Be informed about informality: Risks of informal contracting

Informal formation of commercial contract

Except in some limited circumstances, formality and a written document are not required to bring a commercial contract into existence [1].  A contract can be made orally, which includes by face-to-face discussions, via telephone or by video call.  However, if a relationship breaks down and a dispute occurs, it can be difficult to establish the existence of, and/or to identify the terms of, an oral contract.

Although it is possible to agree a contract in an informal manner and in an informal setting, parties should be aware that the greater the informality of the context, the greater will be the scrutiny of any claim of intended legal relations. Parties who conduct business in informal settings should, therefore, keep a clear record of agreements reached which are intended to be legally binding.

The lack of any specific need for formality and/or documentation means that contracts can also be formed by conduct. The practical point to note here is that parties should not discuss terms or act in any way that is inconsistent with their contractual intentions.  To do so could result in a contract coming into effect inadvertently, prematurely or on unsuitable terms.

What about agreed ‘Heads of Terms’?

In many cases, commercial negotiations entail something more than mere informal, oral discussions.  Parties often agree ‘heads of terms’, ‘letters of intent’, ‘memoranda of understanding’ and ‘terms sheets’ to record the terms on which they wish to do business.  Disputes often arise as to whether or when such agreements are binding.

The recent case of Pretoria Energy v Blankney Estates [2] demonstrates that, if not properly managed, pre-contractual communications or documents can result in a contract being formed. Businesses and people can inadvertently become bound to terms, obligations and liabilities to which they might never otherwise agree.

In these cases, a court will consider objectively what was communicated between the parties by words and conduct in order to establish whether a legally binding contract exists and, if so, on what terms.

Informality and the ‘last shot’ doctrine

The ‘last shot’ principle comes into play where parties make and accept contractual offers and counter-offers each using their own written standard terms in the hope that theirs will prevail to govern the contract. Most of the time, whether a party’s terms will apply depends on whether their terms were the ‘last’ to pass before the contract was concluded.

However, the terms of a contractual relationship can depend on a number of co-existing and competing factors, including whether the terms were properly drawn to an opponent’s attention, whether the contract was stated to be subject to particular terms and whether the last shot principle has been displaced by any expressly stated and accepted earlier terms.

The content of any informal discussions or oral agreements accompanying the exchanging of parties’ respective standard terms can therefore significantly impact not only the point at which any binding contract comes into existence, but also, crucially, its terms.

The recent TRW v Panasonic [3] case highlighted that clever drafting in standard terms can assist in party in overriding the ‘last shot’ principle.

Latin lesson: What is ‘quantum meruit’ and can it compensate for failings in informal commercial contracts?

Another facet of increasing informality in business is the fact that many lawyers and clients think that the principal of ‘quantum meruit’ provides a fall-back remedy more readily than it does.

Under this principle, a court may make an award to a party based on what they deserve to be paid for what they have done or supplied.  A common perception is therefore that, if an informal commercial contract arrangement has failings or gaps, the principle of ‘quantum meruit’ can nevertheless afford a fair solution.

However, quantum meruit is more nuanced than people often think.  It is not  easy to establish or creates uncertainty if you need to place reliance on it.  Whether to make an award on the basis of quantum meruit is in the court’s discretion. Such claims are therefore not a guaranteed safety net.

Importantly, in Moorgate Capital (Corporate Finance) v H.I.G. European Capital Partners LLP [4], the High Court recently stated that there is no general right to payment in the absence of a contract and it is not the function of the law to create contractual terms and remedies where the parties have failed to do so.

Informality in business: What practical advice arises for commercial contract negotiators?

Before undertaking any work, supplying any goods or services or incurring any significant expenses or obligations, any business or person involved in discussions concerning potential commercial arrangements should:

• review their negotiating practices and be aware of the risks associated with informality
• educate staff as to the risks of both inadvertent contract formation and of conducting business on the assumption that contractual backing exists, or exists on certain terms, when in fact it may not
• clearly record whether any agreement reached is intended to have legal effect, or whether the parties require any such agreement to be formally documented and signed by the parties before it has contractual force
• ensure that different teams are aligned to the same position (so that, for example, operational teams within a business behave consistently with, say, the procurement team)
• clarify that any counterparties have committed to their side of the bargain, and that all necessary terms are consistently understood between the parties.

In the vast majority of commercial cases, the best advice will be not to start work, invest any significant time or money, or other proceed with a venture, until a formal written contract has been completed.

Commercial contracts and formality/informality: How we can help

Informal/pre-contractual communications and negotiations can be a minefield. An understanding of key contractual principles, as well as an awareness of the practical scenarios in which such risks 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 only when that is actually required.

For further information or staff training in relation to pre-contract traps and tips; for assistance in relation to effective commercial contract drafting; or for strategic advice if and when any informal negotiations do result in issues or disputes, please contact our commercial contract specialist Gwendoline Davies, Jack Heward and Jake Phillips.  They, or any member of the Commercial and Commercial Dispute Resolution teams, will be very happy to help.

[1] See Walker Morris’ earlier briefing on informal commercial contract formation

[2] See Walker Morris’ briefing Don’t let Heads of Terms bite!

[3] https://www.walkermorris.co.uk/in-brief/contract-formation-and-the-battle-of-the-forms-high-court-shoots-down-last-shot-doctrine/

[4] [2019] EWHC 1421 (Comm) and see https://www.walkermorris.co.uk/in-brief/a-quantum-meruit-a-remedy-for-risk-takers/ and https://www.walkermorris.co.uk/in-brief/restitution-a-remedy-when-a-contract-falls-short/