For commercial reasons, contractors commonly commence work under a letter of intent (LoI), before the terms of their contract have been agreed, on the assumption that, ultimately, terms will be finalised.
When the agreed terms fail to materialise, courts typically have to determine whether there was a contract in place between the parties; and, if so, what were its terms.
We reported on one such case - RTS Flexible Systems Ltd v Molkerei Alois Muller GmbH & Co KG  EWHC 1097 (TCC) - in our June 2008 Updater. This case has now been before the Court of Appeal, which has reversed a key finding of the lower court. The case is of significant interest to contractors and employers alike.
The decision at first instance
The facts of the case are set out in our June 2008 Updater (June 2008 Updater). In short:
- The contractor carried out works and was paid by the employer whilst negotiations proceeded on the terms of the MF/1 contract which the parties proposed to enter.
- Although final drafts of the MF/1 contract were prepared, several of the schedules had not been agreed and no formal contract was ever executed between the parties.
The judge decided:
- During the period of the LoI - when the parties were negotiating the terms of the MF/1 contract - there was a contract between the parties for the contractor to carry out works for an agreed price on the terms of the LoI, without agreement having been reached as to the applicable contract conditions that applied.
- (The contractor had argued that its terms and conditions had applied; whilst the employer had argued that the only contract conditions were those set out in the LoI.)
- After the expiry of the LoI - when the parties continued negotiating the terms of the MF/1 contract - the natural inference was that the parties continued just as they had done before (although the contract also included certain documents which had been agreed by the parties after the expiry of the LoI).
In other words, after the expiry of the LoI:
- there was a contract between the parties (for the contractor to carry out the works for an agreed price); and
- this contract did not include any contract conditions (in the sense of either the contractor’s terms and conditions or the MF/1 conditions).
This had a significant impact on the contractor’s liability to the employer.
It is worthwhile considering the significance of both these findings, before we analyse the Court of Appeal’s decision.
The court’s decision that there was a contract
The court reached the conclusion that there was a contract between the parties on the basis that:
- it was unrealistic to argue that there was no intention to enter into legal relations between the parties where (as here) the scope of the work and the price for the work had been agreed; and
- the natural inference was there was a contract between the parties, even though this contract could not be spelt out by a classic analysis of offer and acceptance.
The court’s finding - that there was a contract between the parties - meant that the contractor could be liable to the employer for breach of contract. In theory, the contractor’s liability for any breach of contract could exceed the amount it had been paid by the employer.
(In contrast, if the court had found that there was no contract in place between the parties after the LoI expired, the employer’s only remedy against the contractor would have been by way of an abatement (if the works carried out by the contractor were worth less than the amount the contractor had been paid, as a result of any defect/omission in the works).)
The court’s decision that MF/1 conditions did not apply to the contract
The court reached the conclusion that MF/1 conditions did not apply because:
- the LoI stated that the final contract terms were not to be contractually agreed until signature;
- the contract was designed to operate as a composite whole consisting of all the terms and conditions of MF/1 and its schedules. Although many of the schedules had been finalised, several had not been agreed;
- the parties had not proceeded on the basis of the MF/1 conditions; and
- clause 48 of the MF/1 conditions provided that the contract would not become effective until each party had executed a counterpart and exchanged it with the other (which had not occurred).
The court’s finding - that the contract between the parties did not incorporate the MF/1 conditions - meant that the contractor’s liability would not be limited by reference to any of the MF/1 conditions which (if incorporated) would limit both the scope and amount of the contractor’s liability.
(The MF/1 conditions limit the scope of the contractor’s liability by (for example) excluding consequential losses; and contain a cap which limits the contractor’s liability.)
The contractor’s change of stance
Having (unsuccessfully) argued before the court at first instance that there was a contract between the parties (on the terms of the contractor’s own terms and conditions), the contractor changed its stance.
Influenced, no doubt, by the impact of the court’s findings on both the scope and amount of its liability, the contractor sought to argue:
- There was no contract in existence between the parties. As a result, the contractor was entitled to payment on the basis of quantum meruit and its maximum potential liability to the employer was the return of the money it had received for the works (by way of abatement for defects).
- If this argument failed, any contract between the parties included the MF/1 terms (which limited its liability to the contract price).
The case went before the Court of Appeal.
RTS Flexible Systems Ltd v Molkerei Alois Muller GmbH & Co KG  EWCA Civ 26
The contractor argued that this case was similar to British Steel Corporation v Cleveland Bridge and Engineering Co Ltd  1 AII ER 504, in which Robert Goff J had concluded that there was no contract between the parties, on the basis that:
- contracts for the supply of goods/services were often subject to the standard terms of the contractor which typically included terms limiting the contractor’s liability in relation to defects; providing for liquidated damages for delay and defects; and excluding liability for consequential losses;
- it was impossible to predict, during negotiations between the parties, what liability (if any) a contractor would assume for defective goods or late delivery, if a formal contract was subsequently entered into;
- if the employer asked the contractor to commence carrying out works and services before the parties entered into a formal contact, it would be difficult to infer from the contractor’s performance that it assumed any responsibility for its performance;
- it would be an “extraordinary result” if, by taking steps to perform, the contractor assumed unlimited liability for its contractual performance, which it would not have assumed under any contract.
The Court of Appeal:
- accepted the contractor’s argument that the court’s findings at first instance resulted in the very same “extraordinary result” that the court had rejected in the Cleveland Bridge case; and
- found that there was no contract in existence between the parties after expiry of the LoI.
The Court of Appeal disagreed with the judge’s conclusion that the effect of clause 48 of the MF/1 Conditions was to prevent any contract on the MF/1 terms from coming into existence. The Court of Appeal considered that clause 48 of MF/1 provided a “complete answer”. Clause 48 prevented any contract from coming into existence between the parties.
The significance of the Court of Appeal’s finding
As a result of the Court of Appeal’s finding (for reasons explained above):
- the contractor was not liable in contract to the employer after expiry of the LoI;
- the contractor was entitled to be paid on the basis of quantum meruit; and
- in the event of any defects in the works, the employer’s rights against the contractor were limited to recovering the contract price (by way of an abatement).
The Court of Appeal admitted that its finding that there was no contract was unsatisfactory; but considered that the judge’s finding was also unsatisfactory since it achieved a bargain that neither side had intended.
It is hard to disagree with the Court of Appeal’s conclusion that both its and the judge’s decisions were unsatisfactory:
- The judge’s decision resulted in the contractor’s potential liability to the employer being far greater than it was prepared to undertake during negotiations between the parties. This was an “extraordinary result” (which highlighted the dangers to a contractor of proceeding under an expired LoI).
- The Court of Appeal’s decision resulted in the contractor undertaking no contractual liability whatsoever to the employer - arguably, also an “extraordinary result” (which highlights the dangers to an employer of proceeding under an expired LoI).
This case demonstrates that the risks involved to employers in proceeding under an expired LoI cannot be overstated.