Commercial contract formation: Don’t forget first principles

6th April 2017

In the commercial world, so much is about contacts, relationships and face-to-face communication. As such, at the outset of many ventures, relationships are positive and parties are eager to get on with doing business together, often before legal documentation is put in place.  As the recent case of MacInnes v Gross (1) [1] highlights, however, there are some real risks associated with proceeding in this way. An understanding of the basics of commercial contract law is crucial for managing those risks.

Formation of contracts: back to basics

A contract is formed when all of the following key elements are present:

• offer;
• acceptance;
• consideration (i.e. money or money’s worth);
• intention to create legal relations; and
• certainty of terms.

Whilst a contract can be made orally (face-to-face or via some communication medium such as the telephone), it is important to remember that a party may have difficulty in establishing the existence of and/or proving the terms of an oral contract if a relationship breaks down and a dispute arises.

In addition, although in a commercial context there is a rebuttable presumption of an intention to create legal relations, the legal burden is on the party claiming that a binding contract has been made to prove the intention to create legal relations, and that can be evidentially difficult in the absence of any express agreement.

The recent case of MacInnes v Gross provides one example of how a lack of understanding and formality in relation to contractual arrangements can have devastating consequences.

MacInnes v Gross – an expensive mistake

In a very typical scenario, Mr MacInnes (who worked for Investec) and Mr Gross (who ran his own business, RunningBall) had made contact with each other in business from time to time over a number of years before they eventually spoke in any detail about working together. Then, in March 2011, following various exchanges between them, Mr MacInnes and Mr Gross talked about the potential sale of Mr Gross’ business one evening over dinner at a restaurant.  Mr MacInnes later alleged, when claiming €13.5 million in these proceedings, that an oral contract was made during that discussion, in which it was agreed that he would provide services to Mr Gross with a view to maximising Mr Gross’ return on the sale of the RunningBall business, and that he would receive, in exchange, remuneration calculated by reference to a formula which gave him 15% of the difference between the target price of RunningBall and the actual sale price. Mr Gross, however, denied that there was any binding contract between himself and Mr MacInnes, either in the terms alleged or at all.

The High Court rejected Mr MacInnes’ claim and the following key points make essential reading for all commercial parties.

• As mentioned above, whilst the starting point in commercial cases is that there is a presumption of the requisite intention to create legal relations, that presumption can be displaced either by express evidence to the contrary or by an objective assessment of the parties’ intentions.
• In making that assessment, the court will consider not the parties’ subjective intentions, but rather what was communicated between them by words or conduct and whether that leads objectively to a conclusion that they intended to create legal relations [2].
• A relevant factor is likely to be the degree of precision with which the alleged agreement is expressed, and vagueness and uncertainty may be grounds for concluding that there was no intention to create legal relations at all.
• The court noted that the more complex the subject matter (and the alleged details of the contract in this case were quite complex), the more likely it is that the parties will want to enshrine any contract in a written document.
• Further, while it is certainly possible to conclude a contract in an informal manner and in an informal setting, the court suggested that the greater the informality of the context, the greater should be the scrutiny of any claim of intended legal relations.
• It was also relevant that, despite Mr MacInnes’ contention, the court found that no firm agreement had been reached on the critical question of Mr MacInnes’ remuneration.
• In this particular case, English was not Mr Gross’ first language, and the court noted that this might suggest that further caution should be required before finding that a contract had been concluded in such informal circumstances.

Practical guidance

Commercial parties should review their negotiating practices and be aware of the risks associated with informality. On the one hand, the lack of any specific requirement for formality and/or documentation means that contracts can be formed orally and by conduct as well as in writing; and it is therefore important that parties should not discuss terms or act in any way that is inconsistent with their contractual intentions in case a contract comes into effect prematurely, inadvertently or on unsuitable terms.  On the other, and as shown by the MacInnes v Gross (1) decision, the fact that an intention to create legal relations is a necessary component of any valid contract can mean that, depending upon the particular circumstances, it can be a costly mistake to assume that a contract has come into being at all.

It is essential that businesses educate their staff as to the risks of both inadvertent contract formation and of conducting business (and therefore going on to incur expenses and responsibilities) on the assumption that contractual backing exists when in fact it may not.

An understanding of some key contractual principles, as well as an awareness of the practical scenarios in which informal commercial discussions may arise for any particular business, will be key to getting the balance right between being able to quickly obtain sufficient comfort to enable parties to proceed with their plans, and becoming legally bound when that is actually required.

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[1] Please note that this briefing is concerned with MacInnes v Gross (1) [2017] EWHC 46 (QB) – the commercial contracts dispute.
[2] as per the test set out in the leading case of RTS Flexible Systems Ltd v Molkerei Alois Muller GmbH & Co KG [2010] UKSC 14