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					                                CASE SUMMARY:
                      CONTRACT DRAFTING PITFALLS AND TIPS


   Battle of the forms

Tekdata Interconnections Limited v Amphenol Limited [2009] EWCA Civ 1209

Tekdata purchased goods from Amphenol and a dispute arose as to which party’s terms and
conditions applied. Tekdata had placed purchase orders with Amphenol which stated that the
purchase was to be on Tekdata’s terms and conditions. Amphenol had then sent
acknowledgments of the orders which stated that the purchase was to be on Amphenol’s
standard terms and conditions. The parties had then proceeded with the supply and purchase
of the goods.

At first instance, the judge accepted Tekdata’s argument that it was never intended that
Amphenol’s terms and conditions would apply and the parties had intended that Tekdata’s
terms and conditions would apply, despite the fact that the last document passing between
the parties (Amphenol’s acknowledgment) stated that Amphenol’s terms and conditions
would apply. Amphenol appealed.

The Court of Appeal stated that the traditional view was that if no further documentation
passed between the parties after Amphenol’s acknowledgment then its terms and conditions
would apply. The Court indicated that to depart from that conclusion, it would be necessary
to show that both parties intended that some other terms would prevail, either because that
had been expressly agreed or because such an agreement was necessarily inferred from the
circumstances. The fact that other terms and conditions would make more commercial sense
was not sufficient, and it would always be difficult to displace the traditional analysis that
Amphenol’s terms and conditions would apply as their statement as to the terms and
conditions was the last statement between the parties. There was not sufficient evidence to
depart from the traditional analysis in this case and the appeal was allowed.

Summary

If each party states that its own terms and conditions apply, the last party to
make that statement will generally succeed, unless an express agreement
otherwise can be shown, and this will always be difficult to show.

In practice - if you do not want to contract on another party’s terms and
conditions, make this clear on each and every opportunity that the other party
refers to their own terms and conditions.



   “Subject to contract”, oral contracts and the “gentleman’s agreement”

RTS Flexible Systems Ltd v Molkerei Alois Müller GmbH & Co KG [2010] UKSC 14

RTS supplied automated packaging equipment to Molkerei. Prior to the supply, Molkerei had
sent a letter of intent to RTS which included a draft contract. That draft contract included a
clause limiting RTS’s liability in the case of certain disputes, but it also included a clause
indicating that the contract would not be binding unless it was signed and executed by the
parties.

The parties never executed the contract, but they went ahead with the supply. A dispute
arose which included a claim by Molkerei against RTS for failing to supply equipment of the
correct specification. The court was required to decide whether the terms of the draft
contract applied, including a limitation of liability, despite the contract not having been signed
and executed.

The Supreme Court decided that if the parties had performed their obligations, that would
suggest they had intended to enter into a legal relationship. In addition, when a contract
included a limitation of liability clause, it would be hard to later argue that a party who
commenced work had accepted more liability than provided for by the limitation of liability
clause. The parties’ conduct showed that they had acted as if the draft contract applied and
had treated it as if it were not merely a draft; this showed that they had intended to waive
the clause in the contract that stated it would not take effect unless signed. The draft
contract applied.

This case can be contrasted with the recent case of Everton Football Club Co Limited v Sail
Group Ltd and Alexander Ross Ltd [2011] EWHC 126. In that case, negotiations between
Everton and Sail Group concerning a contract had proceeded on a ‘subject to contract’ basis.
Everton alleged that it had agreed all important matters with Sail Group and that Sail Group
had then indicated it would be sending the signed agreements back to Everton, and on that
basis, a contract had been formed.

The court determined that this was insufficient to show that a contract had been concluded
and that the ‘subject to contract’ nature of the negotiations had not changed. In reaching
that decision, the court took into account that Sail Group had made clear from the outset that
it could not enter a contact other than through its CEO, that the parties had never departed
from the position that a written contract would have to be concluded, and that some aspects
of the negotiations were still outstanding. In contrast with the case of RTS, the parties had
not gone on to perform the contract.

A final case in which the court considered these issues was Van der Garde v Force India
Formula One Team Ltd [2010] EWHC 2373. Mr Van Der Garde was an aspiring Formula One
driver, and Force India owned and operated a Formula One racing team. Mr Van der Garde
argued that Force India had agreed to provide him with the opportunity to practice or race in
a Formula One car over a distance of 6,000 km, and that in breach of contract they had failed
to give him this opportunity. Force India claimed that the offer of the mileage was subject to
certain conditions which had been agreed orally at a meeting prior to the execution of the
relevant written contracts.

The High Court judgment was that no oral agreement had been reached at the earlier
meeting but only a ‘gentleman’s agreement’ which was not binding. The court reached this
conclusion on the basis that the surrounding correspondence suggested the contracting
parties believed that they were not legally bound to act as agreed, although they were
expected to honor the agreement.
The court was also invited to take the gentlemen’s agreement into account when trying to
resolve particular uncertainties arising out of the written contract. The court concluded that
that would not be appropriate - to do so may be misleading as it may well be the case that a
party intended to depart from what formed part of an earlier gentleman's agreement when
entering into a binding contract.

