Contract Formation

In the first of a new series of articles, Construction and Commercial Litigation Partner, Richard Millard, looks at recent developments in Construction Law.

The recent decision in the Supreme Court (formerly the House of Lords) in RTS Flexible Systems Limited (Respondents) v Molkerei Alois Müller Gmbh & Co KG [2010] UKSC 14 highlights the problems that businesses can create for themselves when they postpone finalising the terms of a contract.

Very often, parties begin to draw up a formal written contract but start to perform the contract before the formal terms are fully agreed. In this situation the courts have to decide whether a legally binding contract has come into existence, and on what terms. There are numerous cases looking at the position where letters of intent are issued as a preliminary step to a formal contract, or where terms are passed back and forth and end up sitting in someone’s drawer.

In January 2005, RTS successfully tendered for a £1.68 million project to supply Müller with an automated system for packaging yoghurt pots. It was agreed that RTS would begin work on the basis of a four week letter of intent while the parties negotiated the terms of a final contract.

The form of contract being used stipulated that the Contract would only become effective once all counterparts had been signed by the contracting parties and exchanged.

The parties agreed the majority of the terms during which time RTS continued to work on the project beyond the time period stipulated in the letter of intent. The project ran into difficulties and the issue was whether a contract had been entered into.

The Supreme Court found that on the evidence the parties had reached agreement during the course of which by their conduct they had waived reliance on compliance with the above clause that required all counterparts to be signed and delivered.It reached a different conclusion to the lower Courts. Lord Clarke commented that

   "the different decisions in the courts below and the arguments in this court demonstrate the perils of beginning work without agreeing the precise basis upon which it is to be done. The moral of the story to is to agree first and to start work later."

Businesses may not always find it possible to agree on the terms before work starts but every effort should be made to finalise those terms at the earliest opportunity. This case highlights how cautious parties must be when beginning to carry out their side of the contract as they may waive the protection offered by a "subject to contract" provision. It is far better to reach an agreement on the terms or have certainty as to what each parties’ obligations are and avoid the potential for a dispute arising at a later date.

To discuss the issues raised in this article or indeed any matter concerning your construction business please contact Richard Millard by email or call us on 01908 692769.