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Commercial Contracts - Drafting Techniques and Precedents
Commercial Contracts - Drafting Techniques and Precedents
PROFESSIONAL
INSIGHTS
COMMERCIAL
CONTRACTS
DRAFTING TECHNIQUES
AND PRECEDENTS
Robert Ribeiro
PH.D BARRISTER
IFC
THOROGOOD
PROFESSIONAL
INSIGHTS
COMMERCIAL
CONTRACTS
DRAFTING TECHNIQUES
AND PRECEDENTS
Robert Ribeiro
PH.D BARRISTER
Published in 2003, updated 2005
Introduction....................................................................................................1
APPENDICES 90
Appendix 1
List of cases cited .......................................................................................91
Appendix 2
List of statutes and other enactments mentioned in the text................95
The ideas for this Report have been developing during the past decade and repre-
sent aspects of current drafting practice, as well as new legislation and case law.
Among statutory developments, the one that immediately springs to mind is
the Contracts (Rights of Third Parties) Act 1999, which will affect contract
planning and risk management, not least because of its potential to catch people
unaware of its full implications. Cases about this Act are already beginning to
come on stream, and an important example is included in this Report.
Among major areas of case law, we may single out judgments clarifying the law
on agreements to agree and other related agreements, such as lock-out agree-
ments; we would also count the steps taken by the courts towards the
clarification of the law relating to indemnities as welcome additions to the vast
body of contract law.
Whereas, in the first edition of this Report, the law of misrepresentation was
singled out as an area of potential difficulty, we can now say with some confi-
dence that it is on the way to being clarified, and that certain simple steps can
be taken to avoid unnecessary liability in this respect.
Our understanding of clauses making time of the essence, and of their conse-
quences, has become enhanced during the last few years, as has our appreciation
of the fine distinction between exclusions of liability and limits of liability, and
its consequences for the construction of terms. We have also become increas-
ingly aware of the perils of using terms of art that are undefined, or expressions
that are too uncertain in meaning to be valid.
Other areas of law that are of increasing interest to those who draft contracts
are the laws of restraint of trade, the Human Rights Act 1998, the Rome Conven-
tion 1980 and the Brussels Convention 1968, dealing with choice of law and
jurisdiction, respectively.
However, this Report was never intended to be another book on case law and
statute. It is above all a work about how one sets about drafting a commercial
contract, whether it is of an everyday type, such as a sale of a business or a
purchase of goods, or whether it is a more unusual venture. Questions will always
arise, such as what should one include; what should one be wary of; why should
one form of words be better or worse than another; why does yet another form
of words have (for those who are not familiar with the precedents) an entirely
More than any other question, perhaps, the one that recurs is, ‘How do I begin
to draft a commercial contract? Where do I start?’ That is where this Report
begins.
Chapter 1
The commercial and legal
objectives
Getting started: preliminary considerations ......................................4
Drafting precedents...............................................................................4
Rectification .........................................................................................10
Drafting precedents
Drafting precedents are a useful sounding board for ideas, and for reminding
us of things that may be included in contracts and of ways in which they may
be written; but they should not be used as the first stage of drafting a commer-
cial contract. It is at a later stage, after we have sketched out a preliminary draft
or list of ideas, that precedents may be of value.
1. Planning
2. Financial control
3. Risk management
The following are some notable cases in which the wishes and needs of the client
became important issues.
What the charterers needed was to be able to make the owners liable in damages
for failure to comply with their instructions, whether or not the consequences
of such failure had been in the contemplation of the owners at the time of the
contract. But the clause did not contain precise words to this effect and a claim
for a loss of a discount on the cost of petroleum, due to a loading of the cargo
at the wrong time, failed because the owners of the ship had been unaware of
the consequences.
But the precedent used for this occasion contained particularly obscure
wording and did not make clear the terms on which the money was payable. It
was held by the House of Lords that this was not an on-demand bond at all but
only a conditional guarantee which, being dependent upon the precise state of
accounts between the contractor and the sub-contractor, was subject to set-off
and counterclaim.
out. Such sums can be claimed as damages, but damages are subject to defences
such as remoteness, failure to mitigate loss, the rule against penalties, and certain
forms of statutory protection in favour of the tenant. Properly framed, however,
the duty to reimburse will constitute a debt, not damages, and this will make
the defences mentioned above inapplicable. In this case the landlord’s claim in
debt was successful.
Planning
The first of these ideas can be implemented at the beginning of, and throughout
the drafting of a commercial contract. We might begin by asking ‘What are we
trying to achieve?’ – in respect of the contract as a whole and also clause by
clause. We will also be relating the contract, as written, to the commercial venture
as planned, and will be trying to ensure that the contract mirrors the programme
or sequence of events required, as well as the correct allocation of obligations
and risks. At this stage the obligations of each party, programme and risks of
each party, can be set out.
Financial control
This is partly an extension of the obligations clauses, since the duties of each
party in respect of payments to be made will be set out here. But it is more than
simply a matter of price, consideration or payment. It will also involve the question
of whether or not any security is required from either party, such as a bond or
guarantee, or a deposit. It will also involve the question of when any refund or
repayment may become due. It will also involve the question of whether or not
deductions from monies owing (whether by way of set-off or counterclaim) are
permitted. Another aspect of financial planning, which involves fine legal distinc-
tions, has already been seen in the distinctions between a financial liability in
damages and an obligation to pay a debt, or to reimburse a sum of money (which
is a form of debt); this distinction is related to the distinctions between a warranty,
an indemnity and a promise (or covenant) to pay an identified sum of money.
Risk management
In many, but not all, contracts, this may account for a high percentage of the
text of the document. Virtually all ‘boilerplate clauses’ (i.e. those clauses that are
routinely used and not normally negotiated or customized for the particular
contract) are put into a contract for purposes of risk management. The same is
true of limits of liability. In Chapter four there will be details of boilerplate clauses
dealing with matters such as force majeure, the right to assign or to sub-contract
or sub-let, waiver, invalidity and severance, notices, choice of law and jurisdiction,
and so on.
The philosophy that a contract, or any term of it, should create a meeting of
minds and not give rise to mis-understanding, should permeate every aspect
of the drafting of commercial contracts. Those involved in drafting should
remember that if misunderstandings or ambiguities arise, equitable remedies
such as rectification or specific performance or the avoidance of forfeiture, are
not easy to come by.
‘3a The tenant shall use its best endeavours to obtain all necessary
licences, permissions, approvals and consents in respect of the
development.’
The agreement was made in 1978, but by 1984 work had not started, and
the respondents, the owners of the site, (referred to as the ‘Landlords’ in the
agreement), claimed that the agreement was terminated by repudiation by
the appellants (referred to as the ‘Tenant’). The appellants began the action,
arguing firstly that the expression ‘as soon as reasonably practicable’ allowed
them to take into account economic factors (for example interest rates), so
they were not in willful default.
This part of the argument shows the importance of clarifying all matters
relating to time obligations, even if, or especially if, they are in apparently
plain language. The problem with time provisions is that words alone do not
necessarily make plain their intended meaning. Or the parties may each read
the words and intend to give them an entirely different meaning.
The alternative argument put by the appellants was that even if they were
in willful default, the terms of Clause 4 of the contract did not allow for termi-
nation, but provided just the opposite (see the italicized words). The
problem for the courts was in trying to decide whether the contract had a
word missing, or whether the parties intended it to be as drafted; and if they
did, what they intended it to mean.
The clause might have been intended as a default clause; but if so it was badly
drafted. Or it might have been intended as a continuation of a programme,
so that in any event, including willful default of the Tenant, the intended lease
of the property intended for development would go ahead. This is a perfectly
plausible explanation of Clause 4, but for the inelegant and ambiguous wording.
We may draw two conclusions for drafting from this case. One is that time
provisions need to be clearly defined, in this case either by putting an end
date after the words ‘as soon as reasonably practicable’, or by defining the
matters to be taken into account in deciding what is ‘reasonably practicable’.
The other is that terms should not contain ambiguities or consequences that
seem somewhat improbable or contrary to normal principles. If for some
commercial reason terms do have to be drafted on an abnormal basis, then
this should be clarified for the avoidance of any doubt. Above all, the parties
to the contract need to know what has been stated and how it will work.
Rectification
This remedy should be understood by those who have to draft and negotiate
contracts since it arises under the rules of equity and is subject to certain quali-
fications. It is not an all-purpose cure for incorrect drafting or poor proof-reading.
In our case history above, the remedy of rectification was, perhaps surprisingly,
not asked for when the case first appeared in the Chancery Division. The reason
was probably that one party was in breach of the agreement, and equity will
not usually assist a party in breach. The other reason is that the parties almost
certainly did not know what the correct version of Clause 4 of the agreement
was meant to be, and that, as we shall see, is an important requirement to obtain
rectification. So the case had to be argued on other grounds.
