Are Contract Terms Really Binding? Part 1 of 2

1. The Unfair Contract Terms Act 1977 ("UCTA") is concerned with terms that exclude or restrict "business liability". This is defined at section 1(3) as:

   "liability for the breach of obligations or duties arising –

   1. from things done or to be done by a person in the course of business (whether his own business or another’s);

   2. from the occupation of premises used for business purposes of the occupier."

2. Notably, by paragraph 1 of Schedule 1 the relevant provisions of UCTA do not extend to:

   " any contract so far as it relates to the creation or transfer of an interest in land, or to the termination of such an interest, whether by extinction, merger, surrender, forfeiture or otherwise.

3. The exclusion or restriction of negligence liability for loss or damage other than personal injury or death is permissible, but only insofar as the term or notice satisfies the requirement of reasonableness. This is set out at section 2:
   1. "A person cannot by reference to any contract term or to a notice given to persons generally or to particular persons exclude or restrict his liability for death or personal injury resulting from negligence.

   2. In the case of other loss or damage, a person cannot so exclude or restrict his liability for negligence except in so far as the term or notice satisfies the requirement of reasonableness."

4. Where one party "deals as consumer" or on the other party’s "written standard terms of business", then the other party cannot exclude or restrict his liability for breach of contract, except subject to the requirement of reasonableness. This is set out at section 3:
   1. " This section applies as between contracting parties where one of them deals as consumer or on the other’s written standard terms of business.

   2. As against that party, the other cannot by reference to any contract term –
      1. when himself in breach of contract, exclude or restrict any liability of his in respect of the breach;

      2. claim to be entitled—
         1. to render a contractual performance substantially different from that which was reasonably expected of him, or

         2. in respect of the whole or any part of his contractual obligation, to render no performance at all,

5. Note also that section 13(1) goes further:

   "To the extent that this Part of this Act prevents the exclusion or restriction of any liability it also prevents—

   1. making the liability or its enforcement subject to restrictive or onerous conditions;

   2. excluding or restricting any right or remedy in respect of the liability, or subjecting a person to any prejudice in consequence of his pursuing any such right or remedy;

   3. excluding or restricting rules of evidence or procedure…"

6. The expression "deals as consumer" is defined at section 12, which states that:

   "A party to a contract "deals as consumer" in relation to another party if –

   1. he neither makes the contract in the course of a business nor holds himself out as doing so; and

   2. the other party does make the contract in the course of a business."

7. By section 11(2), the factors set out in Schedule 2 are regarded as relevant to the assessment of the reasonableness of a contract term. Even though these factors only expressly apply to sections 6 and 7 of UCTA, they are generally considered in considering the reasonableness of contract terms for other sections of the Act. The factors are:
   1. " the strength of the bargaining positions of the parties relative to each other, taking into account (among other things) alternative means by which the customer’s requirements could have been met;

   2. whether the customer received an inducement to agree to the term, or in accepting it had an opportunity of entering into a similar contract with other persons, but without having to accept a similar term;

   3. whether the customer knew or ought reasonably to have known of the existence and extent of the term (having regard, among other things, to any custom of the trade and any course of dealing between the parties);

   4. where the term excludes or restricts any relevant liability if some condition is not complied with, whether it was reasonable at the time of the contract to expect that compliance with that condition would be practicable;

   5. whether the goods were manufactured, processed or adapted to the special order of the customer."

   It is to be noted that where the term seeks to limit liability, the availability of resources and the possibility of insurance coverage will be especially relevant to the test of reasonableness, and that limitation clauses are generally more favourably received than exclusion clauses. However, the House of Lords stated in Smith v Eric S. Bush [1990] 1 A.C. 831 that it was impossible to set out an exhaustive list of all the factors and circumstances which the Courts should take into account.

8. A helpful example of the way in which the Courts apply UCTA is Watford Electronics Ltd v Sanderson CFL [2001] BLR 143:
   1. The Court of Appeal firstly identified the scope and effect of the exclusion clause as a matter of construction;

   2. The Court of Appeal then considered the circumstances which were, or ought reasonably to have been, known to or in the contemplation of the parties when the contract was made;

   3. In so doing, the Court of Appeal indicated that UCTA should be applied on the basis that bargains between commercial parties containing exclusion or limitation clauses should be considered reasonable unless one party has taken unfair advantage of the other, or a term is so unreasonable that it cannot properly have been considered. The threshold is therefore high (though note the decision in St Alban’s City and District Council v International Computers [1996] 4 All E.R. 481 where a commercial bargain was found to be unreasonable).

