UK: Lessons From 2002 For Contract Negotiators and Draftsmen

Last Updated: 1 February 2003

2002 was a busy year in contract law. Cases like the high profile litigation between the Football League and Carlton and Granada made the headlines and explored fundamental contractual issues such as contract formation, authority, and the requirements for a guarantee.

So what lessons can be learnt from 2002?

1. Heads of terms and offer letters should be reviewed before exchanging contracts, to ensure that all matters dealt with in the heads of terms are addressed in the final form agreement.

2. Parties intending to assume obligations under a contract, including parents and subsidiaries of contracting parties, must be signatories to the contract.

3. It is unwise to commit to substantial financial investment or to proceed for any substantial period of time on the basis of a heads of terms.

All three of these lessons can be learnt from Carlton Communications v The Football League [2002] EWHC 1650. This case involved the Football League selling the television rights to matches to OnDigital for approximately £315 million. OnDigital (which was later renamed ITV Digital) was owned by Carlton and Granada (50% each). OnDigital fell into financial difficulties and the company went into administration in March 2002 leaving outstanding liabilities under the contract of approximately £180 million. Faced with a significant financial loss, the Football League attempted to establish that Carlton and Granada had guaranteed the liabilities of OnDigital and were liable to meet the outstanding payments on the original three-year contract.

In terms of documentation, the initial bid document sent in June 2000 by OnDigital (effectively a heads of terms) in relation to the right to screen Football League matches stated that, "OnDigital and its shareholders will guarantee all funding to the Football League outlined in this document." The bid document was stated to be "subject to contract." Later that month, a short-form binding contract was entered into by OnDigital and the Football League in which the parties agreed to use their best endeavours to execute a long-form agreement within 60 days and which referred back to the initial bid document but did not refer specifically to any guarantee arrangements. No long-form agreement was ever signed. The parties however proceeded on the terms of the short-form contract until proceedings were commenced in April 2002.

The Court dismissed the Football League’s claim that Carlton and Granada had guaranteed the obligations of OnDigital. The Court concluded that there was no such guarantee because:

(a) Neither Carlton nor Granada were a party to, or signatories of, the initial bid document or the short-form agreement. The Football League could not rely on implied or ostensible authority of OnDigital to commit its parents, Carlton and Granada, to a guarantee arrangement. It is a basic principle of company law that a company has its own legal personality distinct from its shareholders and a company is not an agent of its shareholders.

(b) A commitment to a guarantee could not be construed from the short-form contract. The initial bid was subject to contract and contained no offer capable of acceptance. The short-form contract was clearly only a contract between OnDigital and the Football League and did not specifically refer to a guarantee from the parent companies.

(c) Under Section 4 of the Statute of Frauds 1677, a person cannot be made to answer for the debt, default or miscarriage of another person unless the agreement is in writing and signed by the party to be charged therewith or some other person lawfully authorised.

4. Care needs to be taken to ensure that provisions in contracts are sufficiently certain to be enforceable.

In iSOFT Group plc v Misys Holdings Ltd [2002] EWHC 2094, the parties to a share purchase agreement agreed a restrictive covenant in favour of the purchaser. They then agreed a compromise arrangement under which, if the vendor purchased an entity with a competing business within the restrictive covenant period, it had to offer to sell that business to the purchaser on such "detailed terms and conditions which are fair and reasonable" to the parties. The provision was triggered but the parties could not agree the terms of the sale.

The vendor claimed that the clause was unenforceable. The Judge agreed saying that, if the provision meant that the purchaser had to make an offer capable of acceptance, then the clause was too uncertain to be enforced because the Court would have to write an entire contract. Conversely, if the word "offer" did not mean an offer capable of acceptance, then the clause was simply an agreement to agree which would be unenforceable.

With the requirement to offer to sell having been found unenforceable, the question arose as to whether the vendor was not permitted to purchase the business at all on the basis that the whole clause had fallen away leaving only the restrictive covenant (there was a severance clause which deemed any unenforceable provision severed).

The Judge held that there was still a provision under which the vendor could purchase a competing business but the purchaser was then simply left with an unenforceable agreement to agree the sale.

5. Alternative dispute resolution clauses, including those without an identifiable procedure, may more readily be found to be binding.

In the decision of Cable & Wireless plc v IBM United Kingdom Limited [2002] 2 All ER (Comm) 1041, Mr Justice Colman strongly endorsed alternative dispute resolution (ADR). He held that a clause that specifically referred disputes to ADR, but was vague in terms of the precise nature of the procedure that should be used, was nevertheless enforceable. He then went further and stated:

"I would wish to add that contractual references to ADR which did not include provision for an identifiable procedure would not necessarily fail to be enforceable by reason of uncertainty. An important consideration would be whether the obligation to mediate was expressed in unqualified and mandatory terms… In principle however, where there is an unqualified reference to ADR, a sufficiently certain and definable minimum duty of participation should not be hard to find."