3. The party seeking rectification must show that the proposed rectification
does not conflict with any of the other agreed terms of the contract.
‘Plain, intelligible language’ is compulsory in those contracts that fall within the
ambit of the EC Directive on Unfair Terms in Consumer Contracts, 1993, and
the UK Regulations, 1999, which give it effect. Under these rules, the Office of
Fair Trading can require that terms be put into plain language and can enforce
this, if necessary, by application for an injunction. In any case before the courts,
if there is any doubt about the meaning of a term in a consumer contract falling
within these rules, the interpretation most favourable to the consumer will prevail.
3. Short sentences.
6. Avoiding the passive tense: say, for example, ‘The Seller will deliver
the Goods on or before the following date...’, rather than ‘The Goods
will be delivered by the Seller on or before the following date...’
10. Use recitals where appropriate to clarify the background to the contract.
12 Use formulae where necessary, but check that they do exactly what
is intended.
Obscure words
A few examples will suffice to give the reader an idea of what to be wary of.
For example, the word ‘forthwith’ is sometimes used in terms of contracts. Few
people, however, have any precise knowledge of its meaning. Some readers will
think that it means ‘at once’, or ‘without delay’; others will think that it means
as soon as is reasonably practicable. Since at least two of the cases we will be
looking at in the next chapter were about time provisions, and in one case turned
upon a matter of minutes, meanings of expressions such as this can be of consid-
erable importance.
The argument of the owners was that this meant that a demolition order either
had to be made immediately or not at all. The Court of Appeal disagreed and
Harman LJ. stated: “Forthwith is not a precise time, and provided that no harm
is done, forthwith means any reasonable time thereafter.”
Everything in this case turns on the meaning of the words ‘deem’ or ‘deemed’.
The words are common enough and have come to the aid of those drafting
contracts on numerous occasions. For instance, there are terms under which
a person is deemed, after a stated period of time to have accepted goods, or
clauses under which certain property is deemed to belong to a party at a certain
time. However, the precise meaning of the words can be obscure because it leads
to a question of whether the state of affairs that is deemed to exist really exists,
as a matter of fact or of law, or is merely treated for the time being as though
it exists. If the latter is the case, this can lead to difficult questions as to how to
classify this provisional state of affairs.
In this case a contract for the separation of shale from coal by means of a coal
washing plant provided by Clause 53(2) that all plant, goods and material owned
by the contractor was, when on site, deemed to be the property of the council.
By another clause of the same contract, the council could in certain circumstances,
such as the liquidation of the contractor, retain the plant and sell it on comple-
tion of the works. In the event, the contractor got into financial difficulties and
left the site leaving the plant there. The administrator applied for delivery of
the plant, or payment for its use.
In the Chancery Division and the Court of Appeal it was held that the terms of
the contract did not have the effect of transferring legal ownership of the plant
to the council. Millett L.J. stated that while ‘deeming’ provisions can in some
cases pass legal ownership, the words were ambiguous, whereas words such
as ‘shall be and become’ would have been adequate to pass legal title.
What the council had in this case was a possessory right, together with a power
of sale. But the power of sale was invalid in this case, since it required regis-
tration as a floating charge, under the Companies Act 1985, and this had not
been done.
The council had drafted terms which achieved some possessory rights, but these
stopped short of what the council really wanted, and caused the litigation.
What this case demonstrates is that an obscure word can give rise to extremely
complicated legal relationships, and a failure to achieve commercial objectives.
In this case a term of a contract for the sale of sugar provided that a bond provided
by the seller would be ‘liable to be forfeited’ if the seller failed to fulfil any terms
or conditions of the contract.
The normal law applicable to bonds is that if a purchaser holding a bond ‘calls’
the bond, i.e. demands and receives payment, there will be an accounting proce-
dure at a later stage, so that the purchaser is neither over-compensated nor
under-compensated. But the purchaser argued in this case that ‘liable to be
forfeited’ meant that there was no right on the part of the seller to call for an
account. This form of wording is not usual and the purchaser thought that it
displaced the normal rules applicable to bonds.
The Court of Appeal held that it was legitimate for a court to look at the context
and the commercial background to the contract, in interpreting this provision,
so as to avoid an unreasonable result, and accordingly they held that the purchaser
was only entitled to retain sums equal to its actual loss. This conclusion seems
entirely just, but the case again shows that a simple commercial device can be
made unnecessarily contentious by the use of a few ambiguous words.
Recently, in the above case, it was held by the Commercial Court that in relation
to an agreement to supply a distributor exclusively with certain machines for
use in the UK, the expression ‘for as long as is permitted by law’ was too uncer-
tain to have effect.
The expression related to rights of renewal of five year periods ‘for so long as
permitted by law’. The parties had allowed the agreement to run for the initial
five years and for one five year period of renewal. The judge decided that the
basic five year period of the agreement, together with the five year period of
renewal was reasonable for the protection of the distributor’s investment. But
the words used were too uncertain to allow further renewals. If the words were
construed so as to entitle the distributors to renew in perpetuity, this would be
void as a restraint of trade.
(The expressions ‘number one’ and ‘number two’ are, one would expect, terms
that need a formula to calculate and explain them.)
The contract stated that the ranking was to be based upon ‘the average of her
best week’s ranking in each month’. The problem was that when this term was
applied to the relevant period, and her best rankings were added together and
divided by 12, the result was a figure of 2.5. This gave rise to the litigation in
question.
If the parties, at the time when the contract was drafted, had attempted to express
the relevant terms as a detailed formula then the ambiguity would immediately
have been spotted, and a suitable corrective formula or statement could have
been put into the contract.
In the event, the Court of Appeal held that the numerical figure arrived at was
not sufficient on its own to qualify for a bonus, and that a comparative ranking
with other players was the main criterion. There were other players, who by
the same criteria ranked higher than the plaintiff, so she in fact ranked only fourth
and did not qualify for the bonus.
The term should have been set out to show that (for example), in the case of the
number 2 ranking:
• 2.0 (including any number between 2.0 and 2.5) qualifies for the £550,000
bonus;
Chapter 2
Strategic ends: some important
decisions to be made about the
terms of the contract
Time: is it to be or not to be of the essence?.....................................18
Controlling assignment.......................................................................23
Material breach....................................................................................35
These statements can also be put into ‘plain English’ versions and in consumer
contracts it would not be advisable to use the words ‘of the essence’, unless one
is prepared to add in ‘plain English’ details of what is meant, since otherwise
the terms might not be sufficiently plain for a consumer to be capable of under-
standing their true meaning. We will deal with this point in more detail when
we look at the ways in which the validity of a contract can be contested in Chapter
six.
Further, the contract stated that if the purchaser failed to complete in time, the
deposit would be ‘absolutely forfeited for liquidated damages (and not a penalty)’
to the vendor. There was the usual deposit of 10% of the purchase price.
As it turned out, the cheque for the purchase price was delivered ten minutes
too late, and the vendor rescinded the contract and claimed that the deposit was
forfeited.
deposit had been a form of liquidated damages, then arguably it could indeed
have been a penalty, since the sum may not have been a genuine pre-estimate
of likely loss to the vendor. But the Judicial Committee of the Privy Council held
that this was a deposit, and the forfeiture of a deposit is not the same thing as
damages. The rule against penalties would only have applied in the circumstances
if the deposit had been too large to be a genuine deposit.
Finally, the appellant argued that equitable relief should be granted against the
harsh consequences of time being of the essence. The Judicial Committee held
that there was no general principle of equitable relief in this area, and that there
were no specific grounds in this particular case. It was stated by Lord Hoffmann
that if the court accepted the argument that ten minutes delay was not late enough
for the normal rules of breach of an essential term to apply, then it would
frequently be faced with arguments about how late was too late. So the usual
rules applied.
The buyer argued that it was entitled to take into account its own financial position
when seeking to agree a commissioning date. The seller argued that the only
criteria were technical and operationally practical criteria (i.e. financial criteria
were not relevant).
The Court of Appeal held by a majority that, when taken in their contractual
setting, and in particularly in view of the fact that there was a fall-back date if
the parties were unable to agree, the words used did not impose upon the buyer
an obligation to disregard the financial effect upon the buyer of agreeing a
commissioning date.
Putting this into a commercial context, if a third party is permitted to take advan-
tage of a contract, this could be potentially harmful to the commercial interests
of one or the other of the two original contracting parties. To exclude, or control
the rights of third parties, parties drafting a commercial contract need to bear
in mind three concepts:
1. Assignment of rights.
3. The rights of third parties under the Contracts (Rights of Third Parties)
Act 1999.
Novation
Since novation can be agreed upon at any time, or declined at any time, it is not
usual to draft clauses in a contract either permitting it or restricting it.
