UK - Always get it in writing: English Supreme Court finds a contract exists despite lack of written agreement
In March 2010 the Supreme Court handed down its decision in RTS Flexible Systems Ltd (RTS) v Molkerei Alois Muller GmbH & Co KG (Muller)  which clarified that there was a contract between RTS and Muller, despite the agreement being expressed as "subject to contract" and no written contract ever having been signed. In so doing, the Supreme Court highlighted the perils of beginning work without agreeing the precise basis on which that work is to be done and reached a different conclusion from both the Court of Appeal and the High Court.
RTS specialises in the supply of automated machines for packaging and product handling in the food and consumer goods industry. Muller, a well know leading European dairy product supplier, entered into discussions with RTS regarding automating its product re-packaging process. While negotiations were continuing, and before the terms of the contract had been agreed, RTS began work on the basis of a letter of intent and the understanding that ultimately terms would be finalised.
Muller sent RTS the letter of intent in February 2005 setting out a draft contract, providing that the work had to be completed by 30 September 2005 for a price of Ł1.6 million and incorporate Muller's amended standard MF/1 construction contract conditions (MF/1 conditions). The significance of the MF/1 conditions is that they contained provisions on many matters, including limitations on liability and liquidated damages.
By 5 July 2005, substantive agreement had been reached on all major points and a draft final contract was produced, which stated that it would not become effective until each party had executed and exchanged a counterpart. This was never done. Rather, with all the terms having been agreed, the parties proceeded with the project and on 25 August 2005, the agreement was varied in important respects.
A dispute later arose between the parties in relation to the delivery by RTS of certain equipment to Muller. The main issue to be decided by the Supreme Court was whether the parties had entered into a contract following the expiry of the letter of intent and, if so, the terms of that contract.
The first instance and Court of Appeal proceedings
The judge at first instance found that after expiry of the letter of intent, a new contract had been concluded. He held that the parties had reached full agreement on the essential terms of the contract and that, in view of their performance of those terms. It was unrealistic to suppose that the parties had not intended to create legal relations. However, the contract was based on limited terms. The trial judge declined to find that the contract included the final draft version of the MF/1 conditions, holding that the following counterparts clause prevented this unless and until executed by each party:
"The Contract may be executed in any number of counterparts provided that it shall not become effective until each party has executed a counterpart and exchanged it with the other." (Clause 48)
RTS appealed the judge's conclusions. Finding in favour of RTS, the Court of Appeal overturned the trial judge's decision. It was held that on the wording of the counterparts clause, any contract (not just the MF/1 conditions) was prevented from coming into existence until a written agreement was executed and as a result, no contract had come into existence after termination of the letter of intent.
Muller appealed to the Supreme Court.
The Supreme Court's decision
The Supreme Court reached a different conclusion from both the Court of Appeal and the High Court, Lord Clarke delivering the judgement of the court to which all of its members contributed.
The Supreme Court identified three possible conclusions that were open to it: (1) there was no contract between the parties (as held by the Court of Appeal); (2) there was a contract between the parties on the limited terms found by the trial judge; or (3) there was an agreement between the parties on some other wider terms.
In respect of the first possibility, the Supreme Court found the idea that there was no contract to be unconvincing. Agreeing with the trial judge, the Supreme Court held that it was unrealistic to suppose that the parties did not intend to create legal relations. It was common ground that the parties had agreed the price, which must have formed part of a contract between them. As the parties accepted that the letter of intent expired and was not revived, the contract containing the price must have been contained in some other agreement.
As regards the second possible outcome, the Supreme Court emphasised that it was relevant that the parties treated the agreement reached on 25 August as a variation of the agreement that they had reached by 5 July and it was not until they were in dispute that suggestion was made that there was no contract. Equally however, it would make no commercial sense to hold that the work was to be carried out on some, but not all, of the terms agreed by 5 July.
Finally, in considering the third possibility, their Lordships argued that two questions arose: (i) whether the parties intended to be bound by what was agreed or whether there were further terms which they regarded as essential or which the law regards as essential in order for the contract to be legally enforceable, and (ii) whether the parties departed from the original understanding or agreement that it was to be 'subject to contract'.
In answer to the first question, the Supreme Court stated that the parties had reached essential agreement by 5 July. None of the issues outstanding after that date were regarded as essential matters requiring agreement before a contract could be binding. In respect of question two, it was held that it is possible for an agreement "subject to contract" to become legally binding if the parties later agree to waive that condition, as the parties in this case did on or by 25 August.
The court noted the perils of beginning work without first agreeing the precise basis upon which it is to be done, the moral of the story being to agree first and to start work later.
The Supreme Court's judgment is a significant reminder of the risks involved in proceeding with work under a letter of intent. Whilst commercial pressures will continue to result in contractors commencing work before a full and final written contract is concluded, it is prudent to ensure that critical terms are sufficiently set out in the letter of intent and that final terms are agreed upon in a written contract as soon as possible thereafter. It is also helpful if the parties use clear language to reflect their intentions with regard to the creation of binding legal obligations.
