In RTS Flexible Systems v Molkerei Alois Müller GmbH, the Supreme Court has held that where a clause in a draft contract provided that the contract would not become effective until signed by the parties, the parties had waived that requirement by beginning work on the project. They had entered into a contract on the terms of the draft, even though it had never been signed.
Müller wanted RTS to supply machinery for the packaging and handling of multi-pack yoghurts. On 21 February 2005 the parties signed a letter of intent which provided for a period of negotiation of the final contract. This period ended on 27 May 2005 but by that date the final contract had still not been executed.
During the negotiation period RTS had begun work on the project and it continued with this work after 27 May. Müller partly paid for the work. A dispute subsequently arose between the parties. The High Court and subsequently the Court of Appeal were called on to decide whether a contract between the parties had ever come into existence.
During the negotiations a draft contract had been circulated between the parties and almost all of the terms were agreed. The draft contract incorporated amended industry standard MF1 conditions. These conditions included limitations on liability (insisted upon by RTS) and liquidated damages provisions. The MF1 conditions also contained 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."
The High Court had previously held that a contract had been concluded between the parties after the letter of intent had expired because the parties had reached agreement on all of the essential terms and because they had mutually performed obligations under it. The High Court said that a contract could be created by mutual performance rather than in the normal manner of offer and acceptance. The court found, however, that the MF1 conditions did not form part of this contract because, amongst other things, the counterparts clause had not been complied with.
On appeal, the Court of Appeal held the counterparts clause prevented any contract coming into existence between the parties until a written agreement was executed, not just incorporation of the MF1 conditions into the contract. It said the result of the High Court's decision was that RTS was being asked to assume unlimited liability for its performance under the version of the contract that the High Court found existed. This was a greater responsibility than RTS would have assumed under the final written contract had it been executed. The counterparts clause must apply to the entire contract to prevent any contract whatsoever from being formed before execution. This left RTS to seek payment on a quantum meruit basis and to argue that any liability to Müller was limited to the return of monies paid (rather than for full breach of contract).
The case went to the Supreme Court which said that it was required to rule on two issues; (1) whether the parties had entered into a contract after the letter of intent had expired and if so (2) what the terms of the contract were. The court said that it must look at all the circumstances of the case and make an objective assessment of the position, considering what the reasonable business-person would make of the situation between the parties. Lord Clarke said:
"Whether there is a binding contract between the parties and, if so, upon what terms depends upon what they have agreed. It depends not upon their subjective state of mind, but upon a consideration of what was communicated between them by words or conduct, and whether that leads objectively to a conclusion that they intended to create legal relations and had agreed upon all the terms which they regarded or the law requires as essential for the formation of legally binding relations. Even if certain terms of economic or other significance to the parties have not been finalised, an objective appraisal of their words and conduct may lead to the conclusion that they did not intend agreement of such terms to be a pre-condition to a concluded and legally binding agreement."
The court held that the parties had entered into a contract after the letter of intent had expired which governed their relationship from that time. Because the parties had begun performing the contract, they had waived the counterparts clause by conduct meaning that a contract could come into existence between them even though no contract was ever signed. The terms of the contract were those which the parties had agreed and which were contained in the draft contract. This included the MF1 terms. The court was satisfied that the parties had agreed all of the terms which they regarded as essential and that those issues yet to be agreed were minor in nature and not regarded by the parties as pre-conditions to a binding contract. The court commented that its decision made more commercial sense than that reached by the High Court (which found that there was a contract but on only some of the terms agreed between the parties with some of the most fundamental missing) and the Court of Appeal (which found that the parties were performing pursuant to no agreement between them at all).
Although the decision in this case is fact specific, it is an interesting decision as illustrating the undesirability of beginning work before a contract is concluded. There is no problem while the commercial relationship is working well. But if a dispute arises considerable cost could be involved in establishing what the contractual position is and what the parties' obligations, rights and remedies are. In this case, the parties had to litigate through the entire court system to establish this. This will have involved significant cost. Lord Clarke in the Supreme Court said the following:
"The different decisions in the courts below and the arguments in this court demonstrate the perils of beginning work without agreeing the precise basis upon which it is to be done. The moral of the story is to agree first and to start work later."
Click here for a copy of the Supreme Court's judgment