Part 3 – Subject to contract

By Peter Mills and Robert Gallagher*

Credit departments, procurement teams, business development and legal teams will find this article useful.

We also look what happens if a party enters into a second contract, incorrectly believing that the first was not binding eg because the first dealing was “subject to contract” at the time.

Apart from any need for signing and authority, when does a contract become legally binding?

A contract is formed and becomes legally binding, if:essential terms are sufficiently certain, and the parties intend to be bound. 

The meaning of “terms” in a contract and whether a party intended to be bound are to be determined by what a reasonable person would have understood. This requires consideration not only of the words used, but also of the surrounding circumstances known to the parties, and the purpose and object of the transaction. The actual intention of a party is not relevant, even if important economic and other terms of significance (but not essential) have not been finalised.2

  • The substance of communications and documents, and not the form of any discussions or document, will be important.
  • These principles apply to all contracts, whether written or verbal and whether or not in relation to land.
  • If a “contract” is not legally binding, then the parties are not bound and neither can be sued under the “contract”.

    What does “subject to contract” mean?

When negotiating contracts, parties might call the document a “memorandum of understanding” or use the words “subject to contract” or “subject to execution of the contract”. These words do not of themselves resolve the questions of whether and when a contract becomes legally binding.

Negotiations (whether or not they use the above words) will fall into one of four classes3.

(1) the parties have reached finality in arranging all the terms of their bargain and intend to be immediately bound to the performance of those terms, but at the same time propose to have the terms restated in a form which will be fuller or more precise but not different in effect – this is a legally binding contract.

(2) the parties have completely agreed upon all the terms of their bargain and intend no departure from or addition to that which their agreed terms express or imply, but nevertheless have made performance of one or more of the terms conditional upon the execution of a formal document – this too is a legally binding contract.

(3) the intention of the parties is not to make a concluded bargain at all, unless and until they execute a formal contract – this is not a legally binding contract.

(4)one in which the parties were content to be bound immediately and exclusively by the terms which they had agreed upon while expecting to make a further contract in substitution for the first contract, containing, by consent, additional terms – this is a legally binding contract.4

In Stellard’s Case, after considering numerous emails and documents passing between the parties, and that urgency was important as due diligence had to be started, the court found that the contract, as constituted by emails, fell into the first of the above classes, and was a legally binding contract. That was so, even for a contract for the sale of land which must be in writing and signed by all parties to be bound. The Court held that the contract was formed on the passing of the following specific emails:

By the intending Buyer (Stellard): “This offer is of course subject to contract and due diligence as previously discussed.”

In response by the intending Seller (NQF): “We accept the below offer which we understand will be subject to execution of the Contract provided (with agreed amendments) on Monday …”

Despite this, and unknown to Stellard at the time, NQF continued discussions for a second contract for the sale of the same land and business, to achieve a higher sale price. The effect of the court decision was not only that Stellard had a legally binding contract with NQF, but that NQF also would be liable for damages for breach of the other contract if made with the second buyer.

Takeaway – be careful when using phrases like “subject to contract”. It will not always protect a party, especially one who decides that they really want to use the first price to increase other bids5. If a party then enters into a second contract, whilst legally bound by the first, it will likely also face a claim for damages by the second “bidder”. This is very important if a party deals with unique or rare assets.

What common contracts should you be careful with?

Many contracts are formed by businesses every day. Some of these arise from normal business, whilst others are more complicated, such as settlements of litigation or disputes. The “rules” discussed in this series should be considered in your deal making. Some further examples of complexity in this area are as follows:

  • Jennings Case – binding settlement contract after mediation

This case shows that settlement of litigation by mediation (or negotiation) may be binding as soon as the lawyers involved “shake hands”, whether they do that physically or notionally over the telephone. If an offer is made it can become a contract when the other party says, “I accept”. The parties’ previous rights are lost, and converted into rights under the settlement agreement.

Takeaway – be certain of what the mediation and settlement is to cover. Ensure mediation agreements are suitably worded as to when the parties will be bound eg. many formal Mediation Agreements specify that there is no agreement unless the terms are reduced to writing and signed by all parties. This is prudent where complex issues are involved.

  • Secure Parking Case – council tender not accepted and so nobody entitled to sue

A council tender was lodged by Secure. The council proposed that a clause in the tender be changed so that bank guarantees, as opposed to performance bonds, be provided by Secure. The variation was “in substance” different to the terms of the tender lodged, and Secure did not agree to the proposed variation.

The council purported to “terminate” the contract based on Secure’s failure to provide the bank guarantees, and sought damages for the breach.

Secure counter sued for damages for unlawful termination by the council, saying the variation was never accepted and they had never agreed to provide bank guarantees as part of the contract.

The court held that neither party was entitled to sue, as a legally binding contract had never been entered into in the first place. This reinforces the first principles discussed above, that the essential terms must be certain and agreed.

Takeaway – no matter how much paperwork is generated and signed, if a term of a contract is in substance an essential term which has not been agreed upon, then no legally binding contract has been formed. Making sure that all of the essential terms are agreed upon will not always be an easy task.

