The Supreme Court has held that a contract existed between parties on the terms of a formal written agreement between them that was never signed, even though the draft agreement expressly provided that the contract would not be effective until each party had executed it.
In RTS Flexible Systems Limited v. Molkerei Alois Müller Gmbh & Company KG, RTS and Müller, the well-known yoghurt supplier, negotiated about RTS installing equipment at one of Müller’s packing facilities. The parties entered into a letter of intent (LOI) on 21 February 2005, which enabled work to begin on agreed terms. The LOI contemplated that full contractual terms would be finalised, agreed and signed within 4 weeks of the date of the letter. The LOI expired on 27 May 2005 but the work on the project continued after its expiry. The detailed contractual terms were substantially agreed and a draft contract was ready for signature by 5 July 2005. The contract was never signed, but the work continued after 5 July nonetheless.
The draft contract contained a clause which provided that 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”. This was, in effect, a ‘subject to contract’ provision.
Following a dispute between the parties, the Supreme Court had to consider whether a contract had been formed and, if it had, on what terms. The court said that these questions depend on a consideration of what was communicated between the parties by words or conduct, and whether that leads to a conclusion that they intended to create legal relations and had agreed upon all the terms which were essential for the formation of legally binding relations. Even if certain terms of economic or other significance to the parties have not been finalised, an appraisal of their words and conduct may lead to the conclusion that they did not intend agreement of such terms to be a pre-condition to a concluded and legally binding agreement.
On the facts of the case, the court held that all the terms which the parties treated as essential were agreed and the parties were performing the contract without a formal contract being signed or exchanged. The court found that a contract had been formed between the parties on the terms substantially agreed by 5 July.
The court went on to say that it is possible for an agreement ‘subject to contract’ to become legally binding if the parties later agree to waive that condition. It is necessary to have unequivocal agreement that the ‘subject to contract’ provision is to be waived, although this need not be by express agreement. Such unequivocal agreement to a waiver could be inferred from communications between the parties and conduct of one party known to the other. Here, the parties had waived the ‘subject to contract’ provision by their subsequent performance of the contract. Following the waiver the parties had, in effect, made a firm contract by reference to the terms of their earlier agreement.
In the court’s view, the striking feature of the case was that essentially all the terms of the contract had been agreed between the parties and substantial works were then carried out. The court commented that this case demonstrated “the perils of beginning work without agreeing the precise basis upon which it is to be done” and that the moral of the story is “to agree first and start work later”.
Commercial pressures often result in companies starting work before contractual terms have been fully agreed, leaving the detailed negotiations to follow. The fact that work has begun will not, on its own, mean a contract exists if the parties have not by that stage agreed all the terms that are essential (as between themselves and as required by law) for the contract to be formed. However, businesses will need to be aware that, by beginning to perform their side of a contract before a contract is signed, they risk inadvertently waiving any ‘subject to contract’ protection, and thereby being deemed to have entered into a contract without the benefit of terms and conditions they would normally expect to have. With the goodwill that is generated when a new contract is secured, most businesses do not contemplate that relationships can turn sour when they do, the importance of a well-drafted and protective contract cannot be overstated.