However, there may be cases where a contract is created between A and B in
the knowledge that it will later be novated to a third party. In such cases a provi-
sion to this effect may be drafted into the original contract so that:
Controlling assignment
Unless the contract contains terms restricting in some way the right of one or
both of the parties to assign benefits of that contract, it is assumed as a matter
of law that assignment is permitted. However, as Lord Browne-Wilkinson stated
in one of the leading cases on this subject, “It is trite law that it is in any event
impossible to assign the contract as a whole, including both burden and benefit.
The burden of a contract can never be assigned without the consent of the other
party to the contract, in which case such consent will give rise to a novation.”
(Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd (1994) 1 AC 85, 103).
The right to assign may be controlled in a number of ways: there may be a clause
which states simply that neither of the parties may assign any part of the contract.
Or the words ‘...without the prior written permission of the (other party)’ may
be added. The clauses do not have to be bilateral: there are contracts in which
one party, such as a major supplier or purchaser, restricts the right of the party
it is dealing with to assign, while not mentioning its own rights to assign, which
are assumed to have been preserved.
There will be cases when a purchaser of services or goods will need, for commer-
cial reasons, to take steps to preserve third party rights. This could be done by
negotiating some form of exception to any prohibition of assignment, or a clause
stating that permission to assign, ‘may not unreasonably be withheld’, may
improve the position of the party who may wish to assign rights.
In this case, since no prior permission had been sought, the question of whether
such permission could reasonably have been refused was not strictly necessary
for the decision. Nevertheless, Lord Justice Evans did give some consideration
to this question, and his view gives us an indication of how courts are likely to
deal with this issue in the future. He was prepared to look at the facts of the
case and at the differences between the assignor and the assignee. Chartsearch
would presumably have refused to give permission to assign to Hendry, if such
permission had been asked for. The original party to the contract with Chart-
search was a company and could have been made to give security for costs in
litigation. The assignee, being an individual, and in any case entitled to seek legal
aid, did not have to give security for costs. These were, in the opinion of Lord
Justice Evans, grounds which would have made it reasonable for Chartsearch
to have refused permission to assign.
The issues referred to the Chancery Division, and subsequently the Court of
Appeal, as preliminary issues were whether, and with what effect, the purported
assignment of non-assignable rights could be valid as a creation of a trust. To
these questions Mr Justice Lightman, with whom the Court of Appeal agreed,
gave the following answers:
4. There is no reason why the law should limit the parties’ freedom to
create such trusts.
The immediate result of this case was that the parties reached a settlement on
the basis that the contracts in question were indeed partnership property. The
long-term result is that those who draft contracts might want to make it clear
from the outset that they may wish to put into trust for one or more third parties
some, or all, of the benefits arising from the contract. If they do this, then they
must make sure that the wording of the contract is not inconsistent with this.
If, on the other hand, a party to an intended contract does not wish the other
party to be able to create such a trust, whether deliberately or unintentionally,
then the clause which prohibits assignment will need to be improved and extended
so that it also prohibits the creation of any form of trust.
Another important effect of the new Act will be to confer positive rights upon
certain third parties, such as the right to enforce payment, or the right to enforce
a warranty, or the right to enforce any terms about performance of duties. To
this extent, the new Act will serve a similar purpose to that already served by
the assignment of rights, or the assignment of debts. However, the difference
will be that there will be no need for an assignment, so a term of a contract
restricting or prohibiting assignment will not touch the rights conferred by the
new Act. Moreover, the nature of the rights conferred upon third parties will
be defined and structured by the Act itself, and not by the law of assignment.
The new Act was passed on 11 November 1999 and came into force at once,
but with a period of grace which meant that unless contracting parties
expressly agreed to make use of the new Act at once, it would not affect any
contracts made before 11 May 2000.
Apart from this commencement provision, there are at least two main issues
which have caused some apparent difficulty. These are:
2. Once a third party has acquired such rights, to what extent does this
tie the hands of the two original contracting parties and affect their
ability to alter or to modify terms of the contract or to end the contract
by agreement?
Section 1 (1) of the Act states that subject to the provisions of this Act, ‘a person
who is not a party to a contract (a third party) may in his own right enforce a
term of the contract if:
Subsection (2) provides that subsection (1)(b) above does not apply if on a proper
construction of the contract it appears that the parties did not intend the term
to be enforceable by the third party.
Several points of interest emerge from this text. Firstly, those who wish to make
use of the new laws may expressly confer rights upon one or more third parties.
The rights are to enforce terms rather than the contract as a whole, so one may
select the particular terms to be enforced by the third party, and exclude others.
Secondly, third parties can acquire the right to enforce terms by a rather more
indirect method ‘if the term purports to confer a benefit on (them)’. This rather
obscure provision contains potential dangers. If a third party can successfully
claim that a term appears to confer a benefit on him, he can enforce it even though
this might not have been contemplated by the parties to the contract. However,
subsection (2) enables the parties to the contract to make their intentions clear
in this respect if they so wish.
These are the words of Mr Justice Colman in a case in which shipbrokers sought
to enforce terms of a contract made between owners of ships and the charterers
of those ships. The terms provided that a commission of two per cent would be
paid equally to two companies, one of which was Cleaves. But Cleaves was not
a party to the contract.
The Commercial Court held that since the relevant clause of the contract purported
to confer a benefit upon Cleaves, Cleaves was entitled to enforce the term under
Section 1 of the 1999 Act. Further, since the contracts provided for arbitration,
Cleaves was entitled to refer the matters to arbitration, as this is provided for
by Section 8 of the 1999 Act.
This case is important not only because it is the first to apply the 1999 Act, but
also because it touches upon the subject of the European Convention on Human
Rights, a subject which we will look at in Chapter 6.
Identification
Another of the problems posed by the new Act is that under Section 1 (3) a third
party can acquire the right to enforce a term either by being named in the contract
(as was the position in the above case), or by being identified in the contract as
a member of a class, or by being identified in the contract as answering to a
particular description.
There need be no problem with named third parties. But the word ‘class’ is very
wide, and could include large classes of people who were never intended to
enforce terms.
If a description is used to designate third parties who have rights under the
contract, then it should be born in mind that even descriptions (or classes) such
as ‘members of our group of companies’ can create uncertainties: does the expres-
sion refer only to members at the time the contract is made, or to members at
the time that a claim may be made? This is the kind of issue that would need to
be clarified in the contract.
A third party qualifies by having acquired rights under the contract and by making
the promisor aware that he intends to rely upon those rights.
The section is complex and its details will not be explored here. However, Section
2, subsection (3) provides that the parties are free to include an express term
under which they may by agreement rescind or vary the contract without the
consent of the third party.
A person drafting the termination provisions for a commercial contract will have
to make a number of choices:
1. Should the clause state the termination rights of both parties? If a clause
is drafted in this style, it will normally state that either of the parties
may terminate the contract if any of the listed circumstances occurs.
On the other hand, some lawyers would prefer to have a separate clause
for each party, because the events would be different in each case.
2. Should the clause provide only for breach and insolvency, or should
it provide for other events, such as change of control, or the departure
of or unavailability of key persons?
Apart from these points, it needs to be pointed out that there have been a great
many important cases on the subjects of termination and notices. Almost invari-
ably they have arisen out of ambiguities in the wording of the contracts concerned
or unreasonableness of the provisions.
The courts require clear language, particularly where the exercise of a right to
terminate on account of breach by one of the parties could bring about harsh
consequences.
It is also essential that all provisions about termination should be free from
ambiguity.
The agreement had only one clause that dealt with the subject of termination,
and this was the clause headed ‘Duration of Agreement’. This clause provided
for a party who had committed a material breach of the agreement to have 60
days in which to remedy the breach, after having been required to do so. These
terms led to litigation. Schuler AG relied upon the status of the terms about the
obligations of Wickman Tools Ltd, and argued that any breach of conditions
could lead to immediate termination of the contract. Wickman Tools Ltd relied
upon the express provision for 60 days’ notice. The House of Lords held that it
would take very clear words to displace the natural meaning of the term providing
for 60 days’ notice. The meaning of the word ‘condition’ is normally that the
term is so strong that any breach, no matter how small, permits the non-defaulting
party to terminate with immediate effect; a period of notice is not normally needed.
But presumptive meanings can be displaced when they come into conflict with
other terms which are so clear that their natural meaning simply cannot be disre-
garded. The clause providing for 60 days’ notice was simply too clear in its
meaning to be disregarded.
In this case a clause in a lease provided that the tenant could determine the lease
by serving not less than six months’ notice in writing on the landlord, ‘such notice
to expire on the third anniversary of the term commencement date...’
Purporting to act under this clause, the tenant served notice on 24 June 1994,
to end the lease on 12 January 1995. This was more than the required six months’
notice, but the landlord argued that the third anniversary of the commencement
date was in fact 13 January 1995.