Summary

If parties act as if a draft contract is an executed contract, and go ahead with the
contract, it is likely that they will be treated as having agreed to enter into the
contract on the terms of the draft. Conversely, if it is clearly understood by parties
that a contract will not be binding until executed, then the court will not hold
otherwise, particularly when the parties have not gone ahead and acted as if a
contract was in existence. If parties believe they are not bound by a draft
contract, then a binding contractual agreement has not been reached.

In practice - agree your terms clearly before you start performing your contract,
and if you have discussed entering into a written contract, proceed on that basis.
If you don’t, there is a significant risk of confusion as to whether a contract has
been entered into, and if it has, whether the terms agreed in a draft should be
held to apply even if the contract has not been executed.


   Pre contractual negotiations

Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38

Chartbrook owned a site in Wandsworth. Chartbrook agreed with Persimmon that Persimmon
would construct a mixed residential and commercial development, receive the proceeds of
long leases granted on the property, and pay a sum of money to Chartbrook in return.

The dispute concerned what sum of money Persimmon was contractually obliged to pay to
Chartbrook in relation to a particular balancing payment. The provisions were complicated
and on Chartbrook's interpretation it would receive a significant payment.

The court agreed with Persimmon's interpretation, and indicated that the question was:
"What would a reasonable person having all the background knowledge, which would have
been available to the parties, understand the language in the contract to mean?" The court
agreed that the language was more suggestive of Chartbrook's interpretation, but went on to
explain that the court must also have regard to the background and context of the contract.
The court was invited to overrule a long standing rule that negotiations preceding the
contract cannot be referred to as evidence of the meaning of the contract. The court
accepted that negotiations could sometimes be relevant, but said that they should not be
used to draw inferences as to what the contract means, because to allow such inferences
would lead to uncertainty about the outcome of disputes and increase the cost and
complexity of litigation.

The court did consider, however, that Chartbrook’s interpretation considered alongside other
parts of the contract would make aspects of the contract seem arbitrary and irrational. This
was the main reason why the court decided in favour of Persimmon's interpretation.
This does not mean negotiations will never be relevant - firstly, the contract may be rectified
in instances where, by mistake, a contract does not reflect a common expressed intention of
the parties. Secondly, if the parties have proceeded on the basis that certain words have a
certain meaning, they may be stopped from later denying that meaning.

Summary

In interpreting a contract, the starting point is the ordinary meaning of the
language. However, if there is some ambiguity and the natural language would
lead to an arbitrary or irrational result, the court is likely to conclude that a more
rational result was intended and to interpret language to give a rational result.
Negotiations cannot generally be examined to show what was intended by the
contract, although negotiations can be relevant to a claim that the contract
contains a mistake which should be corrected because it does not reflect the
common intention of the parties.

In practice - make a record of negotiations prior to contracts - even if not relevant
when interpreting a contract, they could help avoid disputes or help to support a
claim for rectification or estoppel. Make sure the contract works as a whole - the
courts will try and make different aspects of the contract work together. Finally,
check the wording carefully before signing, and consider whether any alternative
interpretation could be put on the wording - if you have to check with someone
what it means, arguably it is not clear enough.


   Liquidated damages and penalty clauses

Azimut – Benetti SpA v Healey [2010] EWHC 2234

Azimut-Benetti was a luxury yacht builder. A company registered in the Isle of Man,
Shoreacres Limited, agreed to buy a yacht from Azimut-Benetti. Healey guaranteed
Shoreacres obligations under the contract.

The contract provided that if Shoreacres was more than 45 days late in paying any
installment due under the contract, Azimut-Benetti could terminate the contract and retain
from payments already made or recover from Shoreacres an amount equal to 20% of the
contract price by way of liquidated damages as compensation for its estimated losses and
subject to that retention promptly return the balance of sums received to Shoreacres.
Shoreacres failed to pay one of the installments on time, and Azimut-Benetti terminated the
contract and sought to recover the 20% of the contract price from Healey. Healey argued
that the 20% figure was an unlawful penalty clause and that accordingly neither he nor
Shoreacres was obliged to pay this sum.

The court repeated the established law that a clause which aims to deter a breach is an
unlawful penalty, whereas a clause which aims to estimate the damages that a party will
suffer from a breach of contract is lawful. The court held that if the amount payable pursuant
to the clause was greater than that which might be sustained on breach, then this may
suggest an unlawful penalty clause, but that this was not always the case. The clause might
nonetheless be commercially justifiable provided that its dominant purpose was not to deter
the other party from breach. In considering this question, the court indicated that great
caution must be taken not to upset a bargain entered into voluntarily by commercial parties.

The court concluded that the clause was not simply an estimate of future damages, but it
also provided for payments by Azimut-Benetti to Shoreacre - the return of payments already
made. The clause aimed to strike a fair bargain between the parties in the event that the
contract was to terminate. For that reason, even though 20% of the contract price might not
be a genuine pre-estimate of the loss that might be suffered by Azimut-Benetti on a breach,
the clause was not an unlawful penalty clause, because it had a commercial justification and
was not intended solely to deter a breach of contract.

