UK: Subject to Contract?

Last Updated: 1 June 2010
Article by Gerard Dempsey

The recent Supreme Court decision in the case of RTS Flexible Systems Limited v Molkerei Alois Müller Gmbh & Co KG [2010] UKSC 14 is a reminder of the dangers to businesses of commencing work on commercial projects without having agreed contractual terms in advance. In this case the court held that a contract had come into effect in spite of the fact that the agreement had never been signed and included a clause which stated that the agreement would not become effective until it had been signed and exchanged by both parties.

RTS, a provider of automation systems for packaging foods, had been awarded the contract to supply the well known dairy product manufacturer Muller with an automated system for packaging some of its dairy products. RTS began work on this project on the basis of a four week letter of intent ("LOI") pending agreement of a final contract between the parties. A draft contract incorporating Muller's amended version of the mechanical engineering industry's standard terms for such projects ("Standard Terms") was subsequently prepared but never signed.

After the LOI had expired, RTS continued working on the project and the parties continued to negotiate terms. The parties later reached agreement on most of the major issues and continued to work on the project on the basis that other less substantive issues could be agreed during the course of the project and that agreement of these terms should not be a precondition to a concluded agreement.

A dispute subsequently arose between RTS and Muller over a number of matters including whether the equipment provided by Muller was defective. Muller paid RTS only a portion of the contract price and RTS brought a claim against Muller for either the unpaid balance of the contract price, or damages.

The preliminary issues tried were: (a) whether a contract had ever come into existence between the parties; and (b) if a contract had come into existence, what its terms were.

RTS argued that either the terms of the LOI continued to govern the relationship between the parties or that a new contract incorporating the draft Standard Terms had come into effect after the LOI had expired. Muller contended that the draft Standard Terms had not come into effect as they had not been signed. Muller relied, inter alia, on the existence of a clause in the draft Standard Terms stating that the contract would not become effective until each party had executed a counterpart of the contract and exchanged it with the other. Whilst not actually being couched as a 'subject to contract' clause it was contended to have the same effect.

The Supreme Court held that in light of the fact that all essential terms of the contract had been agreed by the parties, and that the parties had commenced performance (and continued that performance during negotiations), that a contract which incorporated the Standard Terms had in fact come into existence. The court noted that the draft Standard Terms (incorporating the 'subject to contract' clause) had been varied by the parties, and on that basis the judge considered that the parties had effectively waived this 'subject to contract' provision. The court held that it made no commercial sense to find that there was no contract in existence, when the parties had in fact agreed to vary that contract.

Comment

In today's fast moving commercial world it is not always possible to have concluded the final contractual details of a proposed commercial project in advance. The reality is that businesses often enter into and perform procurement and supply projects before a contract has even been drawn up. Indeed, it is quite often the case that where a business has successfully tendered for a contract, its success has in some way been due to previous performance for that client. In these circumstances it is naieve to think that a successful tenderer, who has been supplying a client for, in some cases many years, will suddenly 'down tools' after winning a major bid and refuse to supply that client until a formal contract has been entered into and signed.

However, businesses do need to understand the risks associated with this approach and should make every effort to nail down the specifics of a contract and agree its terms, if possible before the supply begins, but if not, as soon as possible thereafter.

Merely hiding behind 'subject to contract' type clauses and refusing to sign a contract will not always shield parties from risk and the courts will in some instances look to a course of conduct between parties to ascertain the existence and terms of a contract.

www.rosenblatt-law.co.uk

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.

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