The Court of Appeal held that as ‘12 January’ could not mean ‘13 January’, the
notice was ineffective. The majority of the House of Lords held that when the
tenant gave the notice he did in fact intend to terminate on the third anniver-
sary, although the words that he used had misdescribed that anniversary.
For practical purposes it becomes clear that if anniversaries are relevant to dates
for termination (or indeed any other dates), it would be good practice to state
what that anniversary is, as a calendar date. Not least of the problems in the
above case is that the tenant may have thought that what was required was a
notice to expire at the last moment of the day before the anniversary, or the first
moment of the actual anniversary, that is, midnight on 12 January 1995. A good
contract term would have left no doubt as to what was really required.
In this case the parties had entered into an agreement for the supply, support
and maintenance of software by Harbinger. The terms of the agreement (as varied)
provided for a supply of software for an initial period of three and a half years,
and continuing thereafter for automatic renewal of terms of one year, unless
and until terminated by either party upon one hundred and eighty days’ prior
written notice.
The problem with a term drafted in this way is that it is not clear whether this
means that there is an entitlement to at least one year of automatic renewal, or
whether the notice can be given in such a way as to take effect at the end of the
initial term.
The Court (QBD) opted for the latter interpretation. But it cannot be too strongly
stated that a well drafted contract simply does not allow for these arguments.
2. notice of intention to terminate (either because the breach has not been
remedied, or because it is not capable of being remedied).
It is also helpful to specify the nature of the breach that will give rise to the right
of the party not in breach to terminate.
As far as notice is concerned, the Wickman Tools case already cited shows that
the courts are reluctant to construe a term so as to allow for termination with
immediate effect (except in recognized cases such as where time is of the essence).
But a carefully drafted term may allow for this in the case of breaches which
are not capable of being remedied (such as breaches of confidentiality). If a breach
is capable of being remedied, then it is sensible to provide for a period of notice
in which to remedy the breach, and that if it is not remedied in that time, termi-
nation will take effect immediately.
The contracts were for four years. In the event, the council was not happy with
the performance of the contractor, served default notices and eventually termi-
nated the contracts. The relevant clause stated:
“If the Contractor commits a breach of any of its obligations under the
contract… the Council may, without prejudice to any accrued rights or remedies
under the contract, terminate the Contractor’s employment under the
contract by notice in writing having immediate effect.”
This term has some useful features but it lacks any qualifications about the nature
of the breach, and it lacks any need to give to the defaulting party an opportu-
nity to remedy the breach.
For these reasons the Court of Appeal took the view that the parties could only
have intended the literal interpretation of this term to apply to extreme cases,
which is to say, to repudiatory breaches. The court stated that single breaches,
under this term, would have had to have been repudiatory, while multiple breaches
would have had to have been cumulatively repudiatory, to justify termination
by notice with immediate effect.
Part of the reasoning behind this case is that with long-term contracts in which
the contractor has made considerable investment, without clear words, one would
not normally expect the contractor to have put himself at the risk of having the
whole contract terminated for comparatively minor reasons. In this respect, the
Court of Appeal was following the decision of the House of Lords in Antaios
Compania SA v Salen Redeiera (1985) AC 191.
From the point of view of a lawyer who may wish to give to his client an oppor-
tunity to terminate a contract on grounds of breach, it is desirable to avoid the
effect of the above two cases, and to avoid the need to prove repudiation by the
other party. Repudiation means one or more breaches that are so serious that
either they show that the defaulting party has no real intention of performing
his obligations, or they effectively deprive the non-defaulting party of a
substantial part of the benefit of the contract. In the Rice case, above, it was
not possible for the council to prove that the breaches amounted to repudia-
tion.
Material breach
The words ‘material breach’ are more likely to achieve the required effect of being
credible and enforceable.
National Power argued that by analogy with the Antaios case, if ‘any breach’
in a time charter meant ‘any repudiatory breach’, then ‘material breach’ must
also mean ‘repudiatory breach’.
Here it was held, however, that the term had a provision for notice and for
remedying the breach. It was not solely about termination. So the approach taken
by the judge was less stringent than in the two previous cases. He held in partic-
ular that in this context a material breach did not have to be as serious a breach
as a repudiatory breach.
When drafting such a term, some lawyers will leave ‘material breach’ undefined,
on the basis that it is a breach of greater magnitude than a minor breach, but
less than a repudiation. Other lawyers will attempt to define it. It can of course
be simply defined in terms of whether it can or cannot be remedied within the
period of notice.
Chapter 3
Structuring the contract
The title and the description of the parties.......................................38
Post-contractual arrangements..........................................................44
A recent case which shows the difficulties that can arise if the parties are left
in any doubt about the nature of the agreement they have entered into is Thames
Tideway Properties Ltd v Serfaty & Partners (1999) 2 Lloyds Law Reports.
The question before the court was what was the nature of this contract. If it was
an annual shipping contract, then its terms would have governed all shipments
during the year 1993 to the exclusion of any other standard terms of the parties.
The alternative argument was that this contract was not an annual contract,
but an exclusivity agreement which also provided for a trial shipment. This
interpretation, which was the one accepted by the court, meant that subsequent
shipments would be on other terms, depending upon how they had been formed.
This finding was of considerable importance in the particular case, since in a
later shipment there had been damage caused by fire, and the standard condi-
tions of trading of Thames Tideway Properties contained a limit of liability, which
in the event was held to be applicable to that particular shipment.
There is also the possibility that one may wish to make a claim against a company,
which appears to be performing a contract, only to find that the real contracting
party is a different company, which may, conceivably, become insolvent.
An example of why the correct description of the parties is important is the law
of set-off. Normally, and in the absence of any special terms of the contract, the
right to set-off one debt against another only exists if all the debts are between
the identical parties.
The recitals
These are not essential for every commercial contract and it is a mistake to use
them if they do not contribute anything. There are doubtless a number of differing
views about the purposes to be served by recitals, but in this work the view that
will be offered is that recitals are included to establish the following matters:
Recitals are not the place to set out any of the promises, undertakings,
warranties or assurances given by either of the parties, since all of these should
be terms of the contract. Nor are they the place to set out the meaning of words,
since these should be in the definitions clause.
‘Whereas
D) The Client relies upon the knowledge, skill and expertise of the Designer
in the Field of Activities (as described in this Agreement).
Not every judge has agreed with this view. In Scottish Power Plc v Britoil (Explo-
ration) Ltd (1997) Court of Appeal, Staughton L.J. stated that the ‘background’,
or surrounding circumstances that a court should take into account, should be
limited to those which would have been in the minds of the parties, with the
knowledge of each party, at the relevant time.
Whatever view one takes, it is clear that recitals can aid the process of under-
standing and interpreting contracts, since in many cases they will provide an
agreed summary of the surrounding circumstances of the contract.
• Definitions
• Assignment
• Secrecy
• Indemnities
A benefit, in some cases, of having a contract executed as a deed is that the period
in which a party may claim for breach of contract, or for an unpaid contractual
debt, is twelve years rather than six years. It is good practice on the part of the
purchaser, in a contract for expensive items with a long life-cycle, to execute
the contract of purchase as a deed.
Northern & Shell plc v John Laing (2002) 25 Con. Law Rep
In this case a deed of warranty contained a statement that:
‘This Deed shall come into effect on the day following the date of issue of
the Certificate of Practical Completion under the Building Contract for the
Merchant’s House.’
The deed, under seal, therefore referred to a date which was in fact 25 August
1989, but the deed was executed on 16 January 1990.
A claim was issued against John Laing on 14 January 2002, on the basis that if
a deed was executed on 16 January 1990, there would still be two days left to
run before claims under the deed were statute-barred. The question before the
court was whether or not the words in the deed brought it into effect earlier
than its date of execution and, if so, whether this operated retrospectively so
as to make the claim statute-barred.
The court held that the claim was indeed statute-barred because retrospective
effect occurs if that is the intention of the parties, and the words in the deed to
that effect meant that time began to run on 25 August 1989. The claim made on
14 January 2002 was outside the twelve year period running from 25 August
1989.
Pre-contractual arrangements
Sometimes an agreement has to be entered into which is separate from the main
agreement, and which precedes and facilitates the setting up of the main agree-
ment. A secrecy, or confidentiality agreement is an example of this, since it may
be needed so that two parties may communicate in confidence, as part of the
process of negotiating the main contract.
In the USA there had been a case in which it was held by the United States Court
of Appeal that an agreement to negotiate in good faith is enforceable (Channel
Home Centers v Grossman (1986) 795 F 2d). However, the House of Lords rejected
this as a proposition of English law. Subsequent cases of interest have been the
following:
The background to this was that Mr Lambert was an author who had produced
certain characters and drawings and stories about them, and had assigned
existing and future copyrights in the work to HTV. The above clause envisaged
the possibility that HTV would assign its rights to an American company in antic-
ipation of making a film. At first instance the judge dismissed the claim of Mr
Lambert as showing no cause of action.
