In this briefing we look at the lessons to be learnt from some of the English contract law cases of 2012 which, whilst not all arising out of contracts relating to real estate are of relevance to the real estate industry when drawing up or interpreting contracts or agreements. A brief summary and some practical tips follow.
- Formation of contracts - agreements to agree and letters of intent
There were a number of key cases in 2012 which considered the issue of whether a contract had actually been formed, including the status of side letters and letters of intent. As these cases illustrate, it is vital to ensure that an agreement is sufficiently certain to be enforceable as a contract.
In this case Merit, the claimant sub-contractor, began work under a letter of intent with Balfour Beatty on the understanding that they would subsequently enter into a contract which would include an arbitration clause. The letter of intent was expressed to be "subject to contract" and did not include an arbitration clause. Although discussions continued between the parties as to the terms of contract, a final form contract was never entered into. The final exchange of letters indicated that the parties had not agreed the contract price although the difference between them was only some £37,500 as against an overall contract sum of some £1.6 million. Merit brought an action in relation to the work which it had carried out and Balfour Beatty sought to rely on the arbitration clause in the draft contract and applied to stay Merit's proceedings.
The Court of Appeal concluded that no mechanism had been agreed by the parties to arrive at a "fair" price. The amount in dispute might not seem substantial but it was not de minimis or non-essential. There was therefore no final contract and no arbitration clause. The work was still being carried out under the terms of the letter of intent.
The next two cases both considered provisions requiring the contracting parties to negotiate in good faith the terms of a further agreement. In both cases the relevant provision was held to be unenforceable even though it was included in a professionally drafted commercial document.
In this first case Mr Barbudev appealed to the Court of Appeal against a first instance decision, which found that a side letter was not enforceable under English law. Mr Barbudev had agreed to sell his company to Warburg Pincus and wanted to reinvest part of the proceeds of sale into the company formed by Warburg to make the acquisition. The terms of that reinvestment could not be agreed by the deadline for execution of the share purchase agreement so it was agreed that the parties would enter into a side letter relating to it. The side letter, which had been drafted by external lawyers, contained the following term:
"in consideration for you agreeing to enter into the Proposed Transaction … the Purchaser hereby agrees that … we shall offer you the opportunity to invest in the Purchaser on the terms to be agreed between us which shall be set out in the Investment Agreement and we agree to negotiate the Investment Agreement in good faith with you."
Mr Barbudev claimed that the side letter constituted a binding contract, but at first instance the judge held that there was no clear intention to create legal relations and the letter itself was too uncertain and lacking in detail to be enforceable. Mr Barbudev appealed on the basis that the judge, when considering whether there had been an intention to create legal relations with the side letter, should have considered the side letter in its wider commercial context i.e. as a safeguard of Mr Barbudev's right to reinvest because the Investment Agreement could not be finalised before the signature of the share purchase agreement.
The Court of Appeal agreed with Mr Barbudev that the judge at first instance should have considered the commercial circumstances of the side letter when deciding whether there had been an intention to create legal relations. It also said that the fact that the side letter was drafted by legal professionals, included language of legal relations (e.g. "in consideration of you agreeing to enter into…"), referred to English law and included a confidentiality agreement, all indicated that it was intended to create legal relations. However, this finding did not necessarily mean that the side letter created a legally enforceable contractual right for Mr Barbudev to acquire the stake at the price indicated. The Court of Appeal unanimously dismissed the appeal, holding that, despite the intention to create legal relations, the side letter was only an agreement to agree and therefore could not constitute a binding commitment. In addition, the side letter was deemed to be too uncertain to be legally enforceable as it omitted key details to make an Investment Agreement with Mr Barbudev sufficiently workable.
In the second case, in an application for summary judgment Mr Shaker sought the return of a US$3.55m deposit paid pursuant to a letter of intent in respect of a potential transaction concerning the purchase and operation of an aircraft, then owned by a company within the Vistajet group. It was accepted that the letter of intent was intended to be binding in respect of certain matters, including the payment and refund of the deposit.
The letter of intent contained a provision that, if the parties:
"despite the exercise of good faith and reasonable endeavours fail to reach agreement, execute and deliver the Transaction Documents before the Cut-Off Date … the Guarantor [i.e. Vistajet] shall within five (5) business days following the Cut-Off Date refund the deposit to [Mr Shaker]."
Vistajet argued that Mr Shaker was not entitled to the return of his deposit as he did not proceed in good faith or use reasonable endeavours to agree the relevant transaction documents, which were pre-conditions for the return of the deposit.
The judge referred to Barbudev as authority for the proposition that agreements to use reasonable endeavours to agree or to negotiate in good faith are unenforceable. He said, "The reason for such unenforceability is that there are no objective criteria by which the court can decide whether a party has acted unreasonably and that a duty to negotiate in good faith is unworkable because it is inherently inconsistent with the position of a negotiating party". The judge went on to decide that, even if the requirement to negotiate in good faith in this case was a condition precedent to the return of the deposit, it was nevertheless unenforceable for the same reasons that a requirement to use reasonable endeavours to agree was unenforceable. Mr Shaker was therefore entitled to the return of his deposit.
