Some clarity on no oral modification clauses

Recent case clarifies that no oral modification clauses are valid but fails to clarify the practical benefit test.
New Zealand Corporate/Commercial Law
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The UK Supreme Court has provided some welcome clarity on the status and reach of "no oral modification" clauses.

We expect that the decision will likely be applied in New Zealand, with the effect that any variations to a contract must be agreed in writing.

The case

The dispute in Rock Advertising v MWB arose when Rock Advertising began to fall behind in its lease payments on office space provided by MWB. Rock Advertising's director proposed a deferred payment schedule, the effect of which would slightly reduce Rock Advertising's obligation to pay. The proposal was made, and agreed, over the phone.

The Supreme Court held that any oral agreement was ineffective because of a no oral modification clause in the lease contract. It declined to consider whether the practical benefit of an improved prospect of being paid could be valid consideration, an issue on which there is a considerable body of conflicting case law.

No oral modification clauses

Such clauses have been ruled to be ineffective in some previous cases on the basis that any term in a contract can be varied orally and that this applies equally to no oral modification clauses.

The problem that this interpretation creates is that it limits the parties' autonomy to bind themselves as to the form of any future variation. It also removes access to the practical advantages and certainty that no oral modification clauses can provide – for example, protecting against situations in which a party seeks to undermine an agreement by informal means.

The UK Supreme Court held by majority that the conceptual difficulty of no oral modification clauses was more apparent than real: "The natural inference from the parties' failure to observe the formal requirements of a No Oral Modification clause is not that they intended to dispense with it but that they overlooked it. If, on the other hand, they had it in mind, then they were courting invalidity with their eyes open" (at paragraph [15]).

Consideration and practical benefit

For an agreement to be enforceable at common law, it must be supported by consideration. This creates difficulties where parties have renegotiated a debt, agreeing that the debtor will pay less than the total debt owing, effectively the situation in Rock Advertising. However, the courts will sometimes infer a practical benefit from the variation, on the basis that the creditor receives an increased likelihood of payment.

There are conflicting authorities on whether a practical benefit is valid consideration, and Rock Advertising provided an opportunity for the UK Supreme Court to consider the issue. However, the Court held that the no oral modification finding was enough to dispose of the appeal.

Chapman Tripp comment

There is limited New Zealand authority on no oral modification contracts, and Rock Advertising is a welcome clarification that will likely be applied in New Zealand. Enforcing no oral modification clauses increases certainty in commercial contracts, as any variations must be reduced to writing.

However, Rock Advertising represents a missed opportunity to clarify the practical benefit test, which has been applied in New Zealand (although the situation is not yet settled, see Teat v Willcox [2013] NZCA 162).

The application of a practical benefit test to a contract variation can prevent smaller businesses being strong-armed into reducing payments owing. Alternatively, debtors have sometimes negotiated in good faith to reduce a debt, and may have managed their finances in reliance on the variation. Recognising the practical benefit of such an arrangement may avoid an injustice.

But the practical benefit rule risks creating uncertainty in contract law, as the scope of what constitutes a practical benefit is unclear. Further guidance from the courts is needed.

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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