Where work has commenced but discussions on commercial and legal terms are still ongoing, parties need to consider whether a contract will be deemed to exist and, if so, what the terms of that contract will be?

In an ideal world, parties would agree a formal written contract each time goods or services are to be supplied and the final contract would be signed by both parties before any work commences. However, we all know it’s not an ideal world.

Work will start before a contract is signed for a wide range of reasons, including: perceived urgency or the need to meet project milestones;

  • lack of resource to negotiate and finalise a contract;
  • a supplier’s desire to appear keen and efficient to a new customer;
  • a reluctance to address difficult issues early in a new business relationship.

Where a dispute arises out of work carried out before a contract is signed, things can become messy. These cases are always decided on their facts, with the court trying to ascertain the parties’ intentions from chains of email correspondence, draft documents, notes of meetings and evidence about conversations between the parties. A recent case (RTS Flexible Systems Limited v Molkerei Alois Müller Gmbh & Co KG [2010] UKSC 14) went all the way to the Supreme Court. Given the time and cost involved in taking a case to the Supreme Court, Lord Clarke gave the following warning in his judgment: “the moral of the story is to agree first and to start work later”.

If the parties cannot agree a formal contract in advance, they may try to protect their positions by putting in place some kind of pre-contractual document. Documents of this type go under a wide range of names (memorandum of understanding, heads of terms, heads of agreement and letter of intent, to name but a few). However, whatever you call it, the intention is to agree the key terms on which the parties will trade and to confirm which of those key terms, in the absence of a formal signed contract, is intended to be contractually binding.

Whether a pre-contractual document is in place or the parties have simply been negotiating a formal contract or exchanging emails, the following principles apply:

  • in a commercial context, there is a rebuttable presumption that parties intend their contracts to be legally binding;
  • phrases such as “subject to contract” are likely to rebut the presumption of an intention to create legal relations;  
  • however, the “subject to contract” status can be waived expressly or by the parties’ correspondence and conduct;
  • therefore, if work is being carried out and an agreed payment is to be made, a court is likely to find that a contract exists;
  • where a contract has been fully or substantially performed, the courts are strongly inclined to find the existence of a contract.  

Of course, there may be advantages or disadvantages to each party if a contract is found to be in place. Therefore, businesses should bear the following points in mind:

  • just because a formal contract has not been signed, do not assume that no contract is in place;
  • do not assume that “subject to contract” or similar phrases will always mean that no contract exists. If the parties behave in such a way as to suggest a contract exists, it is likely to be found to exist;
  • always be clear with the other party about the basis on which you are doing pre-contractual work (for example, before starting, send an email stating: “We will be carrying out the work next week on the basis of the contract sent to you on [date]”).

This last point is particularly important. If the party providing the goods or services has made it clear that they are being provided on a particular basis then the court is very likely to construe that basis as a term of the contract. It is therefore important that businesses state their intentions clearly and in so doing create a useful evidence trail should the need arise.