The Court of Appeal held that this was not an agreement to agree or to negotiate,
but an agreement to use all reasonable endeavours to procure that a third party
did something. The Court held that there was sufficient certainty in this to be
enforceable. Moreover, there was an element of negativity in it: a right of first
negotiation excludes other parties from being first.
Post-contractual arrangements
These may include matters such as guarantees and bonds. It is not uncommon
for parties A and B to make a contract which provides that, within a certain
number of days of the contract being made, party A will procure that party C
provides a guarantee or bond in favour of party B.
This is normal procedure in many commercial contracts for sale and purchase
of major items or services. It is intended as security for the performance of the
seller of its obligations. But a problem of structure may arise in so far as consid-
eration must move from the promisee, and party B will not have been the one
to give any consideration to the guarantor, party C. If there is any considera-
tion at all, it will have come from party A, who will usually be a client of the
guarantor (i.e. of a bank or of an insurance company).
will be executed as a deed. In some cases the parties will want to state that the
willingness of party B to make the main contract with party A is the consider-
ation for the guarantee by party C to party B. While this is indeed possible, the
problem will be that if the provision of the guarantee or bond is after the forma-
tion of the main contract, then the consideration will be past consideration, or
the promise of something one is already bound to do. This will not be good consid-
eration, so the order of formation of the contracts will need to be reversed.
A case that has dominated this area of the law for several years is Thomas Witter
Ltd v TBP Industries Ltd (1996) 2 All.E.R.
‘This Agreement sets forth the entire agreement and understanding between
the parties… in connection with the Business and the sale and purchase
described herein. In particular, but without prejudice to the generality of the
foregoing, the Purchaser acknowledges that it has not been induced to enter
this Agreement by any representation or warranty other than the statements
contained or referred to in Schedule 6.’
This provision was combined with a limitation clause which stated that the sellers
would not be liable for a breach of the agreement or a claim in respect of a
warranty, unless written notice was given by 1st January 1992.
The claim by Thomas Witter Ltd was for rescission and/or damages for misrep-
resentation or breach of contract.
This was on the grounds that during negotiations there had been mis-statements
about the basis of accounts of the company to be sold, and in particular an
overstatement of a one-off expense. One of the statements became a term of
the contract, while the others remained as representations. The defence was
that firstly the entire agreement clause effectively excluded any liability for misrep-
resentation and, secondly, in respect of the warranty, notice of a breach had to
be given in accordance with the required procedure, within the time limit stated.
It was alleged that this had not been done.
The Chancery Division of the High Court awarded damages for misrepresen-
tation and for breach of warranty. In doing so, the judge made a number of
findings and propositions of law:
1. The notice did in fact contain all the formal requirements and had been
given in time, and since there was no other restriction of claims for
breach of warranty this part of the claim succeeded.
2. The particular style of entire agreement clause did not state in so many
words that liability for, or remedies in respect of, misrepresentation
were excluded. It was a ‘no reliance’ clause, in which the draftsman
was trying to prevent liability for misrepresentation from arising by
stating that the party in question never relied upon any representation
in the first place. In this case the judge thought that the wording of
this particular clause was not adequate to exclude liability for
misrepresentation.
3. The judge went on to say, in a statement that has affected the way in
which many lawyers have since drafted these kinds of clauses, that
even if the exclusion of liability had been explicit, it would not have
been fair or reasonable within the meaning of Section 3 of the
Misrepresentation Act 1967. This was because the clause would have
purported to exclude liability for all kinds of misrepresentation,
including fraudulent misrepresentation.
SALE OF A COMPANY
Inaccurate statements
about accounts,
made prior to contract
1. Time limit 1. Notice was in time:
for notice of breach Damages for breach
of warranty of warranty
Some became
warranties
Others remained
as representations
3. Even if sufficient,
term was not
reasonable
Damages awarded
MISREPRESENTATION
Fraudulent Innocent
Rescission
and/or
Recission
and damages Damages under S.2 (1) Damages under S.2 (2)
in tort of Misrepresentation Act 1967 of the 1967 Act in lieu of
for deceit if defendant unable to show rescission at discretion
reasonable grounds for belief of Court, if rescission
that statement was true was available
In the years following this case, many lawyers have added words to their entire
agreement clauses to the effect that the clause in question does not purport to
limit or exclude any liability for fraudulent misrepresentation.
In this case the Court of Appeal took the view that it was fair and reasonable
to limit the remedy of set-off to a specified sum in respect of any breaches of
warranty or misrepresentations. No exception had been made for fraudulent
misrepresentation, but the Court thought that this was not unreasonable in the
context of set-off, and in the context of what would have been, at that stage, a
mere claim in respect of fraud.
On the other hand, in South West Water Services v International Computers Ltd
(1999) BLR, the Thomas Witter case was followed.
As regards ‘non-reliance’ clauses, the Witter case may have been decided correctly
on its own facts, but the general proposition that non-reliance clauses are inade-
quate to prevent liability for misrepresentation from arising is not true. Just the
opposite is the case.
“There are, it seems to me, at least two good reasons why courts should not
refuse to give effect to an acknowledgment of non-reliance in a commercial
contract between parties of equal bargaining power.... First it is reasonable
to assume that the parties desire commercial certainty. They want to order
their affairs on the basis that the bargain between them can be found within
the document which they have signed. They want to avoid the uncertainty
of litigation based on allegations as to the content of oral discussions at pre-
contractual meetings. Second... it is legitimate and commercially desirable
that both parties should be able to measure the risk, and agree the price, on
the basis of the warranties which have been given and accepted.”
From this we may conclude that for the time being, and barring a different
approach being taken by the House of Lords (which has yet to decide a case
about this point), clauses in which parties state that they do not rely upon
warranties or representations made by the other party, other than those included
in the written agreement, are effective to prevent liability from arising, other
than under the written terms of the contract.
In the above case, Lord Justice Chadwick stated that the requirement of reason-
ableness under Section 3 of the Misrepresentation Act 1967 (as amended by
Section 8 of the Unfair Contract Terms Act 1977), does not apply to such a ‘non-
reliance’ clause, because the clause does not exclude or limit liability for
misrepresentation. What it does is to prevent the liability from arising in the
first place.
If this is the case, then the rules applying to ‘non-reliance’ clauses are more lenient
to the person relying upon such clauses than the rules that would apply to an
outright exclusion of liability for misrepresentation. This approach has in fact
been accepted by the High Court, in the case of SAM Business Systems Ltd v
Hedley & Co (2003), 1 All.E.R. (Comm) 465, in which Judge Bowsher QC noted
than the particular entire agreement clause used by SAM Business Systems Ltd
had not been drafted in the ‘non-reliance’ style, but instead as an exclusion of
liability for misrepresentation. He said that such a term would have to satisfy
the requirement of reasonableness, whereas the one used in Watford v Sanderson
did not.
So we can conclude that the statement in the Thomas Witter case, that non-reliance
clauses are ineffective, is wrong as a general proposition, although it may have
been a correct conclusion to come to on the facts of that particular case.
The reason why the results of cases may occasionally differ on their own facts
is that the effectiveness of a non-reliance clause, according to Lord Justice
Chadwick, is based upon the law of estoppel. There may be cases where it is
not fair or reasonable to allow a party to use a non-reliance clause to stop the
other party from alleging misrepresentation. It may be that the Thomas Witter
case was one of these.
Commercially, time is saved and negotiations only need to be carried out once,
at the beginning.
Chapter 4
How to manage the risks
Risks ......................................................................................................53
Insurance ..............................................................................................54
Indemnities ...........................................................................................55
Risks
One of the most important aims of a commercial contract is to manage the risks.
In reality a fine distinction can be made between risk avoidance, risk alloca-
tion and risk management.
In the first case, one or both of the parties can see a risk, and it is then agreed
in the contract that a term will be included which avoids or eliminates the risk.
An obvious example would be to avoid an unreliable jurisdiction by opting for
jurisdiction or arbitration in a territory with a good reputation in this field.
With risk allocation, the risk will not have been eliminated, but the parties will
have taken account, in the price and other terms, of the fact that the risk is to
be placed upon one party rather than the other. Risk allocation is common in
cases of delivery of goods, or in hazardous works, such as exploration. In contracts
with an element of design, it is particularly important to deal with the matter
of risk. The possibility of infringement of the intellectual property rights of a
third party may also be a matter of risk allocation. Insurance and indemnities
are a part of risk allocation.
Risk management means that both parties have accepted that a risk exists, and
steps have been taken, either in the terms of contract, or by other commercial
means related to the contract, to manage the risk so as to make it commercially
acceptable, without necessarily being able to eliminate it altogether. Financial
controls, such as guarantees, are a form of risk management. So are limits and
exclusions of liability. So are clauses providing for termination. Force majeure
clauses are, above all, a form of risk management.