9. For a recent example of a limitation clause being found to be reasonable under UCTA, see Shepherd Homes Limited v Encia Remediation Limited [2007] EWHC 70(TCC) where the contractor’s liability was limited to the contract price (which was in fact less than the minimum insurance cover required under the contract).

10. The Regulations subject various terms in consumer contracts to a twofold test:
    1. The term should be "fair";

    2. The term should be in "plain, intelligible language."

11. The Regulations apply to terms in contracts between any seller or supplier and a consumer: see Regulation 4(1). A consumer is defined in Regulation 3 as:

    "any natural person who, in contracts covered by these Regulations, is acting for purposes which are outside his trade, business or profession."

    A "seller or supplier" is defined as:

    "any natural or legal person who, in contracts covered by these Regulations, is acting for purposes relating to his trade, business or profession, whether publicly owned or privately owned."

12. Accordingly, a company – as opposed to a human being – will not be able to rely upon the Regulations.

13. There has been some debate as to whether or not the Regulations apply to contracts for the sale of land: see Chitty (29^th ed 2004) paragraph 15-014. However, in light of the Court of Appeal’s decision in London Borough of Newham v Khatun [2004] EWCA Civ 55; [2005] QB 37, it seems that they do apply.

14. The range of contract terms caught by the Regulations varies according to which of the tests is applicable:
    1. The requirement of fairness applies to any term "which has not been individually negotiated". Regulation 5(2) further explains that:

       "A term shall always be regarded as not having been individually negotiated where it has been drafted in advance and the consumer has therefore not been able to influence the substance of the term."

       Regulation 6(2) further identifies the limits of its application, reflecting the fact that the focus of the Regulations is on unfair terms rather than unfair contracts:

       "In so far as it is in plain intelligible language, the assessment of fairness of a term shall not relate –

       1. to the definition of the main subject matter of the contract, or

       2. to the adequacy of the price or remuneration, as against the goods or services supplied in exchange."

    2. The requirement that a term is in "plain, intelligible language" applies to any written term of the contract in accordance with Regulation 7(1):

    "A seller or supplier shall ensure that any written term of a contract is expressed in plain, intelligible language."

15. The test of unfairness is defined in Regulations 5(1) and 6(1):
    5. (1) A contractual term which has not been individually negotiated shall be regarded as unfair if, contrary to the requirement of good faith, it causes a significant imbalance in the parties’ rights and obligations arising under the contract, to the detriment of the consumer.

    6. (1) Without prejudice to regulation 12, the unfairness of a contractual term shall be assessed, taking into account the nature of the goods or services for which the contract was concluded and by referring, at the time of conclusion of the contract, to all the circumstances attending the conclusion of the contract and to all the other terms of the contract or of another contract on which it is dependent.

16. The test can be broken down into two principal elements. These are:

1. The test of unfairness itself;

2. The contents of the "grey list" of terms to be found in Schedule 2 to the Regulations.

17. As to the test of unfairness, a two-stage process is envisaged by the Regulations. When a clause is being assessed, the following factors should be considered:
    1. Whether the term causes a significant imbalance in the parties’ rights and obligations arising under the contract, contrary to the requirement of good faith, to the detriment of the consumer (Regulation 5(1)).

       In this regard, it should be noted that the focus is on the potential unfairness of the clause, not its application to the particular facts. However, even if a term appears to be severely prejudicial to a consumer, the term could still be considered to be fair if it is counterbalanced by a corresponding term which could act to the consumer’s advantage.

       In making an assessment of good faith, Schedule 2 of the 1994 version of the Regulations required account to be taken of: the bargaining positions of the parties; whether the consumer had an inducement to agree to the term; whether the goods and services were supplied to the special order of the consumer; and the extent to which the seller or supplier has dealt equitably with the consumer. This test has not been carried through to the 1999 Regulations. Nevertheless, it is thought that it will still be relevant because these factors feature in the preambles to the relevant European Directive: see Chitty paragraph 15-058.

    2. The nature of the goods or services, all the circumstances attending the conclusion of the contract and all the other terms of the contract or of another contract on which it is dependent should be taken into account: see Regulation 6(1).

       "Circumstances" which might be relevant include whether the seller may have pressurised the consumer into concluding the contract and the degree to which the consumer has been given the chance to read and understand the terms of the contract. Other material factors will be whether the contract provides for a "cooling off" period.

