Supreme Court rules that contract exists despite "subject to contract" provision

A case involving the impact of a counterparts clause in a draft agreement has gone all the way to the Supreme Court, which ruled on 10 March that a contract existed.

In RTS Flexible Systems v Müller [2010] UKSC 14, RTS began work on the basis of a letter of intent whilst the parties continued to negotiate the final contract. The draft contract contained a counterparts clause which provided that no contract would come into existence until each party had executed and exchanged the counterparts.

No contract was ever signed and a dispute arose. The courts treated the counterparts clause as a "subject to contract" provision. The High Court ruled that there was a contract, but on limited terms. The Court of Appeal reversed this, finding that there could be no contract until the agreement was signed. However, the Supreme Court unanimously found that the counterparts clause had been waived by conduct and that there was a contract on wider terms than those found by the trial judge. As noted by the Supreme Court, this case demonstrates the perils of beginning work without first agreeing the precise basis upon which that work is to be done – a relatively common scenario.

Facts

After provision of quotations by RTS for the design and installation of packaging machines for Müller, Müller sent RTS a letter of intent on 5 July 2005, which provided that the parties were to have four weeks to finalise, agree and sign a contract based on Müller's amended MF/1 conditions. The amended MF/1 conditions contained limitations on liability and liquidated damages provisions and also the following counterparts clause:

"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". (Clause 48)

RTS began work on the basis of the letter of intent and the parties continued to negotiate the final contract, extending the period of the letter of intent while they did so.  On 25 August, the agreement was varied in important respects.  When the letter of intent expired, RTS continued to build and deliver the equipment, and was partially paid for it. However, no contract was ever signed as contemplated and a dispute arose between the parties.

The trial judge found that, after the expiry of the letter of intent, a new contract had been concluded between the parties. He held that the parties had reached full agreement on the essential terms of the contract and that, in view of their performance of those terms, it was unrealistic to suppose that the parties had not intended to create legal relations. However, he also held that the contract did not incorporate the amended MF/1 conditions because, among other reasons, the counterparts clause prevented the incorporation of the MF/1 conditions into the contract unless and until executed by each party. RTS appealed.

In the Court of Appeal RTS argued that no final agreement had been reached as to all the essential terms, and on the wording of Clause 48, any contract (not just the MF/1 conditions) was prevented from coming into existence until a written agreement was executed. The Court of Appeal accepted these submissions. It ruled that the judge had misinterpreted Clause 48. The definition of 'Contract' in that clause did not just apply to the amended MF/1 conditions but it also operated to prevent any contract coming into existence until the parties had entered into a written agreement. Müller appealed to the Supreme Court.

Decision of the Supreme Court

The key issue was whether the parties had made a contract after the expiry of the letter of intent and if so on what terms. The Supreme Court allowed Müller’s appeal, reversing the finding of the Court of Appeal that there was no contract after the letter of intent expired. In the Supreme Court’s view, there was a binding contract and it was not of the limited kind found at first instance. Of relevance to the Supreme Court was the fact that the price had been agreed, extensive work had been undertaken, and that variations were not agreed “subject to contract”. Accordingly, the Court inferred that the parties had agreed to waive the "subject to contract" proviso, and to rule otherwise made no commercial sense. By 5 July they had reached an agreement designed to operate as a composite whole. None of the issues outstanding thereafter were regarded as essential matters requiring agreement before the contract could be binding. As such, the parties had reached a binding agreement on or about 25 August on the terms agreed on or before 5 July as subsequently varied.

Comment

The Court recognised that there would not usually be a contract on terms that were agreed "subject to contract" and the courts should not impose contracts on parties, but all would depend on the facts of the case. The Court analysed the authorities in detail and found that where parties had conducted negotiations on the basis that, when reached, their agreement would be incorporated in a formal contract, the issue to be determined was whether they had nevertheless agreed to enter into a contract notwithstanding that earlier understanding or agreement. In the Supreme Court's view, the parties had entered into an agreement on the facts.

In many ways the findings of the courts below were difficult decisions. The High Court found that there was a contract but not on the draft terms, whereas the Court of Appeal held that the counterparts clause was agreed and yet the effect of this provision was that there was no contract.

The clear message in this judgment is that, wherever possible, parties should agree first and start work later.  If this is not possible, ensure that letters of intent are drafted in very clear terms, stating what work is to be done, for what price and for what period.  If the letter of intent expires, it should be expressly extended as necessary.  Absent clear written statements there will be considerable uncertainty (and scope for litigation) as to whether a contract has been concluded at all.  The starting point will be that where there is an unsigned contract with a counterparts clause, the negotiations remain "subject to contract". If there is a contract, what the terms of that contract are will be informed by conduct.