Insurance
Other than Employer’s Liability insurance, there are few forms of insurance that
are compulsory. So insurance is usually a matter for the parties to decide upon
as a matter of risk allocation, and to be taken into account in the price. It is there-
fore up to the parties to set out, as terms of the contract, whether or not any of
the following forms of insurance is required, and if so, which of the parties shall
arrange it and at whose cost, and for what period of time.
Part of risk management is to provide, where relevant, that one party not only
agrees to take out such insurance, but also agrees that it shall be with an insurer
approved by the other party, and that the policy, or evidence of it, shall be made
available to the other party for inspection. In some cases, and with some forms
of insurance, the contract will provide that insurance of an item must be at full
replacement value. In other cases, such as the last three examples above, a
minimum amount for any one claim will be stipulated.
However, it is not enough for one party simply to require the other to insure
against certain risks. If this alone is done, the problem will be that the law of
subrogation may apply in the event of a claim. Under the law of subrogation,
the insurer of a party that has suffered a loss for which the insurer has paid,
may borrow the claim of the party that has suffered the loss.
So, it is not enough for two parties simply to state that materials on site shall
be insured by the supplier. The supplier may still own the goods, and if the goods
are lost or damaged due to the fault of the site owner or another party in control
of the site, the insurer may pay the supplier in respect of the loss and then sue
one or both of the other parties, borrowing the claim that the supplier would
have had in contract or in tort. So the site owner and any other party may well
require an indemnity to be contained in the respective contracts so that, once
the insurer has paid, there will be no right of subrogation.
Indemnities
Many of the drafting faults with indemnities arise from a misunderstanding of
what indemnities are intended to do, and are capable of doing. Further errors
sometimes arise due to a failure to appreciate that indemnities are subject to
well-established rules of interpretation, and will not be stretched by the courts
to cover circumstances that are not in fact covered by express words or by neces-
sary implication.
There are various options open to those drafting contracts, as far as indemni-
ties are concerned. They may make them unilateral which is the normal style
of many contracts. A unilateral indemnity is a classic form of risk allocation.
The party giving an indemnity, for example against any claims by third parties
for infringement of intellectual property rights, is taking on the risk of such claims
being made by third parties. Sometimes the contract terms may require each
party to give the other an indemnity of the same kind, depending upon who is
responsible for the infringement. These are reciprocal indemnities. One is given
in return for the other but they do not cover identical circumstances. The indem-
nity given by, for example an author to a publisher, covers the possibility that
the author may be responsible for the infringement. The indemnity given by
the publisher to the author covers the possibility that the publisher may be respon-
sible for the infringement.
Such clauses have caused a great deal of confusion in the past (and some poor
drafting) because the parties have not always been entirely aware of their purpose.
To understand this purpose we will sketch out a hypothetical case.
In practice the words ‘indemnity’ and/or ‘indemnify’ are used because they cover
the arrangement of the risks and the promise not to sue. So the clause will
probably state that each party will indemnify the other against all of the speci-
fied kinds of loss or liability arising from the death or injury of any of its own
employees, or arising from damage to or loss or destruction of its own equip-
ment, resulting from the performance of the contract.
Properly drafted, with the consent of the respective insurers, and with the neces-
sary provisions covering possible negligence of either or both of the parties,
these clauses are a valuable aspect of commercial planning and risk allocation.
The main problem that arises is as regards mutual understanding and expec-
tations. It is vital that such clauses should, if used, be drafted clearly and accurately,
and vital that they should be properly explained to the client. There are other
options open to the client, and no party should enter a mutual indemnity arrange-
ment without being aware of its full implications.
Boilerplate clauses
These clauses are an important part of the structure of a commercial contract.
They are also useful devices for risk management. The list below is of clauses
that are typically regarded as boilerplate clauses, but perhaps they should only
be regarded as such if the clauses are standard ones and not drafted to a partic-
ular client’s requirements or to serve a particular purpose in a specially
negotiated contract.
• Clauses providing that the parties may vary the contract or rescind it
by agreement without the need for the consent of any third party
• Clauses preventing third party rights from arising under the Contracts
(Rights of Third Parties) Act 1999
• Clauses about choice of law and jurisdiction and the language of the
contract
Many of these boilerplate clauses will have been encountered earlier in this work,
so no further discussion of them is required. Those that have not been looked
at already will be examined now.
of persons who would be able to give a waiver. The reason that this is impor-
tant is that no consideration is required for a waiver and a once a waiver is granted
and relied upon it cannot be retracted. The clause could also restrict the scope
of the waiver and so help to avoid any ambiguity about what it is that has been
waived.
• penalties,
A boilerplate clause about invalidity and severance aims at severing the invalid
term from the contract and then agreeing what effect this has upon the contract.
In some cases, if a term is invalid it may not be possible for the contract to continue
at all, because the term is so fundamental. This would be true of terms about
price or about what is to be performed. The boilerplate clause should be drafted
so as to take account of this.
In some cases the contract could be performed without the need to replace the
invalid clause. In these cases the boilerplate clause is easy to draft: one simply
states that the invalid term will be severed from the contract and the remainder
of the contract will continue to be binding.
For a recent case on severance, see Days Medical Aids Ltd v Pihsiang Machinery
Manufacturing Co Ltd (2004) 1 All.E.R. 991, the facts of which are set out in Chapter
1 of this Report.
But there is a third and more ambitious possibility, which is that the parties may
wish to replace the invalid term.
This is not easy because provisions for the replacement of invalid terms may
involve agreements to agree new terms, or to negotiate new terms to replace
the old. As long as it is understood that these will not be legally enforceable,
they may still serve a practical or commercial purpose. If necessary, such provi-
sions could always have a fall-back provision if the parties fail to reach
agreement, such as arbitration or some other form of referral to a third party,
which the parties agree to be bound by.
The important thing is that the clause must be drafted so as to give rise to mutual
understanding rather than the reverse. It must clarify issues and not obscure
them. There is no particular legal format for drafting clauses about the giving
of notices: all that is needed is a plain statement about the means by which notice
may be given, the address to which it must be given, any time limits that are
applicable and any requirements as to the content of such notices. Among cases
that we have seen in previous chapters, the Thomas Witter case and the Mannai
case, are examples of how clauses about either the deadline for a notice or the
content of a notice, can become an issue in litigation. This is what the person
drafting such a clause is aiming to avoid.
Force majeure clauses are more than simply a list of circumstances. They also
set out procedures for their use, such as the giving of notices containing certain
details within certain time limits. They also set out the position that the parties
will be in as a result of force majeure, for example whether the contract will
continue after a period of suspension, or whether it will be terminated. It is not
usual to provide for termination except where the force majeure lasts for longer
than agreed maximum period.
The High Court, in London, held that as the agreement had connections with
several countries, other than France, the mandatory rules did not override the
choice of law.
Chapter 5
How the Courts will interpret
what is written
Ambiguities, absurdities and technicalities ......................................65
there was no apparent reason behind it. The alternative meaning, distinguishing
between the Pacific and the Caribbean, made more sense.
The question before the courts was whether or not the expression ‘actually paid’
was to be taken literally, or meant something different, that is, ‘the sum actually
payable’. All the courts in question, including the House of Lords, with one
dissenting voice in the Court of Appeal, held that it meant ‘actually payable’, so
that prior payment was not a condition of reimbursement. This case shows that
even definitions in a contract do not necessarily solve all problems, and in this
particular case can be the cause of the problem.
1. The time limit: this provided for a rectification of defects within a period
of eighteen months, after which ‘all liability of the supplier relating to
the work shall terminate.’
2. The cash limit: this provided for repair or replacement of defective items
and went on to state, ‘The supplier’s liability hereunder shall not exceed
15% of the contract price by line item.’
If the strict contra proferentem rule had been applied, there may (although this
point is arguable, since it is only hypothetical) have been weaknesses in these
clauses which would have made them ineffective. The expression ‘relating to
the work’ is uncertain in scope; the expression ‘hereunder’ is even more uncer-
tain. So, applying the rule strictly a court might have given the clauses only the
narrowest meaning, so that they only limited liability in contract, but not in tort.
Even the scope of the contractual liability might have been arguable.
But applying the statement of the House of Lords and of the Privy Council in
the cases of Ailsa Craig Fishing Co Ltd v Malvern Fishing Co Ltd (1983) 1 W.L.R.
and Canada Steamship Lines Ltd v The King (1952) AC, the court in the BHP case
held that there is a distinction to be made between exclusions of liability and
limits of liability. In the latter types of case, the contra proferentem is to be applied
but not in the same strict sense as in the former cases. With limits of liability
the courts can give the words actually used their natural meaning, and if this
is clear and unambiguous it will be sufficient. So the answer to the preliminary
issues raised in the case of the defective pipeline was that the time limit and the
cash limit covered all the liabilities that might arise between the two parties in
relation to that project. As the claim was outside the agreed time limit, this meant
that it could not proceed.