18. In Director General of Fair Trading v First National Bank plc [2002] 1 AC 481, Lord Millett set out the following practical approach to the assessment of unfairness:

    "There can be no one single test of this. It is obviously useful to assess the impact of an impugned term on the parties’ rights…by comparing the effect of the contract with the term and the effect it would have had without it. But the inquiry cannot stop there. It may also be necessary to consider the effect of the inclusion of the term on the substance or the core of the transaction; whether if it were drawn to his attention the consumer would be likely to be surprised by it; whether the term is a standard term, not merely in similar non-negotiable consumer contracts, but in commercial contracts freely negotiated between parties acting at arm’s length; and whether, in such cases, the party adversely affected by the inclusion of the term or his lawyer might reasonably be expected to object to its inclusion and press for its deletion. The list is not necessarily exhaustive; other approaches may sometimes be more appropriate."

19. Note that the OFT publishes regular guidance reports relating to various terms. They are available on its website (http://www.oft.gov.uk/) and can be found by searching for "unfair contract terms".

20. As to the "grey list", the terms identified may not necessarily be held unfair, but will give rise to what is described in Chitty on Contracts, 29^th Edition at 15-069 as "a forensic presumption of unfairness." Although a clause which appears on the list may therefore be found to be fair by a Court, its presence on the list will suggest that it is a clause that needs to be looked at closely. For the purposes of this talk, the following clauses are especially relevant:

    "Terms which have the object or effect of:

    (b) inappropriately excluding or limiting the legal rights of the consumer vis-à-vis the seller or supplier or another party in the event of total or partial non-performance or inadequate performance by the seller or supplier of any of the contractual obligations, including the option of offsetting a debt owed to the seller or supplier against any claim which the consumer may have against him; [i.e. exclusion, limitation and no set-off clauses]

    (e) requiring any consumer who fails to fulfil his obligation to pay a disproportionately high sum in compensation; [i.e. penalty clauses]

    (n) limiting the seller’s or supplier’s obligation to respect commitments undertaken by his agents or making his commitments subject to compliance with a particular formality; [i.e. entire agreement clauses]

    (q) excluding or hindering the consumer’s right to take legal action or exercise any other legal remedy, particularly by requiring the consumer to take disputes exclusively to arbitration not covered by legal provisions, unduly restricting the evidence available to him or imposing on him a burden of proof which, according to the applicable law, should lie with another party to the contract." [i.e. dispute resolution clauses]

21. Regulation 8 states that:

    (1) An unfair term in a contract concluded with a consumer by a seller or supplier shall not be binding on the consumer.

    (2) The contract shall continue to bind the parties if it is capable of continuing in existence without the unfair term.

22. Regulation 7 provides that:

    "(1) A seller or supplier shall ensure that any written term of a contract is expressed in plain, intelligible language.

    (2) If there is a doubt about the meaning of a written term, the interpretation which is most favourable to the consumer shall prevail but this rule shall not apply in proceedings brought under regulation 12."

23. Should a term fail to fulfil the requirement of being in plain and intelligible language, it is clear from Regulation 7 that it will be construed contra proferentem so as to favour the consumer. It should also be noted that a failure to be intelligible is likely to go to the wider assessment of the fairness of the term.

24. The true nature of a penalty clause is that it is designed to discourage breaches of contract, or to secure performance of it, rather than to compensate the injured party for loss occasioned by the breach. In E.C.G.D. v Universal Oil Products Co [1983] 2 All ER 205, Slade LJ defined a penalty clause in the following terms:

    "in the ordinary way, a penalty is a sum which, by the terms of a contract, is made between A and B, A agrees to pay B in the event of non-performance by A of one or more of A’s obligations under the contract with B, and which is not a genuine pre-estimate of the damage which is likely to be suffered by B in the event of such breach."

25. In Dunlop Ltd v New Garage Co Ltd [1915] A.C. 79, Lord Dunedin provided the following well-known guidance:

    "The question whether a sum stipulated is penalty or liquidated damages is a question of construction to be decided upon the terms and inherent circumstances of each particular contract, judged of as at the time of the making of the contract, not as at the time of the breach.

    To assist this task of construction various tests have been suggested, which if applicable to the case under consideration may prove helpful, or even conclusive. Such are:

    (a) It will be held to be a penalty if the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach.

