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The perils of proceeding on a ‘subject to contract’ basis
11 May 2010
The recent case of RTS Flexible Systems Ltd (RTS) v Molkeri
Alois Muller Gmbh & Co (Muller) [2010] UKSC 14 has
highlighted the risks involved in beginning projects without
signing a contract and fully agreeing the terms of the project in
advance.
What happened?
Muller, a well known supplier of dairy products, awarded RTS a
contract worth £1.68 million for the supply of automated packing
machines for packaging and product handling.
Muller and RTS agreed a ‘letter of intent’ in January 2005
setting out the contract price for the entire project and recording
their intention to enter into the ‘MF/1’ model form of general
conditions of contract (modified as appropriate) in due course. The
letter also incorporated a standard clause as follows: “The
Contract may be executed in any number of counterparts provided
that it shall not become effective until each party has executed a
counterpart and exchanged it with the other.”
The letter of intent expired in May 2005 but RTS continued to
work on the contract and both parties continued to negotiate the
terms of the contract.
RTS ran into difficulties with delivery of the original project
timetable, and, although the equipment was subsequently delivered
to Muller, RTS did not carry out the site acceptance testing
provided for in the original tender document and the draft
contract. Muller subsequently alleged that the product had defects
and only paid part of the price. RTS brought a claim against Muller
for the outstanding balance of the contract price. It also claimed
damages.
What did the courts find?
RTS basically argued that there was no contract. If there was a
contract, said RTS, then it included a statement that the agreement
was subject to contract.
What had happened at first instance?
The Court of Appeal ruled that no contract had come into
existence after the letter of intent had expired. Muller appealed
this decision and the parties repeated their arguments to the
Supreme Court.
The Supreme Court overturned the Court of Appeal decision,
ruling that it was unrealistic to suppose that the parties did not
intend to create legal relations, for the following reasons:
- Both parties agreed the contract price and this was binding on
both of them
- If there was no contract, RTS would have effectively been
agreeing to carry out works with no terms agreed at any point
- A variation to the contract was agreed in August 2005 with no
reference to the fact the variation was subject to contract
- On the basis that a contract did exist, it was unrealistic not
to treat the draft contract as a whole and as such this included
the ‘subject to contract’ provision.
The Supreme Court therefore found that the parties had reached a
binding agreement and by their conduct they had waived the ‘subject
to contract’ statement.
What are the implications?
Even though this decision relates to the activities of two
private sector organisations, it is nevertheless an important one
for commissioners of public services because it means that where
work is carried out prior to a contract being agreed, the
protection offered by a ‘subject to contract’ provision may not
actually be there.
As holders of the ‘public purse’, any failure to deliver
services or facilities to the public has the potential to cause
public embarrassment and/or increased scrutiny of the organisation
dealings and arrangements.
Whilst commissioning schedules may mean that contractors are
still required to begin work before the full and final contract has
been settled and signed, public sector organisations must ensure
they can demonstrate that they have taken active steps to reduce
the risks as much as possible.
Before commencing work, commissioners should ensure that the key
contractual terms are sufficiently and clearly documented in heads
of terms, and that the final terms are agreed in a written contract
as soon as possible thereafter.
If it is agreed that the heads of terms will expire on a
particular date, it will be necessary for the parties to address
the situation where work has begun but no formal contact has yet
been signed.
The far better option, in any event, is to refrain from
beginning any economic activity until a formal contract is in place
– and to plan workstreams accordingly in order to achieve this.
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