Mr Justice Colman also held that for the Court not to enforce contractual references to ADR would "fly in the face" of public policy. He observed that a clearly recognised and well-developed process of alternative dispute resolution now existed. As such, a reference to ADR in the contract was certain enough to enforce.

Interestingly, although not surprisingly, Mr Justice Colman interpreted the reference to "ADR procedures recommended by CEDR" as meaning mediation although this was not specifically stated.

The practical implications of this case include:

• Dispute resolution clauses may more readily be found to be binding. Accordingly, existing clauses need to be reviewed, and new clauses carefully drafted, to ensure that they reflect the parties’ intentions. If a reference to ADR is intended to be optional or conditional the clause must state that clearly, otherwise the Court may require the parties to first submit the dispute to ADR before initiating litigation. (See sample ADR Clause below which may be used where parties intend ADR to be optional)

• When drafting ADR clauses, if a specific form of ADR is envisaged this should be spelt out e.g. mediation or early neutral evaluation.

6. When assigning or novating a contract, the terms of the agreement need to be reviewed to ensure that they are workable in respect of the new party.

In Game Group plc v Electronic Boutique Incorporated and Another [2002] EWHC 2117 (Ch), following the novation of a contract, a company was substituted by a limited liability partnership as a party to a contract. However, the change of control clause in the contract was not amended and did not contemplate the change in control of a partnership. The Court was later left to decide the purpose and effect of the clause, and held that no change of control had taken place for the purposes of the contract, despite a change in the ultimate owner of the partnership, because the person behind the entities remained the same.

7. There is a middle ground between the acceptance of a repudiation and a termination when the innocent party is deciding what to do.

Lord Justice Rix in Stocznia Gdanska SA v Latvian Shipping Company (No. 3) [2002] 2 All ER (Comm) 768, addressing the position of an innocent party when faced with repudiation stated:

"there is of course a middle ground between acceptance of repudiation and affirmation of the contract, and that is the period when the innocent party is making up his mind what to do".

The length of that period of time is likely to vary depending on the facts of the case, but is unlikely to be long. As Lord Justice Rix pointed out, if the innocent party does nothing for too long, there may come a time when the law will treat him as having affirmed the contract.

Whilst this decision should not be used as a reason for unnecessarily delaying a decision to affirm or terminate a contract following a repudiation, it does recognise that an innocent party has a period of time in which to decide what to do. However, if the innocent party during such time wishes to call upon the other party to perform, but does not wish such conduct to be viewed as an affirmation of the contract, as a precaution the innocent party should expressly reserve its contractual rights. Note, the innocent party’s failure to do this in Stocznia almost persuaded Lord Justice Rix to conclude that it had affirmed the contract.

8. When limiting liability for claims, the wording should be drafted clearly so as to indicate the type of liability being limited and whether the limit applies to individual or aggregate claims.

In Greatdays Holidays Services Limited v Bannister & Jacobs [2002] EWHC 1133, Greatdays purchased a company, Panita Travel Limited for £50,000. In the Sale Agreement it was warranted that (i) the net assets of the company would exceed a specified level and (ii) proper deductions had been made for payments of salary and benefits. Both these warranties were allegedly breached. Greatdays alleged that breach of the first warranty led to a diminution in value of the company of in excess of £60,000 and breach of the second warranty led to diminution in value of £31,000. Greatdays also claimed damages for negligent misrepresentation in respect of the same matters.

The Sale Agreement included a cap on liability for warranty claims, under the heading "Limitations on Warranties". The cap was as follows:

"The Vendors shall not be liable for any claim… to the extent that… it exceeds the sum of £30,000."

In a hearing of preliminary issues Bannister claimed that this cap should be applied as a cap on the aggregate of all claims, rather than a cap on each of the two individual claims. Bannister tried to argue that in the context of a £50,000 deal it was a commercial absurdity for the cap to apply to each individual claim, rather it should apply to the aggregated claims and therefore evidence surrounding the background to the deal should be considered.

However, it was held that the use of the word "it" in the clause containing the cap clearly referred to a single claim and not an aggregate. Because the wording of the contract was clear and the result of this application of this wording was not a commercial absurdity for the buyers, it was inappropriate to look at evidence on the background to the contract.

