This article first appeared on the Practical Law Arbitration Blog on 8 June 2017.

The role of pre-contractual negotiations in contractual disputes is a much debated topic. Every English lawyer knows that, as a general rule, these materials, usually comprising of previous drafts and discussions, are not relevant to matters of interpretation (see for example Chartbrook Ltd v Persimmon Homes Ltd).

There are limited exceptions to this rule, such as the "private dictionary" scenario where the parties are alleged to have attached a special meaning to their words (that is, the words should not be understood in their plain and ordinary sense). There are also other scenarios, outside the scope of pure contractual interpretation, where pre-contractual negotiations are relevant, for example where rectification is sought or fraud/misrepresentation is alleged. However, beyond these narrow exceptions or non-contractual claims, pre-contractual negotiations remain relevant to contractual disputes, especially in international arbitrations.

Contractual interpretation under other legal systems

First, other legal systems may take a different approach, a particularly live concern given the cross-border nature of international arbitrations. For example, as a matter of Singapore contract law, which whilst in many respects is similar to English law, the door has been left slightly ajar by the courts on this issue (see Zurich Insurance (Singapore) Pte Ltd v B-Gold Interior Design & Construction Pte Ltd). However, the admissibility of pre-contractual negotiations as an aid to contractual interpretation in Singapore does not yet appear to have been successfully relied upon in reported cases to date. In any event, pre-contractual negotiations are particularly relevant where civil law is concerned, not least in view of the duty to negotiate in good faith. The author was recently involved in a dispute involving Japanese law, which adopts a less literal/textual and more permissive approach to contractual interpretation.

That particular dispute turned primarily on whether certain implied terms should be included in a Japanese law-governed contract. In that case, previous drafts of the contract exchanged between the parties were particularly helpful because (a) the exchange demonstrated the involvement of legal counsel for both sides in the negotiation process (and so dismissing possible arguments on unfair bargaining positions) and (b) the implied term that was now being proposed had been raised by the same party at that pre-contractual stage, clearly considered and then rejected in the final executed contract. This provided a persuasive argument to the tribunal that it would be unfair and contrary to the parties' intention for that implied term to now be admitted via the backdoor when the proposing party was unsuccessful at negotiating the term into the contract in the first place.

Whether a binding agreement was concluded

Separately, pre-contractual negotiations may be relevant to establishing whether a binding agreement was concluded. An interesting example of this is found in the facts of the recent Singapore case of BCY v BCZ. The underlying disputes arose out of a proposed sale of shares in a company by the plaintiff to the defendant. The parties negotiated but eventually did not sign the sale and purchase agreement (SPA). The defendant commenced International Chamber of Commerce (ICC) proceedings against the claimant, arguing an interesting twist on the doctrine of separability of the arbitration agreement - namely that although the SPA was never executed, the parties in fact concluded a binding arbitration agreement before the conclusion of the SPA.

The parties exchanged seven drafts of the SPA between 17 June 2013 and 27 August 2013. All drafts provided for New York law as the governing law and from the second draft, disputes were to be resolved by ICC arbitration seated in Singapore. Following commencement of proceedings, a sole arbitrator was appointed and the plaintiff challenged the arbitrator's jurisdiction on the basis that there was no binding arbitration agreement.

The sole arbitrator held that there was a binding arbitration agreement. This ruling was then challenged by the plaintiff before the Singapore courts. The Singapore High Court ultimately rejected the arbitrator's decision. The court analysed and rejected each of the four main arguments advanced by the defendant:

  • The plaintiff proposed the arbitration clause. The court held that this proposal did not evidence an intention by the plaintiff to be bound by the arbitration clause independently of the SPA as the introduction of this provision was clearly part of the negotiations.
  • There were no further changes to the arbitration agreement after the fourth draft SPA and the plaintiff indicated its willingness to sign by the sixth draft SPA. The court held that this did not indicate an intention to be legally bound by the arbitration agreement absent conclusion of the SPA.
  • The proviso "subject to contract" applied only to the SPA, not the arbitration clause. The court was not persuaded by such narrow construction (although the sole arbitrator accepted this argument); it held that all seven drafts of the SPA were negotiated on a "subject to contract" basis on the terms of the draft documents themselves (for example, warranties by each side that the SPA was duly executed) and testimony of negotiators.
  • The arbitration agreement provided for resolution of disputes including those relating to "the existence of the SPA" and so must have been intended to be a binding separate agreement. The court rejected this argument and accepted that such wording is not uncommon and refers to the separability of the arbitration agreement but does not indicate that the arbitration clause was intended to be binding absent the execution of the SPA.

This decision of the Singapore court is a welcome clarification on whether pre-contractual negotiations between sophisticated parties with legal advisors can result in a binding (arbitration) agreement. It is not uncommon for multiple drafts to be exchanged with the dispute resolution provisions (including arbitration clauses) unchanged. In this case, the Singapore court recognised the commercial reality that where ultimately the final agreement was not executed, such extensive negotiations and exchanges should not evidence an intention to create legally binding obligations.

Proving an illegality in connection with negotiations or conclusion of a contract

In certain circumstances, pre-contractual negotiations can evidence illegality during the negotiations or conclusion of a contract, which can then result in serious consequences for the enforceability of the contract. An example of this can be found in the context of establishing non-compliance with public procurement law. In a typical procurement process, the public entity will release a tender that would usually set out the main terms on offer and include a draft form of the agreement to be executed. Once the tender is complete, there will be a negotiation process with the successful bidder to finalise the documentation. Most national procurement regimes and international procurement standards prohibit material changes to be included in the final agreement if the amendments would have either changed the result of the competition or shifted the economic balance in favour of the private party. Breach of such prohibition is significant, as it is common for such breach to result in the final contract being void or annulled for non-compliance with procurement rules.

However, in order to demonstrate a material amendment, one would have to (a) establish the original terms of the tender offer, (b) identify the material changes and (c) establish as far as possible who proposed such changes. This necessarily entails trawling through the pre-contractual drafts exchanged and establishing the chronology in which the drafts were developed, as well as the author of such changes, before assessing these changes as against the original tender offer.

From the foregoing, it is clear that pre-contractual negotiations can play a significant role in international arbitrations. However, by the time disputes arise, it is not always easy to trace all pre-contractual drafts and even if access to the documents is obtained (for example, through the document disclosure stage of an arbitration), it is not uncommon for the documents to be provided in piecemeal or haphazard fashion (for example, emails and attachments are not linked up, multiple identical-seeming drafts without dates or comparisons). As a result, the task of piecing together the past can be laborious and expensive. In view of their relevance to a dispute, it is therefore advisable for a complete record of negotiations to be maintained, which will often be the case if counsel is involved.