  • - “The Satanita” – terms of a competition for multiple participants zzEntrants in a yacht race gave an undertaking to the yacht club that they would be bound by the rules of the club. It was held that all race participants were therefore in a contractual relationship with each other, and bound by the club’s rules. This is an example of a case where the two or more parties to a contract agree to the terms as put forward by a third party.
  • - The “mechanics” of a competition are that the first competitor offers to all others who may enter to observe the rules if they will do so as well. The second and subsequent competitors, by entering the competition, accept this offer and make a similar offer to others and so on.

Takeaway – Even terms for dealings such as online and customer competitions may include contract issues, Privacy Act compliance, and consumer protection laws. Make sure that your competitions are being conducted so that all competitors are bound by the same terms. Otherwise you might even end up with more than one winner!

  • - Pennzoil v Texaco zzIn 1984, Pennzoil made an informal (but binding) contract called a “Memorandum of Agreement” with Getty Oil (called “the MOA”), to purchase a large portion of Getty Oil, in order to give Pennzoil rights to Getty’s oil deposits.
  • - Following the deal, the Texaco oil company, operating under the belief the MOA was not a binding contract, made a contract with Getty (called “the Texaco Contract”) which was inconsistent with Getty Oil’s obligations under the MOA.
  • - Pennzoil sued Texaco for inducing Getty to breach the MOA, and in 1997 Pennzoil won judgement for USD$8.3 billion damages.
  • - Texaco went bankrupt over the judgment.

Takeaway – documents, despite not being called “contracts”, may be binding contracts. Further, if you interfere with a binding contract between other parties, you can also be sued.

Takeaways

A contract will not be binding unless there is agreement on what in substance are the essential terms.

Parties should be cautious on how they sign off or comment when negotiating, as “subject to contract” and similar phrases will not necessarily protect them, and they may be immediately bound even when they did not wish to.

Be extremely cautious if you wish to use a bid by one buyer to increase another buyer’s bid. Whilst in many cases there will not be anything unlawful in doing this, it did not work out for the vendor in Stellard’s Case. You could end up being legally bound under two contracts, forced to sell to the first buyer, and liable to pay damages to the second buyer.

Neither party can sue for loss if there was never a legally binding contract.

Terms for online and customer competitions should be carefully worded and processes used so that all participants are legally bound by the same terms and proper Privacy and other compliance is dealt with.

Conclusion

We hope that this series of articles has proved useful. Please contact us if you wish to discuss how we can assist you. 

By Peter Mills, Special Counsel

pmills@tglaw.com.au

T +61 7 3338 7921

Robert Gallagher, Partner

rgallagher@tglaw.com.au

T +61 7 3338 7920

FOOTNOTES:

1 Stellard Pty Ltd & Anor (“Stellard”) v North Queensland Fuel Pty Ltd (“NQF”) [2015] QSC 119

2 Toll (FGCT) Pty Ltd v Alphapharm Pty Ltd (2004) 219 CLR 165.

3 Dixon CJ, McTiernan and Kitto JJ in Masters v Cameron (1954) 91 CLR 353 at 360.

4 McLelland J, Baulkham Hills Private Hospital Pty Ltd v GR Securities Pty Ltd (1986) 40 NSWLR 622 at 628

5 See also Moffatt Property Development Group Pty Ltd v Hebron Park Pty Ltd (2009) QCA 60, where the terms agreed upon referred to further put and call option terms to yet be prepared. The court held that the essential terms of the contract were still certain and was still binding despite such option terms not being agreed. Again, the sellers had tried to entice other buyers after making the first contract. The other thing not mentioned in the decision is that whilst the buyer successfully obtained an order that the seller had to sell it the land, by the time the court decision was made, a property slump meaned the land was now worth far less.

6 Jennings v Jennings [2016] NSWCA 29

7 Secure Parking Pty Ltd v Woollahra Municipal Council [2016] NSWCA 154

8 Clarke v Dunraven [1897] AC 59.

In Part 1 of this series, we looked at Stellard’s Case1 (in which we acted for the winner), where the courts ruled that the name of an agent typed in an email was a “signature” which bound the company. We also looked at when Credit Applications, their Terms and Conditions of Trade (called “T+C’s”) and guarantees need to be “signed”, whether foreign laws are relevant, and noted that proper processes and systems (both manual and online) are crucial for ensuring a signature is obtained.

In Part 2 of this series, we looked at who has sufficient “authority” to enter into an agreement or sign on behalf of a customer or guarantor. We also looked at what happens if a person does not have authority, such as a salesman granting a general charge over all assets of his employer’s business, and where verification of signing processes and systems were not sufficient.

In this final Part 3 of this series, we look at when parties are legally bound during negotiations, such as when they say the dealings are “subject to contract”. A lot of cases have recently hit the courts over this issue, so it is timely to look at when a contract is legally binding, and what happens if it is not.

The meaning of “terms” in a contract and whether a party intended to be bound are to be determined by what a reasonable person would have understood.

...be careful when using phrases like “subject to contract”. It will not always protect a party, especially one who decides that they really want to use the first price to increase other bids.

Parties should be cautious on how they sign off or comment when negotiating, as “subject to contract” and similar phrases will not necessarily protect them, and they may be immediately bound even when they did not wish to. 

 

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