A recent English Supreme Court case shows how important it is that all key terms in a commercial contract are set out with certainty so as to reflect the agreement between the parties.

The case of RTS Flexible Systems Limited v Molkerei Alois Müller GmbH & Co KG involved an initial claim made by RTS against Müller in the Technology and Construction Court in England, which was subsequently appealed by RTS to the Court of Appeal and was then the subject of a further appeal by Müller to the English Supreme Court. RTS had been contracted by Müller to supply and install machinery for packaging its food products and began work pursuant to a letter of intent.

The letter of intent provided that the full contractual terms would be based on Müller's amended Form MF1 (a model form devised by the Institute of Electrical Engineers) and the full terms and relevant technical specifications would be finalised, agreed and signed within four weeks of the date of the letter. The letter also provided that only Müller would have the right to terminate the supply project and contract, but would be required in these circumstances to reimburse RTS for all reasonable, demonstrable out-of-pocket expenses incurred by RTS up to the date of termination. The letter also stated that it was subject to Müller's amended Form MF1.

Following the expiry of the initial four-week period, RTS continued to carry on the works and Müller continued to pay RTS until a dispute arose between them and RTS brought a claim against Müller. Müller argued that after the initial four-week period, RTS would not be under any obligation to continue working and Müller would have no obligation to pay for work performed after that date. In practical terms, the parties did continue with the commercial arrangements following the termination of the letter of intent. The failure of the parties to clearly express what was to be the position if they failed to agree to final terms contemplated in the letter within four weeks led to the dispute.

The Technology and Construction Court found in favour of Müller in determining that the letter of intent expired following the four-week period. The trial judge concluded that, based upon the fact that both parties had continued to perform their obligations following its expiry (and had, in fact, executed the contract by performance), there was an intention to create legal relations between them. He further held that the parties had entered into a new contract, which was to be found in a combination of documents together comprising the contract between them (but declined to find that the Form MF1 formed part of that contract). RTS appealed this decision to the Court of Appeal.

In contrast to the earlier decision, the Court of Appeal determined that there was no ongoing contract between the parties because the Form MF1 included a 'subject to contract' clause. The judge found that the parties had not entered into a legally-binding contract on the basis of that clause, and that no contract had therefore been formed following the expiry of the letter of intent. The judge found that the parties "for good commercial reasons decided to start work before the terms of their contract had been agreed on the presumption that ultimately the terms would be finalised". Müller appealed this decision to the Supreme Court.

The Supreme Court reversed the decision of the Court of Appeal and found (i) that the letter of intent had expired at the end of the initial period, and (ii) that the parties' conduct after the letter had expired suggested that they intended to enter into (and had entered into) a new contract. It also found that the parties' conduct amounted to a waiver of the 'subject to contract' clause contained in the Form MF1.

The court noted that it was possible for an agreement headed 'subject to contract' to become legally binding if the parties later agree to waive that condition (or in this case to perform the contract). It ruled that the parties had agreed to be bound by the agreed terms without the necessity of a formal written contract.

The court took into consideration in its findings that essentially all of the terms had been agreed between the parties, substantial works were then carried out and a number of variations to the contract had been agreed without any suggestion that it was 'subject to contract'. The resulting inference was that the parties had agreed to waive the 'subject to contract' clause. It was not fatal to the arrangements that a form of contract had not been signed or exchanged, as the essential terms had been agreed and performed. Unlike the judge in the Court of Appeal, the Supreme Court judge held that the final contractual terms and conditions agreed did therefore contain the general MF1 terms, as amended.

The conflicting decisions in the various courts illustrate the issues that can arise in beginning work under a commercial agreement, without agreeing the precise terms upon which such work is to be carried out. The very fact that the three courts reached differing conclusions highlights the difficulty in deciding whether a contract exists and on what terms. The case has application for all forms of commercial contracts, including sales and construction agreements and contracts for services. It does not necessarily constitute authority that in every case where a contract has been negotiated 'subject to contract' and work begins before the formal contract is executed, there will be a contract on the terms that were agreed 'subject to contract'.

The case is of persuasive authority in Ireland, and there is a strong possibility that it would be followed in Ireland on a reasonably similar set of facts.