Formation of contracts
This article is intended to be a basic guide to commercial
contracts in England, Wales and Scotland. Any significant
differences between the position in England and Wales and the
position in Scotland will be noted.
Contract basics
A contract is an agreement reached between two or more parties
which is legally enforceable when executed in accordance with
specific requirements. Contracts should be project specific and
reflect the agreement between the parties. Contracts are obviously
a key part of every business and it is therefore fundamental that
all parties to a contract understand the terms included in a
contract and the rights and responsibilities of the parties under
that contract.
Every contract should have:
- Offer;
- Acceptance;
- Consideration (although note the position in relation to
Scotland below); and
- Intention to create legal relations.
"Acceptance" of an offer occurs when there is an unqualified
acceptance of all the offered terms. However, this is unusual and
there will normally be a period of negotiation. New terms and
conditions introduced through negotiation in effect amount to a
series of counter offers to the original offer, cancelling the
terms of the original offer.
Communication of acceptance
A contract offer has only been accepted when the acceptance is
brought to the attention of the offeror. This applies in the case
of instantaneous communication. It should be noted that silence is
not acceptance. The exception to this rule is when the acceptance
is posted. The offer is deemed to be accepted when the offeree
posts their acceptance.
The now commonplace use of email raises the question of whether
the "postal acceptance rule" applies to emailed acceptances.
Currently there is no statutory law on this point. The contract
could be formed when the email acceptance is read or when the
e-mail acceptance is sent.
Consideration
Consideration is the requirement of reciprocal obligations on
the parties to a contract. Both parties must receive valuable
consideration for performance of their side of the contract.
Consideration is not required in Scotland where donation is
accepted in the law of contract. However, it is extremely unlikely
that a commercial organisation would provide goods or services for
free.
Terms of contract
Contracts can be in writing, made orally, or created through the
actings of the parties. For clarity, most commercial contracts are
in writing to maintain a proper record of the agreement. Oral
contracts create a greater potential for disputes on the terms with
the parties having problems evidencing their position.
Contracts can be formed through a course of dealing between the
parties. Again, the terms and conditions may not be clear. Common
terms are likely to be incorporated in these contracts but if they
are not written down there are still evidential problems.
It is common for contracts to be on a company's standard terms
and conditions. Problems can arise when both parties purport to
contract on their own standard terms and conditions. Qualified
acceptance of an offer while imposing your own standard terms and
conditions is seen as a counter offer. Obviously being unaware of
which terms and conditions the parties are contracting does not
provide the desired clarity or certainty of the contract.
There are different tactics for those parties who wish to
contract on their own terms and conditions including incorporating
the terms into as many pre-contractual documents as possible and
ensuring that your terms appear on the last document between the
parties before the delivery of goods.
Essential Terms
In general the following terms should be included in any
contract:
- Parties – The names and addresses of all the
contracting parties should be clearly stated.
- Definitions and Interpretations – If there any
defined terms in the contract this section should provide specific
and clear definitions . For example, a "Business Day" means any day
which is not a Saturday or Sunday or public holiday in England or
"Associate" is given the meaning given to it in section 435 of the
Insolvency Act 1986.
- Payment Provisions – Both parties should be
aware of the exact price to be paid for the goods or services
provided and the date or dates for payment to be made. The contract
should also list any likely expenses, disbursements or possible
price increases. This section should also note any agreed rate of
interest payable on overdue amounts and the consequences for
failure to pay.
- A specific description of the goods or
services that will be provided under the contract
including the level of service if the contract is for services.
This clause should also include who is responsible for supporting
and maintaining any products throughout the contract.
- Assignation (Scotland) / Assignment
(England/Wales) – If there is an option for one party to
transfer their contractual rights and responsibilities to another
party this should be indicated in the contract along with the
procedure to be followed. If there is no right to assign the
contract this should also be noted.
- Term of contract – The length of the contract
should be stated and it should also be noted whether there are any
options to continue the contract. For example, "This agreement will
continue for another year unless otherwise indicated to [other
party] by 31 January each year".
- Timescale – The specific timescale for the
project should be noted including any deadlines that have to be
met. This section should include any penalties if the deadlines are
not met.
