Legal Briefing

Collateral security: assurances for comfort can give rise to legally enforceable rights

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Corporate and commercial | 01 December 2012

Commercial contracts will very often be the subject of negotiation between parties, and during those negotiations things will be said or recorded, often to assure or comfort one of the parties, that do not appear in the terms of the written contract. Difficulties will inevitably arise where a party relies on such statements and there will often be a degree of uncertainty as to whether such a party 
is able to seek redress should they suffer loss as a result. 


In the case of Thinc Group Ltd v Armstrong & anor [2012], the Court of Appeal considered whether certain assurances that had been made in pre-contractual negotiations could be legally enforceable, despite those assurances apparently contradicting the rights of the parties 
as recorded in the written agreement.

COLLATERAL CONTRACTS

Collateral contracts or warranties may 
arise where pre-contractual assurances 
are made that are intended to have contractual effect. They are considered ‘collateral’ because they are viewed as a separate, but related, contract from the primary agreement. Collateral contracts can alter or supersede terms of the primary written contract, thus helping to resolve 
the conflict where an existing contract 
has omitted crucial terms agreed on during pre-contractual negotiations.

The principle behind the doctrine of collateral contract was summarised succinctly by Lord Denning MR in J. Evans & Son (Portsmouth) Ltd v Andrea Merzario Ltd [1976]:

‘When a person gives a promise or an assurance to another, intending that he should act on it by entering into a contract, and he does act on it by entering into a contract, we hold it is binding.’

The decision in Wake v Renault (UK) Ltd (1996) demonstrated that collateral warranties could have the effect of varying the terms of a written contract where assurances had been given that were sufficiently certain, so as to be distinct 
from a mere statement of intention.

Collateral contracts can therefore be particularly helpful for those attempting to enforce a pre-contractual assurance as to future conduct. However, where the assurance provided is a false statement as to past or present fact, it will more commonly be classed as a misrepresentation, for which parties may be able to obtain damages and/or rescission under the Misrepresentation Act 1967 (or 
in common law).

FACTS OF THE CASE

Mr and Mrs Armstrong (together, the Armstrongs), a married couple, were both financial advisers who had between them almost 40 years of experience in that profession. Thinc Group Ltd (Thinc) was a financial services company seeking to build up a financial advice practice through lateral hires. Thinc’s wealth management division sought to acquire the services of the Armstrongs, along with their existing client base.

After lengthy negotiations, Thinc offered 
an introductory payment of £243,052 to the Armstrongs to encourage them to 
move to Thinc (the supplementary payment). The Armstrongs repeatedly sought reassurance as to the conditions on which this payment might become repayable. Mr and Mrs Armstrong were assured that the only condition applicable to the supplementary payment was that they remain with Thinc for three years from joining (the assurance). Mrs Armstrong had retained a handwritten note of the assurance and, at trial, Thinc did not dispute that the assurance had been given.

Three contracts were offered to Mr and Mrs Armstrong: two separate contracts relating to their individual employment with Thinc (the principal contracts); and a single contract dealing with the supplementary payment (the supplementary contract). The principal contracts were signed on 6 March 2008 and, following a delay to allow Thinc to finalise the amount of the supplementary payment, the supplementary contract was signed on a date between 21 April 2008 and 25 April 2008.

The principal contracts allowed either party to terminate the agreement on three months’ notice, without cause. Nothing in the termination clause, or any schedules linked to it, referred to the supplementary contract.

The supplementary contract provided that the supplementary payment would be immediately repayable if, within three years of the payment being made, any of the ‘repayment events’ occurred. These repayment events included the termination of the principal contracts with Thinc, for whatever reason, whether terminated by the Armstrongs or Thinc themselves. This provision, when considered in conjunction with Thinc’s right under the principal contracts to terminate on notice, without cause, clearly contradicted the assurance provided to the Armstrongs.

On 19 June 2009, Thinc terminated the Armstrongs’ principal contracts on notice without cause and subsequently sought to recover the supplementary payment. The Armstrongs contended that the supplementary payment was not repayable and Thinc commenced proceedings for its recovery.

HIGH COURT DECISION

Thinc’s claim was dismissed by the High Court on 29 November 2011, which 
found inter alia that the assurance, 
provided by Thinc’s representatives during the negotiations, formed a collateral warranty that superseded Thinc’s right to reclaim the payment under the principal contracts.

Thinc appealed this decision on three grounds:

  1. the existence of a collateral warranty had not been pleaded by the Armstrongs;
  2. it was not intended by the parties that the assurance would have contractual effect, and could not therefore form a collateral warranty; and
  3. in any event, there was no reliance on the assurance by the Armstrongs.

COURT OF APPEAL DECISION

The Court of Appeal dismissed all of Thinc’s grounds of appeal.

The Court of Appeal first considered Thinc’s argument that the Armstrongs had not pleaded a defence of collateral warranty. Lord Justice Rix dismissed this notion and stated that the Armstrongs’ re-amended defence:

‘… pleaded the critical assurances given, and relied on them for the purpose of a collateral warranty agreement that provided a defence to the claim for repayment’.