The judge highlighted the fact that there were no objective criteria by which the agreements to be agreed between the parties could be created for the parties by the court in the absence of agreement. Where there are no objective criteria the court is unable to enforce the parties’ agreement to agree.
The parties exchanged a series of e-mails in which they agreed various amendments to a standard form document for a ten year charterparty between Golden Ocean, the claimant, and Trustworth Shipping Pte Ltd, with Trustworth being "fully guaranteed" by SMI, the defendant. Although one of the parties asked the other to provide a full and complete signed agreement incorporating all the key terms, such a document was never created. When relations broke down, Golden Ocean claimed under the guarantee. SMI stated that there was no guarantee as the requirements of Section 4 of the Statute of Frauds 1677 had not been met. Section 4 requires a guarantee, or a memorandum or note of it, to be in writing signed by the guarantor or a person authorised by the guarantor.
The Court of Appeal confirmed the High Court's ruling that an enforceable guarantee can be created by a series of emails authenticated by the online signature of the guarantor. Section 4 of the Statute of Frauds 1677 did not require the agreement in writing to be in a single document or even in a small number of documents. The emails which constituted the alleged contract were signed by including the name of the persons who sent them. If a person puts his name on an email, even if it is just his first name, initials or nickname, then it will be a signature for the purposes of Section 4 as it indicates that the email comes with his authority and he takes responsibility for its contents.
Practice points – formation of contracts
- Consider the use and drafting of side letters very carefully.
- Expressly state whether any side letter is intended to be legally binding as evidence of the parties' intention to create legal relations.
- Consider carefully whether the terms of any side letter are sufficiently certain to be enforced, otherwise the document may be an unenforceable agreement to agree.
- Remember that contracts, including guarantees that do not take the form of a deed, can be formed by an exchange of emails so if you do not want to create an enforceable guarantee while negotiating in writing then it is important to make it clear that you are negotiating subject to contract and do not intend to be bound until a formal document is executed.
- Note however that a deed does need to be signed formally in wet ink – a name in an email would not be sufficient.
- There are additional statutory requirements for a contract for the sale of land which must incorporate all agreed terms into a written contract which must be signed by or on behalf of each party to the contract (section 2, Law of Property (Miscellaneous Provisions) Act 1984).
- Contractual notice provisions
Last year saw a number of cases which looked at various notice provisions in contracts. These cases serve as a reminder of the need to consider what to include in a notice clause at the time of drafting and also the importance of complying strictly with the provisions of the contract when giving notice.
In this case which was taken to the Court of Appeal, Ener-G had given two notices of a breach of warranty but claimed that its first notice had not been validly served. This was a key issue because the contract provided that proceedings had to be served within 12 months of serving the notice of breach. The first notice was delivered by process server on 30 March 2010 and left outside the residence of Mr Hormell, although it was received by him later that day. The second was sent by recorded delivery and received on 1 April 2010. The claim form was then served on 31 March 2011.
The contract provided that:
"Any such notice may be served by delivering it personally or by sending it by pre-paid recorded delivery post to each party…at or to the address referred in the Agreement …"
The dispute therefore centred on whether the first notice had been validly served by being left outside Mr Hormell's residence. If valid, this meant the claim form had been served out of time because it was served more than a year later. However if the first notice was invalid and the second notice prevailed, the claim form would have been served before the one year contractual deadline.
Mr Hormell argued that the first notice was valid, claiming that the methods of service stipulated in the contract were not intended to be mutually exclusive. Ener-G in turn argued that the two methods of service stated in the contract were exclusive and the first notice had not been served in accordance with the contract because it was not served 'personally.' The 12 month time period should therefore have been calculated from service of the second notice.
The Court of Appeal noted that the concept of 'personal service' is well understood to mean service on the recipient personally and the first notice had therefore not been served 'personally'. However, the Court held that this did not matter, because the methods of service specified in the contract were not exclusive, given the use of the word "may". Service of the first notice was therefore valid and the claim form was therefore served one day out of time. Lord Justice Longmore dissented on the question of whether the methods of delivering the notice set out in the contract were exclusive. In his view, where a contract sets out two methods for the service of notices, it was counter-intuitive to conclude that the deliverer could choose any other method to serve a notice. He also pointed out that the deemed service provision in the contract only provided dates for deemed service for the two methods of service set out in the contract.
One of the key issues in this case was whether the defendant airline, Tarom, had validly served notice on Jet2.com terminating a maintenance contract between them. The contract allowed for termination by notice from Tarom when Jet2.com was in default of payment of any sum due under the agreement for 20 business days. On 31 May 2007, Tarom informed Jet2.com by email that Jet2.com owed $80,902.74 for maintenance services which was to be paid before 10 June 2007 (although whether these sums were actually due at this time was in doubt). Tarom claimed that this email on its own was sufficient to constitute notice by which the contract could be validly terminated if the payment was not made on time.