    (b) It will be held to be a penalty if the breach consists only in not paying a sum of money, and the sum stipulated is a sum greater than the sum which ought to have been paid…"

    (c) There is a presumption (but no more) that it is a penalty when "a single lump sum is made payable by way of compensation, on the occurrence of one or more or all of several events, some of which may occasion serious and others but trifling damage.

    On the other hand

    (d) It is no obstacle to the sum stipulated being a genuine pre-estimate of damage, that the consequences of the breach are such as to make precise pre-estimation almost an impossibility. On the contrary, that is just the situation when it is probable that pre-estimated damage was the true bargain between the parties."

26. Out of Lord Dunedin’s judgment, which is still regarded as the definitive guide to the detection of penalty clauses, the following principles have emerged:
    1. Whether a clause is a penalty clause is a question of construction of the contract, to be determined at the date of the contract, and not at the date of the breach;

    2. A sum of money which is payable otherwise than on breach of contract cannot be a penalty: E.G.C.D. v Universal Oil Products [1983] 2 All ER 205;

    3. The fact that a sum of money payable on breach of contract is described by the contract as "liquidated damages" or "penalty" is relevant to but not decisive of its proper categorisation: see Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd and Law v Local Board of Redditch [1892] 1 Q.B. 127;

    4. A sum payable on breach of contract will be held to be a penalty if it is extravagant and unconscionable in amount when compared with the greatest loss which is likely to flow from the breach. The test is whether it is a genuine pre-estimate of loss;

    5. The Courts should not set too stringent a standard and bear in mind that what the parties have agreed should normally be upheld. To do anything else would cause commercial uncertainty: Phillips Hong Kong Ltd v Attorney-General of Hong Kong (1993) 61 BLR 41;

    6. The assessment of whether a sum is a genuine pre-estimate of loss should be made at the time of contracting, but what actually happened subsequently may provide valuable evidence as to what could reasonably be expected to be the loss at the time the contract was made: Phillips Hong Kong Ltd v Attorney-General of Hong Kong (1993) 61 BLR 41;

    7. A pre-estimate of damages does not have to be correct or approximately correct to be genuine. For a pre-estimate not to be genuine, there must be a considerable difference between the damages as estimated and the damages actually suffered: Alfred McAlpine Capital Projects Limited v Tilebox Limited [2005] BLR 271.

27. It should be emphasised that the Courts will be reluctant to find a clause to be a penalty. By way of illustration, in Alfred McAlpine Capital Projects Limited v Tilebox Limited [2005] BLR 271, a sum which was twice the amount of the median loss foreseeable at the time of contracting was allowed.

28. If the clause providing for the payment of specified damages is held to be a penalty clause, it will not be enforced and the innocent party will be confined to a claim for general damages, assessed on the usual basis.

29. Section 108 of the HGCRA 1996 sets out that a construction contract shall:

    "(a) enable a party to give notice at any time of his intention to refer a dispute to adjudication;

    (b) provide a timetable with the object of securing the appointment of the adjudicator and referral of the dispute to him within 7 days of such notice;

    (c) require the adjudicator to reach a decision within 28 days of referral or such longer period as is agreed by the parties after the dispute has been referred;

    (d) allow the adjudicator to extend the period of 28 days by up to 14 days, with the consent of the party by whom the dispute was referred;

    (e) impose a duty on the adjudicator to act impartially; and

    (f) enable the adjudicator to take the initiative in ascertaining the facts and the law.

    (3) The contract shall provide that the decision of the adjudicator is binding until the dispute is finally determined by legal proceedings, by arbitration(if the contract provides for arbitration or the parties otherwise agree to arbitration) or by agreement. The parties may agree to accept the decision of the adjudicator as finally determining the dispute.
     

    (4) The contract shall also provide that the adjudicator is not liable for anything done or omitted in the discharge or purported discharge of his functions as adjudicator unless the act or omission is in bad faith, and that any employee or agent of the adjudicator is similarly protected from liability.
     

    (5) If the contract does not comply with the requirements of subsections(1) to(4), the adjudication provisions of the Scheme for Construction Contracts apply.
     

    (6) For England and Wales, the Scheme may apply the provisions of the Arbitration Act 1996 with such adaptations and modifications as appear to the Minister making the scheme to be appropriate."
     