If there are no clear written statements, there will be considerable scope for uncertainty and litigation as to whether a contract has been concluded and, if so, on what terms.
In addition, if a contract is found to exist, parties should note that the terms of that contract will be informed by conduct and may come into existence as a result of performance. In such circumstances, it may be untenable to argue that the contract is void for vagueness or uncertainty.
Businesses should be aware that the "subject to contract" provision in this case was in fact a counterparts clause (one that is commonly included in English law contracts to allow the parties to execute separate copies of the agreement) which was treated by the courts as a "subject to contract" provision. Businesses are advised to review their boilerplate counterparts clause to see whether it could be construed in this way as they will not always intend a counterparts clause to have this effect. Indeed, the finding may prove detrimental to suppliers who commonly start to carry out contracts on the basis of a draft unsigned agreement.
To conclude, the decision is important because disputes about contract formation in circumstances where work has been performed are common. Following this decision, where it is not possible to agree terms and conditions in an executed written contract before work begins, the parties should ensure that letters of intent are drafted in clear terms, stating the scope of work to be done, the period and the price to be paid.
  UKSC 14
Black clouds for Red Sky as English court finds exclusion clauses in IT contract are unenforceable
On 6 May 2010, the English High Court handed down its decision in Kingsway Hall Hotel Ltd (Kingsway) v Red Sky IT (Hounslow) Ltd (Red Sky), finding that a software supplier's standard exclusion clauses, which attempted to exclude the statutory implied terms as to satisfactory quality and fitness for purpose, were unfair and could not be enforced. In so doing, the High Court reinforced the need for suppliers to give full and accurate information to potential buyers. Whilst the case was decided on its facts alone, it highlights the importance of ensuring that business practices and standard terms are aligned.
Red Sky supplied software and related services for hotel front and back office reservations. Kingsway, who operated a busy four-star hotel, entered into a contract with Red Sky for the provision of a software package, "Entirety", to manage reservations, billing and the checking-in and checking-out of guests. The contract was under Red Sky's standard terms and conditions.
Entirety was recommended by one of Red Sky's employees as being suitable for Kingsway's needs and an improvement on its existing arrangements. The software proved to be unsuitable, particularly in relation to group bookings. It failed to show accurate room availability and there was frequent "screen-freezing". Consequently, Kingsway had to devote more staff time to dealing with reservations and use time-consuming workarounds. Kingsway asked Red Sky to resolve the problems. Although Red Sky made minor improvements, nothing substantially affected Kingsway's fundamental complaints.
Six months after Entirety was installed, Kingsway informed Red Sky that it was rejecting it, claiming that it was neither of satisfactory quality nor fit for purpose. Kingsway argued that it had given Red Sky five months to resolve the problems, but it had failed to do so. Kingsway claimed for both financial loss and additional staff costs incurred in dealing with the problems.
Red Sky attempted to rely on its standard terms and conditions arguing that clause 10.1 applied to exclude all terms relating to satisfactory quality and fitness for purpose implied by the Sale of Goods Act 1979 (SGA) and the Supply of Goods and Services Act 1982 (SGSA). It also relied on clause 10.2, which contained a warranty that the program provided would in all material respects provide the facilities and functions set out in the "Operating Documents". Red Sky claimed the exclusions satisfied the reasonableness test under the Unfair Contract Terms Act 1977 (UCTA) because the software package was an off-the-shelf package, rather than a customised one, which Kingsway bought after both Red Sky had demonstrated the product to its employees and Kingsway's employees had had an opportunity to evaluate the software themselves. As a result, Red Sky argued that Kingsway had relied on its own judgment in deciding the software was fit for purpose and to buy it.
Kingsway counter-argued that the exclusions could only have applied if it had been supplied with the Operating Documents, which was not the case. Furthermore, if clauses 10.1 and 10.2 did apply to exclude the statutory implied terms, they were unreasonable and therefore unfair under UCTA.
The High Court's decision
The High Court found in favour of Kingsway, Judge Toulmin CMG QC providing the judgement. He ruled that the attempt to limit damages by Red Sky was ineffective and that failures to provide information undermined any claim that the limitation clauses were reasonable.
The High Court found that Red Sky's attempted exclusions were predicated on the fact that prospective customers would satisfy themselves as to fitness for purpose of the software by having seen demonstrations and read the Operating Documents. In this context, access to the Operating Documents was crucial and there was no evidence that they had been provided to Kingsway when the contract was signed. Kingsway had relied on Red Sky's positive recommendation in deciding to purchase Entirety and as a result, Red Sky's standard terms excluding liability and limiting damages did not apply.