On the other hand, with exclusions of liability, as opposed to limits, and with
indemnities, the contra proferentem rule applies in its full force. Nothing will
be added and nothing will be implied unless the implication is unavoidable.
“It is now well established that if a person obtains an indemnity against the
consequences of certain acts, the indemnity is not to be construed so as to
include the consequences of his own negligence unless those conse-
quences are covered either expressly or by necessary implication. They are
covered by necessary implication if there is no other subject matter on which
the indemnity could operate. Like most rules of construction, this one depends
upon the presumed intention of the parties.”
In this particular case, a clause under which Whessoe had agreed to indemnify
Shell against all claims arising out of their operations was held not to entitle
Shell to an indemnity in circumstances where the death of a person was caused
partly by the negligence of Whessoe and partly by the negligence of Shell. The
indemnity clause did not provide for this situation and there were other types
of situation in which the indemnity could operate, such as where a third party
might make a claim under statute, and not involving negligence, against Shell.
One of the problems of applying this canon of construction was later on alluded
to by Lord Devlin in Samples of Lawmaking, when he stated that canons of
construction make things much easier for the judges but much more difficult
for the parties who do not know the rules. It is, therefore, particularly impor-
tant that the lawyer drafting the contract should alert the client to the choices
that have to be made. An indemnity can either be drafted in such a way that
the liability is split between the two parties in circumstances where both have
been negligent or the indemnity can be drafted in such a way that the liability
falls entirely upon one of the parties, even though both parties have been negli-
gent. This is what Shell expected in the case discussed, but the clause did not
clearly state this, so the indemnity failed altogether.
If the clause had been correctly drafted, under this kind of agreement (which
would require the consent of the insurers of each party), the parties would not
base liability upon fault or blame but would simply ask whose property was
damaged, or whose employee was injured. This would then determine which
insurer paid for which loss.
In the case in question, which involved the Piper Alpha accident, Lord
Hobhouse said that there was no objection in principle to such provisions and
a court should show no reluctance to give them effect. But the indemnity clause
that the parties had used made no mention of negligence, so it was lacking in
clarity. The principle that without clear words it would not operate to cover the
negligence of the party seeking to be indemnified applied.
E.E. Caledonia was the successor in title to the owners of Piper Alpha. It was
seeking to be indemnified for making a settlement with the widow of an employee
of Orbit Valve Co, following the accident which sank the Piper Alpha platform
in the North Sea. If the indemnity had been properly drafted the position would
have been that under the knock for knock agreement Orbit Valve should have
born this liability to its own employees, so it should have indemnified E.E.
Caledonia. But as the predecessor in title to E.E. Caledonia had been, in some
respect at least, negligent and as the words did not provide for any indemnity
in this situation, the court held that the indemnity did not apply.
If the clause had had a few additional words stating that the indemnity would
apply irrespective of any negligence on the part of the party seeking to be indem-
nified, this would have made a considerable difference, as the clause would now
have the required clarity about the risk allocation. It cannot be too strongly stressed
that there is a commercial choice to be made in these matters and full consul-
tation with the client is needed.
mean is arcane and the result of precedent, and has shown itself liable to catch
out the unwary even up to the present day.
In this particular case, the claim was for the costs of removing and storing defec-
tive equipment, and for loss of profit which should have been earned by the
equipment. The court held that in this contract, and in the absence of any defini-
tion, ‘consequential’ had been used as a synonym for ‘indirect’, and these were
direct and natural losses arising from defects in the equipment.
Although neither the words ‘direct’, nor ‘indirect’, nor ‘consequential’ appear
in this text, we have now reached the position where it seems to be accepted
by the courts that ‘arising naturally’ means ‘direct’. So, by inference, the second
part of the above formula refers to indirect or special damages. These are the
damages that have come to be known as ‘consequential’. So, when a term of a
contract excludes or limits liability for ‘consequential’ loss or damages, it only
excludes those damages that do not arise naturally from the breach of contract.
This in practice means that the value of such exclusions or limits of liability is
far less than many commercial clients would like to imagine.
LOSS OR
DAMAGE
INDIRECT OR
DIRECT
CONSEQUENTIAL
Wang probably thought that this term excluded all liability for loss of profits or
of data, but it did not because of the circularity of the term as drafted. The profits
and data referred to were covered by the words ‘indirect, special or consequential’,
so that direct losses of profits or of data were not excluded.
The lessons to be drawn from the recent cases are surely these:
3. If the client insists upon the use of the word ‘consequential’, or if indeed
the lawyer drafting the contract feels that there is any value left in the
word, then it can be given an express definition in the contract which,
if properly drafted, may succeed in widening its meaning. But the
important thing is not to make such a definition ‘circular’, since this
will achieve very little.
To give an example, the parties may have set out their respective obligations,
and then may have set out a risk allocation. An amendment may then have been
made to the terms, producing a different layout of the tasks to be performed
by the parties. What those drafting the contract may fail to appreciate,
however, is that this may lead a court to take a strict view of the risk allocation.
The court may indeed decide that the alteration to the tasks to be performed
by the parties must have meant that they intended to rearrange the risk alloca-
tion. And the contract will be interpreted in light of this. The case set out below
is a good illustration of this.
This term was intended to restrict the liability of the owners to cases where they
had performed their task negligently. A further term stated that the owners were
not responsible for any other loss or damage arising from any other cause whatso-
ever, even from the neglect or default of the captain or the crew.
But a new clause was typed into the contract during the negotiations and this
stated that ‘all lashing/securing/dunnaging at loading port...will be performed
by vessel’s crew… in owner’s time using materials as on board free of charge to
charterers’.
It will be noted that this clause has altered the tasks to be performed by the owners
or by persons under their control: lashing, securing and dunnaging are
different tasks from, and additional to, stowage.
The Queen’s Bench (Admiralty Court) held that, firstly, the cause of the loss was
the incorrect lashing of the main item, a rear machinery bed (RMB), and that
this negligent lashing, which had been carried out by the crew under the master’s
direction, was the sole cause of the loss.Secondly, the new clause had introduced
a new division of performance. Thirdly, the effect of this new typed clause was
that the owners undertook to perform the lashing operation with due care. The
owners were therefore liable for the negligent lashing, and the term excluding
their liability was not applicable.
Chapter 6
Control by the courts: valid
and invalid terms
The rule against penalties ...................................................................75
Unfair terms: the scope of the Unfair Contract Terms Act 1977....80
In this chapter we will be taking a fresh look at various reasons, common law,
equitable and statutory, why some terms of commercial contracts may be held
by courts to be invalid. Such rules do not stand still and have been added to in
recent years, as well as being reinterpreted from time to time.
Lord Diplock delivered what is probably the definitive text on this subject in the
case of Photoproduction Ltd v Securicor Ltd (1980) AC 827.
The question of whether or not any term amounts to a penalty is a rule of construc-
tion. Then, once the rule of construction has determined that a term amounts
to a penalty, another, and this time a strict rule, comes into play, which is that
the term classified as a penalty is void. It is deleted from the contract, and the
contract continues in being without it. This means that a party claiming to have
suffered damages from a breach of contract will still be able to sue for
damages; but any damages awarded will be assessed according to general princi-
ples for the assessment of damages and will not be liquidated damages.
This case illustrates the canon of construction that, in general, if the same sum
of liquidated damages is payable for different events, there is a presumption
that the sum is a penalty. It is only a presumption and not a hard and fast rule.
for and would pay to the agent the sum of £100,000 ‘by way of liquidated damages,
which sum is agreed by the parties to be a reasonable pre-estimate of the loss and
damage which the agent will suffer on termination of this agreement’.
The Court of Appeal held that this could not be a genuine pre-estimate because
the sum stated was not graduated. It was payable irrespective of the unexpired
duration of the term and did not bear any reasonable relationship to the agent’s
loss. This was therefore a penalty.
Mr Justice Colman held that it was not a penalty, although in some cases interest
uplift could be a penalty. Relevant factors were whether or not the sum was retro-
spective, whether or not it was reasonable, whether or not it was commercially
justified by increased risk to the lender after the default, and whether or not it
was consistent with international banking practice (for example in New York).
It was held that in this case the interest uplift satisfied all these tests.
loss. The case was decided as a matter of construction of the term. But at first
instance Mr Justice Morison stated that if he had been persuaded that there was
a term of the contract which enabled the buyer to call on the bond and to retain
the money when he had suffered no damage, he would have held the provision
to be penal. The comment is not part of the actual decision and raises a point
that may have to be finally decided at some date in the future.