Payment

30. Sections 109 to 113 of the HGCRA 1996 deal with matters relating to payment. These provisions define the various criteria which a construction contract must satisfy or, in default, impose on the parties the relevant provisions of the Scheme for Construction Contracts. If the contractual terms do not satisfy the terms of the HGCRA 1996, they may be unenforceable to the extent recognised below.

31. Section 109 of the HGCRA states that:
    1. " A party to a construction contract is entitled to payment by instalments, stage payments or other periodic payments for any work under the contract unless –
       1. it is specified in the contract that the duration of the work is to be less than 45 days, or

       2. it is agreed between the parties that the duration of the work is estimated to be less than 45 days.

    2. The parties are free to agree the amounts of the payments and the intervals at which, or circumstances in which, they become due.

    3. In the absence of such agreement, the relevant provisions of the Scheme for Construction Contracts apply.

    4. References in the following sections to a payment under the contract include a payment by virtue of this section.

32. Section 109 therefore entitles a party to a construction contract to payment by instalments, stage payments or other periodic payments so long as the construction works are for a duration of longer than 45 days.

33. Section 110 of the HGCRA 1996 states that:
    1. " Every construction contract shall –
       1. provide an adequate mechanism for determining what payments become due under the contract, and when, and

       2. provide for a final date for payment in relation to any sum which becomes due.

       The parties are free to agree how long the period is to be between the date on which a sum becomes due and the final date for payment.

    2. Every construction contract shall provide for the giving of notice by a party not later than five days after the date on which a payment becomes due from him under the contract, or would have become due if –
       1. the other party had carried out his obligation under the contract, and

       2. no set-off or abatement was permitted by reference to any sum claimed to be due under one or more other contracts.

       Specifying the amount (if any) of the payment made or proposed to be made, and the basis on which that amount was calculated.

    3. If or to the extent that a contract does not contain such provision as is mentioned in subsection (1) or (2), the relevant provisions of the Scheme for Construction Contracts apply."

34. The section requires that every construction contract must provide an adequate mechanism for determining what payments are due and when. The HGCRA 1996 does not define an "adequate mechanism", but it presumably requires a contract to be sufficiently certain.

35. Section 111 of the HGCRA 1996 provides that:

    "(1) A party to a construction contract may not withhold payment after the final date for payment of a sum due under the contract unless he has given an effective notice of intention to withhold payment.

    The notice mentioned in section 110(2) may suffice as a notice of intention to withhold payment if it complies with the requirements of this section.

    (2) To be effective such a notice must specify -

    1. the amount proposed to be withheld and the ground for withholding payment, or

    2. if there is more than one ground, each ground and the amount attributable to it,

    and must be given not later than the prescribed period before the final date for payment.

    (3) The parties are free to agree what that prescribed period is to be.

    In the absence of such agreement, the period shall be that provided by the Scheme for Construction Contracts…"

36. The section addresses the pre-existing problem that main contractors were abusing their position wrongfully to withhold payment from sub-contractors.

37. Section 112 provides that, where a sum due under a construction contract is not paid in full by the final date for payment and no effective notice to withhold payment has been given, the person to whom the sum is due has the right to suspend performance of his obligations under the contract to the party to whom payment ought to have been paid. Section 112(1) is in the following terms:

    "Where a sum due under a construction contract is not paid in full by the final date for payment and no effective notice to withhold payment has been given, the person to whom the sum is due has the right (without prejudice to any other right or remedy) to suspend performance of his obligations under the contract to the party by whom payment ought to have been made."

38. The view is expressed in Keating on Construction Contracts, 8^th edition, at 17-057 that in the context of the policy of the HGCRA 1996, the parties cannot exclude or waive the right of suspension.

39. Section 113 of the HGCRA 1996 states that:

    "(1) A provision making payment under a construction contract conditional on the payer receiving payment from a third person is ineffective, unless that third person, or any other person payment by whom is under the contract (directly or indirectly) a condition of payment by that third person, is insolvent

    …

    (6) Where a provision is rendered ineffective by subsection (1), the parties are free to agree other terms for payment.

    In the absence of such agreement, the relevant provisions of the Scheme for Construction Contracts apply."

40. The section is intended to prevent the practice of making a sub-contractor’s entitlement to payment dependent on the contractor receiving payment. Clauses which permit this practice are rendered unenforceable by section 113, save for the exception that the payer is insolvent.

The articles and papers published by Keating Chambers are for the purpose of raising general awareness of issues and stimulating discussion. The contents must not be relied upon or applied in any given situation. There is no substitute for taking appropriate professional advice.