There is a common misconception that oral discussions do not give rise to binding agreements, however, provided the essential elements of a contract exist, oral conversations can form binding agreements, and a court will apply an objective test as to whether or not a contract exists.

Oral negotiations

There is a common misconception that oral discussions do not give rise to binding agreements.

At common law, there is generally no requirement that a contract should be in any particular form or be in writing. Provided the essential elements of a contract exist, oral conversations can form binding agreements, and a court will apply an objective test as to whether or not a contract exists.

When negotiating or discussing the terms of a proposed agreement, it is important that parties consider the following:

  1. has there been offer and acceptance?
  2. has any consideration been provided (in the form of money or services)?
  3. are the essential terms of the agreement specifically clear and certain? has a complete agreement been formed? Are there are essential terms which have not yet been discussed or any other terms which are still being negotiated?
  4. does each party have authority or capacity to enter into the contract?
  5. is there an intention to create legal relations? for example, have the words “subject to contract” have been used?

If parties view their oral negotiations through the prism of contract law and understand the essential elements that make up a contract, disputes as to whether or not an oral agreement has been reached, or what the terms of that oral agreement are, can be avoided.

Oral variations to written contracts

Once parties move to executing a written contract, it is common for that contract to include a term to the effect “this agreement may only be amended or varied in writing signed by all parties” (an “anti-oral variation clause”).

Such a clause is important to set the minimum requirements needed to effect change of the contract and encourage the parties to follow a process. It also protects against accidental and inadvertent variations (and unfounded allegations that casual conversations amounted to a variation).

However, these clauses do not prohibit oral conversations from varying the terms of written contracts (save for in particular circumstances) – in fact, such a clause will not apply if the parties have, by agreement, varied that requirement, and courts appear reluctant to reject an oral variation if it is clearly intended to be binding, even if the written contract contained an anti-oral variation clause, although a court will consider the parties’ express written intention that no oral variations should be effective. This reflects the long-established principle of freedom of parties to contract by whatever means.

In the recent UK case of Globe Motors Inc. v TRW Lucas Varity Electric Steering Ltd [2016] EWCA Civ 396, the court stated an amendment falling short of pre-agreed amendment requirements (such as the requirement of variations to be in writing signed by both parties) would still be effective, provided it could be demonstrated the parties waived those requirements. An example of this might be one party engaging in conduct that amounts to a clear representation that it agrees to the variation, and the other party acting on that representation.

Whilst it is beneficial for parties to have the freedom to agree by whichever means they choose to undertake, parties should be aware of the potential impact of post-contractual oral conversations even if an anti-oral variation clause exists.

Pre-contractual oral representations

If a promise has been made but it is not a binding contract, equity may come to your assistance. Pre-contractual representations may give rise to an estoppel, binding a party to their conduct, if the key elements of equitable estoppel are satisfied. These are:

  1. Creation or encouragement of an assumption by party A that a ‘particular legal relationship’ would be established or that ‘an interest’ would be granted;
  2. Detrimental reliance on that assumption by party B; and
  3. It would be unconscionable for party A to depart from the assumption relied upon.

Equity may intervene to give rise to a promissory estoppel, if a clear, precise and unambiguous representation was made.

The recent case of Crown Melbourne Limited v Cosmopolitan Hotel (Vic) Pty Ltd & Anor [2016] HCA 26 involved a five year commercial lease with no option to renew. A statement was made by the lessor (Crown) to the lessee (Cosmopolitan) to the effect they would be “looked after at renewal time”. It was a condition of the lease that substantial refurbishments would be undertaken, and therefore the lessee was keen to ensure the benefit of significant financial outlay on those refurbishments would be preserved past the five year term.

  1. At first instance, the Victorian Civil and Administrative Tribunal held a collateral contract existed which Crown was estopped from denying, therefore Crown was obliged to offer a renewal for five years.
  2. On appeal, the Supreme Court of Victoria found the statement did not give rise to an enforceable obligation pursuant to a collateral contract, and no estoppel arose as the representation was not sufficiently promissory.
  3. The matter eventually went to the High Court where it was held:

a) There was no collateral contract on the basis:

  • The statement did not have the quality of a contractual promise;
  • The statement was no more than “vaguely encouraging”; and
  • There is no enforceable agreement to renew a lease unless the essential terms are agreed.

b) No estoppel existed because:

  • The promise was not sufficiently detailed, and no reasonable person would have relied on it; and
  • A “clear, precise and unambiguous” statement was required for a promissory estoppel.

This case is a reminder that the best practice is to ensure that all oral promises are included as terms in the written contract. Parties should never assume that a promise will be honoured based on a verbal promise. Whilst equity may come to a party’s aid, this will involve costly litigation and being able to prove that all of the elements of equitable estoppel are met.

You can read further about equitable estoppel here and here.

Conclusion

Parties should be careful when negotiating orally and be mindful of the elements required to form a binding oral contract. If you intend to rely on an oral agreement, take witnesses with you and make file notes of your conversations.

It is always best to formally document an oral agreement as soon as possible after oral negotiations. This will force the parties to turn their minds to all aspects of the agreement and will provide clarity and certainty about rights and obligations. Some initial outlay in properly documenting an agreement may save you costly litigation in the future.

Ensure that any oral promises made are included as terms in the written agreement - never assume an oral promise will be otherwise honoured.