Under common law, one of the more significant rules in this area is that a person
putting forward terms of any contract needs to bring them to the attention of
the other party if they are to be effective. The more unusual or onerous the term,
the more important it will be to bring the existence of the term to the attention
of the other party before the contract is made. Notices that are given too late
will be of no value. Mere receipts will be inadequate to incorporate terms into
a contract. Delivery notes could be the terms of a contract, if the contract was
concluded at the moment of delivery, but in Interfoto Picture Library Ltd v Stiletto
Visual Programmes Ltd (1989) QB, the Court of Appeal held that the more onerous
terms of a lending contract could not be incorporated into the contract by this
method, so the contract would be read without them.
The proceedings were commenced by the seller in the form of an action for the
price, or the outstanding part of it. The buyer argued by way of set-off and counter-
claim that the buyer had the right to deduct the cost of transporting the defective
items (by air from Iran) from the invoiced price. The seller argued that the warranty
in the conditions of contract was binding upon the buyer. The buyer argued
that this part of the conditions of sale either had not been incorporated into the
contract or else was unreasonable under the Unfair Contract Terms Act 1977.
The interesting thing about this argument is that the test of validity of the term
is similar under both common law and statute: if the term is not properly brought
to the attention of the buyer it will not be part of the contract under common
law principles, and it may not satisfy the requirement of reasonableness under
Section 11 of UCTA 1977.
The buyer won on both grounds. In other cases it may be important to be aware
that two distinct grounds for contesting the validity of a term may exist, since
UCTA will not always be applicable – as for example in an international supply
contract.
The 1977 Act is capable of applying to both business contracts and consumer
contracts, but in different circumstances. It applies to all United Kingdom
contracts, but not where a foreign system of law has been chosen, unless the
choice of a foreign system of law is not bona fide, or a UK resident consumer
is involved. It does not apply to ‘international supply contracts’, as defined in
Section 26, nor does it apply where one of the UK systems of law is the law appli-
cable only by choice of the parties.
The main Section of the 1977 Act is Section 3, and this prevents unreasonable
exclusions or contracting out of liability. But to qualify for protection under this
section, a party to a contract must either be a consumer, or else must contract
upon the written standard terms of business of the other party. No other section
of the Act has the identical qualification requirements, but as this is the section
that arises most frequently, there have been a number of occasions to consider
the meaning of ‘written standard terms’.
There is an important link between this Section and the new Contracts (Rights
of Third Parties) Act 1999. By Section 7(2) of the 1999 Act, Section 2(2) of UCTA
1977 does not apply where the negligence consists of the breach of an obliga-
tion arising from a term of a contract and the person seeking to enforce it is a
third party acting in reliance on Section 1 of the 1999 Act.
Other Sections of UCTA 1977 are different again: Sections 6 and 7 are specific
to sales of goods and hire purchase, or contracts of hire, or work and materials,
and prevent contracting out of statutory rights altogether in some cases, while
in other cases it has to satisfy the requirement of reasonableness. But these
sections do not require that the contracts be made upon standard terms of
business.
Section 13 of the 1977 Act confronts us with yet another difficulty. It is intended
primarily as an anti-avoidance section, to prevent elaborate ways of restricting
liability, by reference to remedies or rules of evidence or procedure, from being
used as a means of evading the Act. But it begins with the words: ‘To the extent
that this Part of this Act prevents the exclusion or restriction of any liability it also
prevents…’.
A question that has seldom been aired in the courts is whether or not Section
13 requires either a contract with a consumer or written standard terms of
business, as does Section 3 of the Act, but not Sections 2 or 6 or 7.
Stewart Gill Ltd v Horatio Meyer & Co Ltd (1992) 2 All.E.R. 257
In this case Section 13 was applied to render ineffective a term of a standard
contract of a seller which purported to make it impossible for a buyer to withhold
any part of the price in respect of defective goods, whether by way of set-off
or counterclaim or allegation of defective goods, or for any other reason whatso-
ever. This offended against Section 13, since rights of set-off and other
statutory rights to withhold money would normally have been available to the
buyer. What the case does not do, however, is state whether or not Section 13
would have been applicable if the terms had been negotiated terms rather than
standard terms.
In Sovereign Finance Ltd v Silver Crest Furniture Ltd (1997) C.C.L.R., it was held,
in a hire purchase case, that a clause purporting to exclude all liability was prima
facie unreasonable.
All three contracts were according to the written standard terms of the
supplier but, at the request of Watford, a term had been added to clarify the
warranty commitment of the supplier. It read:
The system apparently did not work in a satisfactory way, and Watford decided
to replace it. They brought a claim for damages of 5,000,000 for breach of contract
or alternatively for negligence and misrepresentation. The misrepresentation
point was dealt with by the entire agreement clause (see Chapter 3 ) which was
of the non-reliance type, and was effective to prevent misrepresentation from
arising.
The main point of the Court of Appeal case was a term containing a limit of liability
to ‘the price of the equipment connected with any claim’.
In the Technology and Construction Court, the judge, following the decision in
the St Albans case, held that this limit of liability was not reasonable. The Court
of Appeal held that this limit of liability was reasonable and therefore effective.
The reasons were:
The Regulations also require that a seller or supplier shall ensure that any written
term of a consumer contract is expressed in plain, intelligible language.
If a term is unfair within the meaning of these Regulations, it will not bind the
consumer. So a consumer will be able to use the Regulations as a defence. But
the Regulations go further than previous legislation since they allow the Office
of Fair Trading, and the qualifying bodies specified in the regulations, to consider
complaints and to apply for injunctions to prevent the continued use of unfair
terms.
What this means for those who draft contracts which are capable of being
consumer contracts, is that the terms must be in plain language and must comply
with the test of fairness laid down, or else there is a risk of one or more terms
being ineffective. There is also the risk that complaints may be made to the Director
General, or to any of the qualifying bodies. If such complaints are made, the
normal action taken is to ask for the offending term(s) to be revised or discon-
tinued. If the user of the terms fails to comply then injunctions may be sought.
At first sight, this term would appear to contravene the Directive and Regula-
tions by using language that is not plain and intelligible. In court it was argued
that it created a significant imbalance and was contrary to the requirements of
good faith.
The Court of Appeal accepted the argument of the Director General of Fair
Trading but the House of Lords reversed this decision, and held on balance that
the term only provided for the consequences that a customer of the bank might
reasonably have expected.
What the case shows is that the arguments can be very close, and careful drafting
is essential.
Under the Late Payment of Commercial Debts (Interest) Act 1998, interest
may be charged by businesses on sums that are overdue from their commer-
cial customers. As of August 7 2002, all businesses and the public sector have
been able to use the Act to charge interest to all businesses and the public sector.
It is possible to draft into a contract a term which will exclude this statutory
interest, but only if the contract between the parties makes its own provision
for a ‘substantial contractual remedy’.
As well as interest at a statutory rate, these new laws also provide for fixed statu-
tory sums which may be added by the creditor in respect of unpaid sums.
ARTICLE 1
ARTICLE 10
ARTICLE 11
However, what this case does show is that human rights have been, and no doubt
will continue to be, invoked even in purely commercial cases.
Appendices
Appendix 1
List of cases cited .................................................................................91
Appendix 2
List of statutes and other enactments mentioned in the text..........95
Appendices
Appendix 1
List of cases cited
AEG (UK)Ltd v Logic Resources Ltd (1995) Court of Appeal, unreported.
Amiri Flight Authority v BAE Systems plc (2004) 1 All.E.R. (Comm) 385.
Cargill Int. SA v Bangladesh Sugar and Food Industries Corp (1998) CLC.
Coca Cola Financial Corp’n v Finsat International Ltd (1996) The Times, 1 May.
Hotel Services Ltd v Hilton International Hotels (UK) Ltd (2000) Court of Appeal.
Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd (1994) 1 AC 85.
Nisshin Shipping Co Ltd v Cleaves & Company Ltd (2004) 1 Lloyds Law Reports 38
Northern & Shell plc v John Laing (2002) 25 Con. Law Rep.
Overseas Medical Supplies Ltd v Orient Transport Services (1999) All.E.R. Comm.
P & O Property Holdings Ltd v Norwich Union Life Assurance Society (1994) EGCS
SAM Business Systems Ltd v Hedley & Co (2003) 1 All.E.R. (Comm) 465
St Albans City & District Council v ICL Ltd (1996) 4 All.E.R. 481.
Thames Tideway Properties Ltd v Serfaty & Partners (1999) 2 Lloyd’s Rep.
Trafalgar House Construction Ltd v General Surety & Guarantee Co (1995)3 WLR
UBH (Mechanical Services) Ltd v Standard Life Assurance Co (1986) The Times
Walters v Whessoe and Shell Refining Co (1960) Unreported, but set out in a
footnote to AMF Ltd v Magnet Bowling Ltd (1968) 2 All.E.R.
Appendix 2
List of statutes and other enactments
mentioned in the text
Misrepresentation Act 1967
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