- Limitation of liability – This section caps
the liability of either party to the contract. For example,
"Neither party shall have any liability to the other party for a
claim of loss of profits..." Ultimately both parties will be
seeking to have no liability to the other side. However, this is
unlikely to be agreed and so both parties should try and limit
there liability during the negotiation stage. It is worth noting
that there are statutes in force (discussed below) that forbid
exclusion of liability in certain contracts.
- Termination provisions – The circumstances
under which the parties to the contract can terminate the agreement
should be stated clearly. The procedure for giving notice to the
other party should be in the contract. For example, "This agreement
can be terminated by either party giving to the other not less than
three months written notice...."
- Dispute Resolution – The procedure to be
followed if the parties have a dispute should be noted. For
example, if there is an option for arbitration or mediation.
- Change of Control – During the course of a
contract one party may change the structure of their company. In
these circumstances the other party may no longer wish to continue
with the contract, for example if the first party transfers a
controlling interest to a competitor of the other party. The
procedure for this situation should be in the contract.
- Confidentiality – Some contracts deal with
commercially sensitive information and the parties may wish to keep
this information confidential. There should be confidentiality
clauses drafted in the contract along with clear indications of who
the confidentiality requirement will apply to.
- Intellectual Property Rights – Many commercial
contracts include a clause stating who will own the intellectual
property rights to any products provided under the contracts. This
clause should specifically state who owns such rights. If anything
is being created the contract should specify who will own the IPRs
in such assets.
- Warranties – In a supply of goods contract
there should be warranties in place stating that the goods comply
with any regulations. For example, if the contract is for provision
of a licence the provider should provide warranties that they have
the necessary rights to grant the licence. Warranties give the
other party a contractual right to sue for damages if there is a
breach of the warranty.
- Indemnity – Indemnities clauses are an express
obligation to compensate by making a money payment for some defined
loss or damage. For example in a software contract the supplier may
indemnify the customer against any claims made by a third party
that the normal use of the software is infringing the rights of the
third party.
- Force Majeure – This clause should cover
situations where performance of the contract is impossible through
no fault of either party. For example, if there is a natural
disaster or civil unrest.
- Applicable law – There should be a clause
indicating which law governs the contract. For example, "This
Agreement shall be governed by and construed in accordance with the
laws of England."
Implied Terms
In reality a contract does not expressly state all the necessary
terms to cover every situation. To fill this gap statutes have been
introduced over the years to codify implied terms and to protect
consumers. These statutes include the Sale of Goods Act and the
Sale of Goods and Services Act which cover all contracts for the
sale of goods and services. The supplier of goods or services must
provide goods of a satisfactory quality which are fit for the
consumer's purpose or perform the service with reasonable skill and
care.
A more general statute to protect buyers is the Unfair Contract
Terms Act. This Act seeks to prevent parties limiting or excluding
their liability in contracts. Generally, any exclusion of liability
must be reasonable.
Execution
Written contracts must be executed in accordance with specific
requirements otherwise they will not be legally enforceable.
Scotland
Following a change in the law in 1995 in order to execute a deed
only a signature is required. However to be formally valid a
document should be subscribed by the granter and witnessed by one
other aged person at least 16. It is worth noting that when
carrying out any due diligence on contracts executed pre-1995 those
contracts should have two witnesses before they are legally
enforceable.
England and Wales
If a document containing contractual terms has been signed, in
the absence of fraud or misrepresentation, the signatory is bound
by the terms even if he has not read them
If a document is unsigned a party is not bound unless he is
aware that the document contained contract terms or the other party
had taken reasonable steps to bring the terms to his notice.
Stringent tests are applied to electronic contracts.
Directors who sign on behalf of a company do so in their
capacity as the company's agent. Contracts signed in this way are
treated as if they had been made by the company itself and it will
be bound.
Contract management
Once the contract has been concluded it is important to monitor
its performance. Both parties should check that the other is
fulfilling its obligations and that any timescales and payment
plans in the contract are being adhered to. It is useful to have
regular project meetings to ensure that everything is going
according to plan and to solve any problems as they arise.