The High Court held that even if the exclusion did apply, the contract terms which restricted Red Sky's liability were unreasonable. Entirety was not fit for the purpose for which it was sold, contrary to SGA. It also did not meet the standard that a reasonable person would regard as satisfactory, taking into account any description of the goods, the price and all other circumstances, so as to satisfy SSGA.
The judge considered that the following factors contributed to the exclusion's unreasonableness:
- The parties were not of equal bargaining power.
- Kingsway and Red Sky bargained only on the price and terms of payment. Kingsway did not receive any inducement to agree Red Sky's standard terms.
- On the facts, there was no long course of dealing between the parties such that Kingsway ought to have known of the existence and the extent of the terms.
- The software was not bespoke.
Ultimately, the High Court concluded that Kingsway had been entitled to reject Entirety. It did so after giving Red Sky every opportunity to improve it so that that it would become of satisfactory quality and fit for purpose. Kingsway was therefore granted damages for loss of profits, loss of goodwill, wasted expenditure on the software and additional staff costs and wasted staff time.
Whilst the High Court's judgement rests on the facts at hand and the failure of the standard terms to satisfy the reasonableness test was specific to the relationship between the parties, anyone involved in negotiating or drafting contracts needs to be aware of the wider implications of the judge's conclusion. Key to the outcome was the fact that there was fundamental difference between the manner in which Red Sky sold the software to Kingsway and the drafting of Red Sky's standard terms of business.
The judgment is a significant signal to software suppliers of the need to ensure that the processes by which they sell their products are precise and that prospective customers are supplied with all relevant information. Suppliers must ensure that their standard terms reflect how their products will be sold in practice and that this remains the case over time. Terms and conditions must be kept up-to-date with new or different sales practices: the sales team should be encouraged to communicate any changes to the legal team to ensure that contractual terms and actual sales practices remain aligned.
  EWHC 965 (TCC)
UK - Office of Government Commerce issues new negotiating guide for ICT Services Model Agreement
On 1 April 2010, the Office of Government Commerce (OGC), in conjunction with Partnerships UK, the OGC'S delivery partner, and industry trade association Intellect launched an 11-page ICT Services Model Agreement Negotiating Guide (the Guide), intended for use with version 2.3 of the ICT Services Model Agreement. Whilst the Guide primarily targets the public sector, many of the issues covered in the guidance will be of use to private sector organisations procuring technology services in addition.
The aim of the Guide is to reduce negotiating and procurement timescales, increase understanding of certain clauses in the Model Agreement which regularly consume disproportionately large amounts of negotiation time and achieve better value for money in the procurement process.
The Guide is set out in the form of a dialogue and focuses on four main provisions:
- due diligence;
- supply chain rights (specifically competitive terms and third party rights);
- authority termination for convenience; and
- limits of liability and indemnities.
For each provision, the Guide details the relevant clauses, the main issues and concerns that can arise during negotiations and guidance to the public authority on how best to address those issues. Of particular interest to private sector ICT customers as well as public authorities, is the guidance on the negotiation of supply chain rights and limits of liability and indemnities.
The Guide warns against the inclusion of unnecessary supply chain rights, emphasising that this is likely to slow down negotiations and potentially lead to extra costs and complexity.
In relation to limits of liability, the Guide sets out three key principles: (a) only those liabilities that cannot be limited by law should be unlimited; (b) the limits of other heads of liability, as listed in the Model Agreement, should be set on the basis of a fair assessment of the relevant risks for the project; and (c) as set out in the Model Agreement, the liabilities should be for direct costs only. Furthermore, the guidance suggests that only indemnities against intellectual property rights infringement should be given as standard practice and that the public authority should consider carefully the cost-benefit implications in obtaining additional indemnities.
Ultimately, the approach encouraged by the Guide is for customers to negotiate realistic provisions that do not include unnecessary rights that might lead to higher costs and longer negotiation times. In view of the fact that the guidance was jointly written by the Government and industry, it stands a better chance of achieving its objective and lawyers in both public and private sectors involved in transactions using the Model Agreement are advised to take the time to consider it.
China - Latest PRC draft "indigenous innovation" government procurement rules: China mulls changes to policy on technology procurement
Amidst the concerns raised by foreign business organisations in China around the definition of "indigenous innovation" and the risk that the latest technology procurement rules will prevent foreign companies from accessing Chinese procurement contracts, the Chinese Ministry of Science and Technology, National Development and Reform Commission and the Chinese Ministry of Finance have released their latest draft of public procurement regulations on indigenous innovation (the Draft).
The Draft is seen by foreign players in China as introducing a relaxation of standards of qualification for public procurement. Previous requirements were that intellectual property attached to a product had to be free from foreign restrictions on its use, disposal or improvement and that trade marks associated with a product had to be owned by a Chinese company registered in China in order for such a product to qualify as indigenous innovation under Chinese law.
Based on the Draft, any company "whose products conformed with Chinese laws and the country's technology policy and which possessed legal rights to the related intellectual property" could now gain accreditation under the rules on indigenous innovation.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.