In the recent case of Newbury v Sun Microsystems , the defendant argued that an offer to settle proceedings was ‘in principle’ only and that a binding contract could not be formed until further terms had been agreed and a formal contract had been signed. It supported this argument by referring to a statement, in the offer letter, that the settlement was to be ‘recorded in a suitably worded agreement’.
The judge rejected this argument and held that a binding contract was formed when the claimant replied later the same day accepting the claimant’s offer. The statement, in the defendant’s offer letter, that the settlement was to be recorded in a suitably worded agreement was not sufficient to ‘negative’ an intention to create legal creations and was not a pre-condition of a contract being formed. Objectively, those words did no more than reflect an intention to record in writing a contract that had already been finalised. The position would have been different if the offer letter had been expressed to be ‘subject to contract’.
The case demonstrates the importance, when negotiating the terms of any contract (not just settlement agreements), of identifying the status of any ‘offer’. If the offer does not contain all of the terms on which the offeror is prepared to be bound, the letter or e-mail should make this clear. Using the phrase ‘subject to contract’ may be a convenient shorthand method of achieving this, although it should be remembered that the court will look at the substance, and not the form, of a communication and the application of a particular label may not be decisive.
The claimant, Mr Newbury, brought a claim for unpaid commission against the defendant, Sun Microsystems (Sun). Shortly before trial was to begin, Sun wrote to Mr Newbury’s solicitors offering to settle the entire proceedings in the following terms:
‘Our client is willing to settle the entire proceedings by paying the claimant within 14 days of accepting this offer, the sum of £601,464.98 (the Settlement Sum) inclusive of interest by way of damages, by means of an electronic transfer into his nominated bank account, in full and final settlement of the claim and counter-claim plus the sum of £180,000 in relation to his legal costs such settlement to be recorded in a suitably worded agreement.’
Mr Newbury’s solicitors accepted the offer in a letter that same day, and stated that they would forward a draft agreement for approval. A dispute subsequently arose as to the terms in which the settlement should be recorded. The defendant wanted the agreement to include terms which dealt with the tax position and which obliged Mr Newbury to keep the terms and existence of the settlement agreement confidential. Mr Newbury, however, said that this was not what had been agreed and that the agreement should simply provide for the payment of the settlement sum and costs.
Mr Newbury’s solicitors applied to the court for a declaration that the parties had already reached a binding contract following Sun’s offer letter and their letter in reply. Sun said that its letter had been ‘in principle’ only and contended that, in determining whether a binding agreement had been formed through the exchange of letters, the court should look at the conduct of the parties after that date, which showed that the parties were still negotiating and that they had not reached a binding contract.
FORMATION OF CONTRACTS
Lewis J’s judgment contains a useful discussion of the rules on formation of contracts, which can be summarised as follows:
- In deciding whether the parties have reached agreement, the whole course of the parties’ negotiations must be considered and an objective test must be applied. The subjective reservations of one party do not prevent the formation of a binding contract.
- Once the parties have to all outward appearances agreed in the same terms on the same subject matter, usually by a process of offer and acceptance, a contract will have been formed.
- Parties, who have agreed on all of the terms of a proposed contract, may not intend a contract to become binding until some further condition, such as the execution of a written agreement, has been satisfied.
- Conversely, it is perfectly possible for the parties to conclude a binding contract, even though it is understood between them that a formal document recording or even adding to the terms agreed will need to be executed subsequently. Whether the parties intend to be bound depends on an objective appraisal of their words and conduct.
- Parties can enter into a binding contract even though there are further terms to be agreed at a later stage. If the parties fail to reach agreement on such further terms, the existing contract is not invalidated unless the failure to reach agreement renders the contract as a whole unworkable or void for uncertainty.
Lewis J granted the declaration sought. He held that, viewed objectively, Sun’s letter and Mr Newbury’s solicitors’ reply gave rise to a binding legal agreement between the parties. This was because:
- Sun’s letter was expressed to be an offer to settle and it set out the terms of that offer.
- The offer was only open for a specified time and, if it was accepted, payment would be made within 14 days.
- Lewis J held that the words ‘such settlement to be recorded in a suitably worded agreement’ were not a reference to terms still to be negotiated. Read objectively, the letter offered to settle on certain terms and, if accepted, those terms would be ‘recorded’: that is they would be committed to writing as an authentic record of what had already been agreed. Execution of that written agreement was not a condition of the creation of a binding agreement.
- It was significant that the letter had not been expressed to be ‘subject to contract’. Had those words been used, it would have been clear that the terms would not be binding until a formal contract had been agreed.
- It was not relevant that, after the exchange of letters, the parties carried on negotiating the terms of the formal agreement. Where a contract is said to be contained in documents, conduct occurring after the date of the documents will not be a legitimate aid in determining whether those documents were intended to give rise to a binding contract. The position is different where a contract is oral, or partly in writing and partly oral, where the parties’ conduct may be relevant to test the evidence as to whether or not the terms were agreed or which terms were included.
SUBSTANCE NOT FORM
As explained above, using the phrase ‘subject to contract’ may be a convenient shorthand method of demonstrating that a party does not yet intend to create legal relations. However, it should be remembered that the court will look at the substance, and not the form, of a communication and the application of a particular label may not be decisive. This was demonstrated by the case ofJirehouse Capital & ors v Beller & anor , where the court found that a contract had been formed despite the fact that the parties’ e-mails were marked ‘subject to contract terms’. In finding that a binding contract had been concluded, the judge commented:
‘The old observation that solicitors’ typewriters had two extra keys marked “subject to contract” and “without prejudice” (suitably adapted to the modern world) is not without a modicum of truth.’
By Geoff Steward, partner, and Jonathan Pratt, professional support lawyer, Macfarlanes LLP.
E-mail: firstname.lastname@example.org; email@example.com.
‘SUBJECT TO CONTRACT’: OVERVIEW OF THE KEY PRINCIPLES
- A binding contract will not be formed unless the parties intend to create legal relations. This is an objective test: it depends not on the subjective state of mind of the parties, but on what was communicated between them.
- The use of the phrase ‘subject to contract’ in commercial negotiations creates a strong presumption that the parties do not want to be bound.
- Where a ‘subject to contract’ qualification is introduced into negotiations it can only cease to apply to the negotiations if the parties expressly, or by necessary implication, agree that it should no longer apply.