Summary

Clauses in contracts which specify a sum payable on a breach of contract will be
ineffective and void if their sole purpose is to deter breaches of contract. If the
figure is a genuine pre-estimate of loss suffered, then that is acceptable. If the
figure is not a genuine pre-estimate of loss, then that would ordinarily point
towards the clause simply aiming to deter a breach of contract and hence being
void, but this conclusion is not inevitable, if the clause has other commercial
justifications.

In practice - in deciding how to draft a clause which stipulates a sum payable on
breach of contact, whether the sum is a genuine pre-estimate of loss needs to be
the starting point. However, in certain circumstances, there may be legitimate
commercial justifications for a more complex clause. If there are, these should be
made clear between the parties prior to entering into the contract, not raised
solely when a dispute arises.


   Retention of title

Bulbinder Singh Sandhu v Jet Star Retail Limited (Mark One) (in administration) [2010] EWHC
B17

Bulbinder had supplied fashion garments to Jet Star, a retailer. The contract between
Bulbinder and Jet Star provided that Bulbinder would retain property, title and ownership of
the garments until it received payment in full. Jet Star went into administration, and some of
the garments were sold to a third party by the administrators. Bulbinder claimed it was
entitled to a claim in the garments at the time that Jet Star entered into administration, and
that the administrators were not entitled to sell the stock on and had committed the tort of
conversion in doing so.

The High Court held that no tort had been committed. It was clearly the intention of the
parties when they entered into the contract that goods supplied by Bulbinder to Jet Star
would be sold on by Jet Star - that was the very nature of Jet Star’s business as a retailer.
The fact that Jet Star went into administration did not change this. The contract provided
specific rights for Bulbinder in such a situation, which could have been exercised. The
contract also allowed Bulbinder to identify the stock which was the subject of the retention of
title and to demand immediate possession of it. Bulbinder had not exercised these rights.
There was no reason to go further and imply a term into the contract that the administrators
were not entitled to sell the stock.

Summary

If stock is supplied for resale by a purchaser, the purchaser is of course entitled to
sell the stock on. The mere existence of a retention of title clause does not change
this, even if the purchaser goes into administration before selling the stock on -
the administrators can sell the stock in the same way the purchaser would have
done had it not been in administration. It is for the supplier, if the contract
provides for rights to terminate a contract/take possession of goods back upon
the purchaser entering into administration, to actually make and act upon the
claim for possession.

In practice - if you have a retention of title of clause, you need to take steps
during the life of the contract to ensure the stock remains readily identifiable
wherever it is. If another party holding your stock enters into an insolvency
arrangement and you have rights to take back possession of the stock under a
retention of title clause, that right should be communicated to the administrator
of other insolvency practitioner and acted upon immediately.


   Restrictive covenants

Francotyp – Postalia Ltd v Whitehead and Suckling [2011] EWHC 367

Francotyp was engaged in manufacturing and supplying franking machines. Whitehead and
Suckling were directors of a company that had been a franchisee of Francotyp, but that
relationship had come to an end. Under the contract between that company and Francotyp,
Whitehead and Suckling were contractually prevented from engaging in certain activities
defined in the contract, and broadly being those which would present competition to
Francotyp in a geographic area referred to in the contract as the ‘Restricted Area’.

There was also a severance clause which provided that if any part of the contract was
ineffective for any reason, the contract would operate with whatever deletion of wording was
necessary to make the clause concerned effective.

The court had to decide whether the severance clause could be used to sever parts of the
wording of the restrictive covenant so that it referred only to the territory in which the
defendant’s company had operated, and was therefore effective.

The High Court held that there was an established principle that wording could only be
severed pursuant to a severance clause if the severance did not modify what remained. In
this case, if the court were to limit the definition of Restricted Area in order to make the
restrictive covenant valid, then the meaning of other clauses which refer to the Restricted
Area would be changed despite those other clauses being valid. The severance would
therefore modify what remained in the contract, and such a severance was not permissible.

Summary

A clause in a contract which provides that, if any part of the contract is void or
ineffective, the offending part is severed and the rest of the contract remains in
force, is only effective if the severance would not change the meaning of the
remainder of the contract. Severing part of a defined phrase in a contract in order
to make a particular clause effective again will have an impact on the defined
phrase wherever used, and accordingly the severance is likely to have an impact
on the remainder of the contract. Such a severance is therefore not permissible.

In practice - as always, great care needs to be taken in drafting restrictive
covenants. If you get this wrong, the meaning of the contract is likely to be
uncertain and potentially ineffective. Care also needs to be taken with using
defined terms - they save time and can create consistency, but only if you are
content for the term to have precisely the same meaning in all the various clauses
it is used, and all the practical circumstances in which it may come into effect. It
may be better to avoid using defined terms in clauses that may need to be
severed, in part or in whole.

				
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