Contracts – are they worth the paper they’re written on?

March 15, 2012

It was Samuel Goldwyn who said that a verbal contract isn't worth the paper it's written on. In fact, the law does not have a problem with verbal contracts; in most cases, there is no requirement for a contract to be in writing. The problem is that, unless a contract is in writing, it’s one person’s word against another about first, was there a contract and second, what were its terms.

What are you talking about ?

But it’s not a malapropism to say that a poorly written contract is not worth the paper it’s written on. If the contract is not clear about what was meant, the parties can fall into dispute. This is ironic because one of the key reasons for having a written contract is to avoid disputes about what you have agreed.

If there is ambiguity in a clause, the courts will seek to interpret the contract so as to give effect to the presumed intention of the parties. They will ask themselves what an objective third party – the innocent bystander - would understand the contract to mean. The starting point is the ordinary meaning of the words in the agreement. In interpreting a contract a court will not generally take into account anything outside the written words but they will take into account the factual background at the time the contract made.

Incorporate your T&Cs

Many everyday contracts are made on the basis of standard contract terms and conditions (T&Cs). But it’s no use having brilliantly drafted T&Cs if they are not part of – or “incorporated” into - the contract. Unless the T&Cs were brought to the attention of, and agreed by, the customer at the time the contract was made, they will simply not apply.

There is usually no problem when the parties sign a contract with all the terms included. However, many businesses trade with standard T&Cs and do not sign formal contracts. The question then is whether the customer actually agreed to the T&Cs at the time the sale was made. For example, if you simply refer to the T&Cs on your invoices, because the invoice is usually issued after the contract has already been made, it is too late to “incorporate” the T&Cs into the contract and they will not be binding.

This can then land you in trouble if you want to enforce your T&Cs. For example, you may want to recover goods delivered under a retention of title clause when the customer goes bust without having paid for the goods. The liquidator will not let you do this, unless you can prove that the T&Cs in which the retention of title clause is contained were properly “incorporated” as part of the sale contract. Or you may need to protect your liability behind a disclaimer clause. If your T&Cs are not part of the contract, then they will not be worth the paper they are printed on.

Battle of the forms

It’s one thing for the supplier to have standard T&Cs of supply, it’s quite another for the customer to have standard T&Cs of purchase. Where both parties try to impose their own standard T&Cs it can be difficult to know which set of terms prevail; this is known as “the battle of the forms”.

Sometimes the battle is won by the last set of T&Cs to be issued before the contract is concluded. This is the “last shot” doctrine. Sometimes, each set of T&Cs knocks out the other, so you end up with neither set applying; there is then, in effect, no written contract.

There is often a clause in T&Cs which tries to say that the T&Cs will prevail over any T&Cs stipulated by the other party. But this is unlikely to work and suffers from the inescapable logic that if the T&Cs do not apply, why should a clause in them have any effect?

The best way to win the battle of the forms is to deal with the conflict head on and explicitly agree with the other party that your T&Cs apply. However, many businesses do not wish to draw too much attention to their small print and prefer to try to make them apply by stealth; for example, by using frequent references to “Terms and conditions apply” in all relevant literature and sales documents.

What are you implying ?

Sometimes terms are written into a contract, even if you have not specifically agreed to them. These are called implied terms.

First, there a number of Statutes that imply terms into certain types of contracts by law. So, for example, in a contract for the sale of goods terms are implied under the Sale of Goods Act as to title, quality and fitness for purpose. In a contract for provision of a service, there is an implied term that the supplier will carry out the service “with reasonable care and skill”.

Second, terms may be implied when it is clear that the parties intended them to be a part of their agreement but did not spell them out. But a court will not write the contract for you. They will only imply a term if it is necessary to “give business efficacy” to the contract (i.e. if without the implied term the contract would not make sense).

Be reasonable

Generally, the parties to a contract can agree whatever terms they like. A court will not interfere and will give effect to the terms agreed. But there are some important exceptions to this.

It is common for either or both parties to try to exclude their liability for breach of a contract or to limit their liability to a particular sum. However, exclusion and limitation clauses are subject to statutory control under the Unfair Contract Terms Act.

Under this Act, some types of liability cannot be excluded or limited at all. For example, any exclusion or limitation of liability for death or personal injury caused by negligence is ineffective. In other cases, liability can be excluded or limited only if the contract term satisfies a test of “reasonableness”.

Typically, a supplier will include a clause which limits or excludes its liability for breach of the contract. For example, this may limit liability to the price paid. Such a clause may be valid in an individually negotiated contract between two businesses. But if the other party is a consumer, or if the contract is on the supplier's written standard T&Cs, the clause will be enforceable only if it satisfies the reasonableness test.

In order to pass the reasonableness test, a contract term must have been “... a fair and reasonable one to be included having regard to the circumstances which were, or ought reasonably to have been, known to or in the contemplation of the parties when the contract was made”.

Of course, lawyers can argue about what is or is not reasonable until the clients go home. And the guidelines developed by the courts are constantly evolving. The lesson is that such clauses will not always protect you and expert advice is needed to make sure that your limitation clauses are worth more than the ink with which they have been printed.

Be fair

When dealing with consumers, there are other some special regulations called the Unfair Terms in Consumer Contracts Regulations. Although standard T&Cs are usually drafted to protect the business, if a term creates a “significant imbalance in the parties' rights and obligations under the contract, to the detriment of consumers”, then the term will not be binding on the consumer.

Also, under these Regulations, a standard term must be written in plain and intelligible language. If there is doubt as to what a term means, the meaning most favourable to the consumer will apply.

What’s the damage ?

When a party breaches a contract, the other (innocent) party is entitled to damages. The innocent party may also be able to terminate the contract, although you can only terminate a contract if the breach is of a fundamental part of the contract.

But how are damages calculated? Damages are not intended to punish the party in breach. They are calculated to put the innocent party into the position it would have been in had the contract been performed satisfactorily. This is known as expectation loss.

Alternatively, damages could be claimed so as to put the innocent party in the position it would have been in if the contract had never been performed. This is known as reliance loss. The innocent party can elect which method of damages calculation is preferable for it.

Usually, a claim is for expectation loss. The calculation is based either on the difference in value (i.e. the difference between what you expected to get and what you actually received) or on the cost of cure (i.e. the cost to put right the defect or whatever went wrong).

An important point is that you cannot recover damages for loss which you could have avoided by taking reasonable steps. This is called the duty to mitigate – it means that if the other party is in breach of the contract, the innocent party must take reasonable steps to minimise its loss.

Contracts are the backbone of any business. They come in many different forms, both standard documents as well as one-off contracts. If they are to work commercially, then they need to work legally. Taking expert advice on your important contracts and standard T&Cs will help ensure that they are worth considerably more than the paper they are written on.

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