The judge held that the email on 31 May 2007 could not constitute valid notice. Although the agreement did not provide for a specific formal notice, the parties could not be found to have intended to terminate the agreement without the significance of the communication being made clear to Jet2.com. There was no evidence that Tarom intended the email to be a valid termination notice at the time of sending and if it had wished it to constitute notice without observing any particular formalities, it should have made its purpose and nature clear. It was also noted that the notice should have accurately set out the sums allegedly due, the non-payment of which gave rise to the termination and, as there was doubt as to which of these sums were actually due, the email could not be considered a valid notice.
Practice points – contractual notice provisions
- If you wish to specify particular methods of contractual service use clear language in the contract to put this beyond question - in particular use "shall" or "must" instead of the permissive "may".
- Make sure that any correspondence intended to serve as a notice of breach or termination is completely clear as to its purpose and, if there are provisions in the contract about how notices must be given, follow them to the letter.
- Good faith clauses
The Barbudev and Shaker cases covered above in the section on the formation of contracts considered the effect of an agreement to negotiate in good faith. In 2012 we also saw a case which considered and upheld an express general obligation to act in good faith.
The NHS Trust had entered into a long term catering contract with Compass which included provisions that enabled the Trust to make deductions from its service payments to Compass if there was any poor performance by Compass. The relationship between the parties deteriorated and both purported to terminate the contract. As part of the rift in the relationship the Trust alleged that there were numerous defects in the performance of the contract by Compass which entitled it to deduct almost £600,000 whereas Compass considered that the amount of permitted deductions was just over £37,000. The Trust failed to respond to requests from Compass for details of its deduction calculations and also failed to respond to attempts by Compass to resolve the dispute. The contract provided that:
"The parties will cooperate with each other in good faith and will take all reasonable action as is necessary for the efficient transmission of information and instructions, and to enable the Trust … to derive the full benefit of the contract."
The court held that the clause imposed a general obligation on both parties to cooperate in good faith and this general obligation was not limited by the two more specific purposes that followed. It was not open to the Trust to interpret that clause in a purely self-interested manner and the absurdity of the Trust’s level of calculations for deductions was a breach of their obligation to act in good faith. It was notable that the contract was a long-term contract and the court suggested that the longer the term of the contract, the more likely it is to be necessary for the parties to work together and cooperate, in order for the contract to actually work. The obligation of good faith requires the parties not to take action which could damage the relationship but instead they should look to work together at all levels in order to perform the contract. The court noted that bad faith is not a prerequisite for a breach of a duty of good faith, and capricious or any other unreasonable behaviour could be held to be a breach of a good faith obligation.
Practice points – good faith clauses
- Consider carefully whether to use good faith wording in a contract - remember that this does not create certainty as to what the parties must do to honour it.
- Consider specifying the actions which a party is required to take to satisfy a good faith obligation and those actions which it is not required to take.
- Do not ignore an existing contractual obligation to use good faith and remember that fulfilling such an obligation will involve more than not acting in bad faith. It could include, for example, a duty of disclosure and a duty to cooperate.
- Execution of documents
Following on from the various cases on the execution of documents over the last few years, in 2012 we saw another example of the dangers of not complying with the requirements for the execution of a deed.
In this case the Adjudicator to HM Land Registry decided that a lease was invalidly executed because the execution page and plan had been signed without the remainder of the lease being attached. The pages were then added to the lease, but this fell foul of the requirements of Section 1(3) of the Law of Property (Miscellaneous Provisions) Act 1989 which provides that:
"An instrument is validly executed as a deed by an individual if, and only if—
(a) it is signed —
(i) by him in the presence of a witness who attests the signature; or
(ii) at his direction and in his presence and the presence of two witnesses who each attest the signature; and
(b) it is delivered as a deed."
The adjudicator, referring to the case of R (on the application of (1) Mercury Tax Group Limited and (2) Darren Neil Masters) v HMRC and others  EWHC 2721 (Admin), held that Section 1(3) clearly provides that the signature and attestation must form part of the physical instrument at the moment of signing. This requirement stands alone, regardless of whether there were earlier drafts (which may or may not have been materially different). The policy argument is that the signature should reflect the proper agreement: if the signature is obtained separately the maker cannot be sure of the terms of the deed and the risk of fraud or mistake remains. The lease was therefore void as it was not made by deed.
The land register was rectified to remove reference to the lease and the charge which had been granted over it. Although the specific facts of this case suggested that the purported lessee had been dishonest in his conduct towards the freeholders, the decision reinforces the need to comply with legal formalities when executing documents, especially deeds. In today's email world, it is all the more important to ensure that proper execution and delivery has taken place.
Practice points – execution of documents
- Consider any applicable statutory or regulatory requirements that may apply to the execution of any document. If an extra layer of formality is required, make sure that you comply with it.
Remember that deeds do have additional requirements of formality, namely:
- the document must make clear on its face that it is intended to be a deed;
- the document must be correctly executed as a deed, meaning that an individual's signature must be witnessed and a company must execute by its common seal, by the signatures of two directors, or by one director and a secretary, or by one director with a witness;
- the document must exist as a full, physical instrument at the time of signing; and
- the deed must be delivered – although there is a rebuttable presumption that a deed executed by a company is delivered on execution, there is no such presumption where a deed is executed by an individual.
- Include wording in deeds stating when delivery is to take place.