The Court of Appeal also rejected Thinc’s contention that there was no reliance placed on the assurance by the Armstrongs. Rix LJ stated that it would be ‘ridiculous’ to suppose that the Armstrongs viewed the assurance as permitting the supplementary payment to be reclaimed as provided for in the written contracts. The Court of Appeal was satisfied on the evidence presented that the Armstrongs had relied on the assurance as meaning the only way the supplementary payment became repayable was if they decided to leave Thinc within three years of joining.

Thinc’s final argument was that there was insufficient evidence in front of the Court that could demonstrate that they had provided the assurance in a fashion that meant that there was a common intention between the parties that it would have contractual effect, although as stated above, it was accepted that the assurance had been given by Thinc.

It was found that there was sufficient intent that the assurance would have contractual effect. Rix LJ noted that the supplementary payment was a ‘critical feature of the deal’ and before it was introduced, the deal had not been of interest to the Armstrongs. They had been repeatedly assured that there were no conditions that would permit recovery of the supplementary payment by Thinc, provided they stayed for three years. Rix LJ held that subjective intention as to contractual relations was found to have ‘existed, and plainly so, on both sides’.

Importantly, the Armstrongs, on signing 
the supplementary contract, were 
already contractually bound to Thinc 
by the terms of the principal contracts. 
The principal contracts were signed on 
6 March 2008; then, in order to receive the supplementary payment, the Armstrongs had to enter the supplementary contract. Rix LJ noted that this put the Armstrongs in an extremely difficult position whereby they were virtually obliged to enter the supplementary contract, regardless of its contents, given their existing obligations under the principal contracts. Were the Armstrongs to have rejected the terms of the supplementary contract they would have still been contracted to work for Thinc, and would have deprived themselves of the supplementary payment that was of such vital importance to the agreement.

Furthermore, it was the principal contracts that contained the basic provisions relating to termination that could trigger the repayment events clause in the supplementary contract, not the supplementary contract itself. However, there was no reference to the supplementary payment within the principal contracts. This led to an overly complex situation whereby the Armstrongs would have had to read the three contracts in conjunction, and with extreme care, to be aware of what Rix LJ called the ‘absurdly broad rights’ reserved by Thinc.

On rejecting Thinc’s grounds for appeal, the Court of Appeal upheld the decision of the High Court. Rix LJ agreed that the assurance formed a collateral warranty that there would be no conditions triggering repayment of the supplementary payment, other than if the Armstrongs, of their own volition, did not stay with Thinc for three years after the supplementary payment was made. He confirmed that the doctrine of collateral warranty could give effect to such a warranty so as to enable it to take precedence over the inconsistent wording of even a signed contract. Furthermore, Rix LJ considered that to give effect to the actual wording of the principal contracts would have made the assurance ‘wholly illusory’ and considered such a construction to be ‘… so unreasonable, so uncommercial, that it is to my mind impossible’.

As the assurance was construed as forming a collateral warranty that varied the terms of the principal contracts and supplementary contract, Thinc could not claim to be entitled to repayment of the supplementary payment following Thinc’s termination of the Armstrongs’ employment.

WHAT THE DECISION DEMONSTRATES

As was noted by the judge in the first instance hearing of the case, courts 
are likely to be very careful before 
finding that an assurance amounts to a 
collateral warranty. In the High Court, 
Judge Stephen Davies paraphrased 
Lord Justice Moore-Bick’s judgment in the case of Peekay Intermark Ltd & anor v Australia and New Zealand Banking Group Ltd [2006], and noted that:

‘… it is an important principle of English law underpinning the whole of commercial life, the erosion of which would have serious repercussions, that someone who signs a document knowing that it is intended to have legal effect is generally bound by its terms’.

It is this vital principle of contractual certainty that means that caution will be exercised before finding a collateral warranty that contradicts the written terms of a contract.

However, this case highlights the fact that, regardless of what is detailed in a primary contract between two parties, the courts are, in the right circumstances, willing to find that pre-contractual assurances can supersede contradictory written contractual provisions.

The finding of a collateral warranty in Thinc was based on many facts peculiar to the circumstances of the case. For instance, the Armstrongs’ age and intention to retire; the particular importance of the supplementary payment to them; and the unwavering reassurances Thinc provided as to the conditions that could trigger repayment. Further, the facts of the case suggest that the assurance needed to have the status of a collateral warranty in order that the agreement conformed with any notion of commercial logic.

It remains the case that not all 
pre-contractual assurances will supersede a written contract. However, as was demonstrated in this case, in the interests of contractual certainty it is vital that all areas that are a major focus point of negotiations are addressed in a clear and consistent manner in the main contract.

COMMENT

For the sake of certainty, all terms on which parties intend to deal ought to be provided for in the written contract. However, where a party is seeking to rely on a pre-contractual assurance, it should be ensured that a written record is maintained – the Armstrongs’ defence was greatly strengthened by the existence of Mrs Armstrong’s handwritten note of the assurance.

Finally, it ought to be borne in mind that this case did not rule out the possibility that an entire agreement clause, properly worded, could exclude claims of a written contract being varied by pre-contractual assurances. It is possible that such an effective entire agreement clause could have saved Thinc, but on the facts it was conceded that an attempted entire agreement clause was ineffective – this concession was based on the fact that Thinc would have had to rely on agreements outside the written contracts to enforce vital terms of the agreement, such as the novation of the benefit of the Armstrongs’ contracts with their client base.