So to summarise:
- If you want to avoid the risk of finding that a binding contract has been formed during negotiations, make it clear at the outset that the discussions are subject to a formal, detailed agreement being signed, label your emails and any draft documentation with “subject to contract”, and confirm the “subject to contract” nature of the discussions prior to the start of any meetings or phone calls.
- And if you decide to start work before the formal contract is signed, then you need to make it crystal clear that the contract negotiations remain “subject to contract”, so as to avoid a court inferring that the subject to contract understanding had been waived by agreement as a result of the parties’ conduct and communications.
Note 1: RTS Flexible Systems Ltd v Molkerei Alois Muller Gmbh & Company KG (UK Production) [2010] UKSC
Tags: subject to contract
Posted in Commercial, Updates | Comments Off on Legal know-how: “subject to contract”
If you are involved in negotiating commercial agreements, you are likely to have come across situations where either you or the other side is unwilling to agree to an absolute obligation (eg “the Distributor shall achieve sales of the Software of at least £1 million in the first 12 months….”), but agrees to use its “reasonable endeavours”, or even “best endeavours”, to do so. And, in our example, it may only be if and when the £1 million sales target is not reached that the parties consider what the words “reasonable endeavours” or “best endeavours” actually mean.
Disputes as to the meaning of “reasonable endeavours” and “best endeavours” (as well as their numerous variants, eg “all reasonable endeavours”, “commercially reasonable endeavours” etc) have ended up in the courts with perhaps unsurprising frequency. But because each of the court cases turns on its facts, and in particular the specific obligation which is the subject of the reasonable/best endeavours qualification, there are no one-size-fits-all definitions.
The best we can do (no pun intended) is to look for some general principles from the cases, and then to consider how we can apply those principles to at least reduce the risk of the endeavours obligations in our agreements ending up in court.
Some guidance from the courts….
- Back in 1980 the Court of Appeal said that a best endeavours obligation required the contracting party “to take all those steps in their power which are capable of producing the desired results … being steps which a prudent, determined and reasonable [person], acting in his own interests and desiring to achieve that result, would take” [1].
- Then in 2007 a court suggested that a key difference between “reasonable” endeavours and “best” endeavours is that a reasonable endeavours obligation does not require a party to sacrifice its own commercial interests” [2], whereas, by extension, a best endeavours obligation may require a party to do so.
- The principle of a party having to sacrifice its own commercial interests was illustrated in the Jet2.com v Blackpool Airport case last year [3]. The agreement between the operator of Blackpool Airport (BAL) and the low cost airline Jet2.com included a provision that BAL would use its best endeavours “to promote Jet’s low cost services”. The Court of Appeal decided that BAL was obliged to continue to operate the airport outside BAL’s standard opening hours for Jet2.com flights even if this resulted in BAL running at a loss.
- But a best endeavours obligation is not absolute, and does allow the relevant party to have some regard for its own commercial interests; in the words on one judge a best endeavours obligation would not require action resulting in “the certain ruin of the Company or … the utter disregard for the interests of shareholders” [4].
- In contrast to best endeavours, a court has held that a reasonable endeavours obligation entitles the relevant contracting party to balance the obligation against all relevant commercial considerations, ie where the party has a number of courses of action available to it, the party need not pursue a course of action which would lead to commercial disadvantage. (The exception to this is where the agreement provides for the specific measures that the party needs to take, in which case the obligation to take those measures, or at least to try to do so, will prevail irrespective of any commercial disadvantages).
- Although “all reasonable endeavours” is often used as a halfway-house or compromise between “reasonable endeavours” and “best endeavours”, the courts have suggested that it should be considered to be more akin to a “best endeavours” obligation. In one case in 2008 it was decided that “all reasonable endeavours” was in fact equivalent to “best endeavours” [5].
…and putting them into practice
- Work on the basis that an endeavours obligation (whether “best”, “reasonable”, or “all reasonable”) will always be subject to differences of opinion – one party’s opinion as to what is reasonable, or even possible, may not be shared by the other party.
- Keep in mind that a best endeavours obligation (and in many situations, an all endeavours obligation) may require the relevant party to sacrifice its own commercial interests in order to satisfy its endeavours obligation. If this is not acceptable to the party, qualify the best endeavours obligation with appropriate language, eg “use all reasonable, but commercially prudent, endeavours”.
- Agree what actual steps are required in order to satisfy the endeavours obligation (and/or what steps are not required to be taken), and when those steps should be taken. Using our distributor sales target example, try to agree what the distributor needs to do as part of their endeavours obligation, eg employ a specific number of sales staff during a specific period, spend a minimum amount on advertising/online marketing, attend specific conferences/marketing events etc.
- Where the endeavours obligation will, or is likely to, require the relevant party to incur expenditure, agree a limit on the amount of that expenditure. So in our example, instead of (or possibly in addition to) outlining the activities that the distributor is obliged to undertake, include a fixed cap on the amount of money that the distributor is required to spend in trying to achieve the sales target.
Notes:
1. IBM United Kingdom Ltd v Rockware Glass Ltd [1980] FSR 335
2. Rhodia International Holdings Ltd v Huntsman International LLC [2007] EWHC 292
3. Jet2.com Limited v Blackpool Airport Limited [2012] EWCA Civ 417
4. Terrell v Mabie Todd and Co. Ltd [1952] 69 RPC 234
5. Hiscox Syndicates Ltd v The Pinnacle Ltd (2008)
Tags: best endeavours, reasonable endeavours
Posted in Commercial, Updates | Comments Off on Best and reasonable endeavours
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