The Court also held that the heading "Limitation on Warranties" made it clear that the cap did not apply to the claims for negligent misrepresentation.

In light of this decision:

• When drafting or reviewing warranties, double check that the wording limiting liability is clear and covers everything that is intended, including for example, liability for negligent misrepresentation.

• Headings in an agreement should be consistent with the text of the document.

• If headings are not intended to affect the interpretation of an agreement, a general clause to that effect should be included in the agreement.

9. If relying on a guarantee, or an undertaking that resembles a guarantee, make sure the agreement is clear and in writing.

In Actionstrength Ltd v International Glass Engineering Limited [2002] 1 WLR 566, (see diagram below), SGG (the building owner) contracted with Inglen (the main contractor) to build a factory for SGG. Inglen then subcontracted with Actionstrength (the subcontractor) to supply the labour to build the factory. Actionstrength threatened to withdraw its labour from Inglen, because Inglen owed it a substantial amount of money for services rendered. To induce Actionstrength to continue supplying labour to Inglen, SGG orally agreed with Actionstrength that if Inglen did not pay Actionstrength, SGG would to that extent redirect to Actionstrength monies due from SGG to Inglen. Inglen failed to meet its liability and SGG refused to redirect any money to Actionstrength.

The question asked of the Court of Appeal was whether the agreement between SGG and Actionstrength was a guarantee within Section 4 of the Statute of Frauds 1677. The Court of Appeal held that the arrangement was a guarantee under Section 4 and therefore must be in writing. Accordingly, the agreement was held to be unenforceable. Note, this was why the claim for a guarantee also failed in the Carlton and Football League case discussed above – there was no guarantee in writing signed by the "guarantors".

10. Failure to make full disclosure to the other party could amount to deceit.

In MacDonald v Polaine and Hill Publishing [2002] EWHC 710, MacDonald and Polaine were joint owners and the directors of a company (EFM) and held discussions about one buying the other out. In the discussions about who was to buy out whom, MacDonald asked Polaine if he was in discussions with any third party about the purchase of the company at that time and Polaine said that he was not. This was later confirmed in writing by Polaine’s solicitors. In addition, MacDonald was given an assurance that all material matters had been disclosed. In fact, Polaine had for some time been in negotiations with Hill Publishing to sell the whole company to it as soon as MacDonald had sold to Polaine. Within a few weeks of completion of the sale of MacDonald’s shares to Polaine, Polaine sold the entire share capital to Hill Publishing at a considerably higher price.

The Court found Polaine liable to MacDonald for the tort of deceit and both Polaine and Hill Publishing liable to MacDonald for the tort of conspiracy. Information given by Polaine later in negotiations did not fully disclose the arrangements with Hill Publishing nor correct the earlier impressions he had given that no other negotiations were taking place. Full disclosure would have meant disclosing the consideration proposed for the acquisition of the whole company.

In addition, Polaine provided confidential information about the company to Hill Publishing without board approval in breach of his duties.

The case raises a number of issues worth bearing in mind when negotiating with third parties including:

• When negotiating a contract, you may need to correct a misleading impression, rather than merely giving carefully worded partial disclosures and allowing the other side to draw its own conclusions.

• If acting for a seller, consider whether you need to incorporate into the sale and purchase agreement representations upon which the seller is relying.

• An entire agreement clause may not be effective against an action for deceit.

• The duty to make full disclosure may extend to advisers – the solicitors in this case were not aware of the misrepresentations, but their position was considered in some detail. Advisers who are aware of a misrepresentation and facilitate it could be liable in tort.

Sample ADR clause (ADR is optional)

This Agreement shall be governed by and construed in accordance with [English law]. If any dispute arises out of or in connection with this Agreement ("Dispute") the parties shall be entitled but not obliged to seek to have the Dispute resolved amicably, prior to the commencement of [High Court] [proceedings] [arbitration], [by use of [insert relevant alternative dispute resolution procedure which has been agreed by both parties e.g. mediation, conciliation, expert determination etc.]] [with the assistance of the [Centre for Effective Dispute Resolution (CEDR)]] [in accordance with [CEDR Solve’s Model Mediation Procedure and Agreement]], by written notice initiating that procedure. If the Dispute has not been resolved to the satisfaction of either party within [ ] days of initiation of the procedure or if either party fails or refuses to participate in or withdraws from participating in the procedure then either party may refer the Dispute to [the High Court] [arbitration].

© Herbert Smith 2003

The content of this article does not constitute legal advice and should not be relied on as such. Specific advice should be sought about your specific circumstances.

For more information on this or other Herbert Smith publications, please email us.

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