To all intents and purposes…

I gave a talk at the end of last year, during which I said “Letters of intent come in all shapes and sizes, but they don’t make up for the lack of a formal written contract. In fact, they should come with a health warning and parties should make sure they sign up to a proper written contract as soon as possible”. It’s in the dark areas of uncertainty that disputes reside.

The accuracy of this analysis is more than adequately demonstrated by the conflicting decisions in the High Court, Court of Appeal and Supreme Court in the recent case of RTS Flexible Systems Limited –v- Molkerei Alois Müller Gmbh & Company KG, which concerned the question of whether a contract existed between the parties and on what terms.

I don’t recall Lord Clarke being at my talk, but he said in his judgment in the Supreme Court:

“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 is to agree first and to start work later”.

The facts of the case

In January 2005, RTS successfully tendered for a £1.68m project to supply Müller with an automated system for packaging yoghurt pots. It was agreed that work would begin under a letter of intent while the terms of the contract were negotiated. A draft contract was drawn up, which incorporated Müller’s MF/1 model form of contract conditions, but it was never signed. The significance of the MF/1 conditions was that they contained detailed provisions on many matters, including liquidated damages and limitation of liability.

The letter of intent expired in May 2005, but RTS continued to work on the project and the parties continued to negotiate the contract.

By July 2005, the parties had reached agreement on all major points and the contract was ready to be signed. However, in the meantime, RTS had encountered difficulties which meant that it wouldn’t be able to comply with the original timetable for the project. As a result, the parties met in August 2005 and agreed to vary the timetable.

Subsequently, RTS’s difficulties got worse and Müller alleged that there were defects in the equipment and refused to pay part of the contract price. RTS brought proceedings. The court had to decide whether there was a contract and on what terms.

Arguments

RTS argued that either (1) there was no contract after the letter of intent expired (and they were therefore entitled to be paid on a quantum meruit basis) or (2) a new contract had come into existence on the terms of the MF/1 conditions. Müller argued that a contract had come into existence after the letter of intent expired, but that it didn’t incorporate the MF/1 conditions.

The Decision

In the High Court, the judge agreed with Müller. The letter of intent had expired in May 2005 and the parties had subsequently reached full agreement on the work to be done and the price to be paid, but not on the basis of the MF/1 conditions because the draft contract incorporating those conditions contained a counterparts clause which read:

“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”.

Although the primary purpose of the counterparts clause was to assist in defining how the contract should be executed, the court treated it as a “subject to contract” provision, ie as defining when the contract should come into existence. Because the parties hadn’t executed the contract, the MF/1 conditions weren’t incorporated. Round 1 to Müller.

RTS appealed.

The Appeal

The Court of Appeal found in favour of RTS. It agreed that the counterparts clause prevented a contract from coming into existence that incorporated the MF/1 conditions, but went further and decided that it prevented any contract at all from coming into existence after the letter of intent expired. RTS were entitled to be paid on a quantum meruit basis. Round 2 to RTS.

Müller appealed.

The final decision

The Supreme Court allowed the appeal. It disagreed with both the other courts. It decided that, although the counterparts clause was a “subject to contract” provision, the parties had subsequently agreed to waive it by agreeing a variation of the contract in August 2005 when RTS had encountered difficulties in complying with the project timetable. No-one had suggested, when the contract was varied, that there was no contract to vary. If that was the case, and there was a contract as at August 2005, it made no commercial sense to decide that the project was proceeding on the basis of some of the agreed contractual terms, but not others. The need for formal execution of the contract had been overtaken by events and the MF/1 conditions had become incorporated. Victory to Müller.

Conclusion

All this goes to show that uncertainty breeds dispute and that nothing is more uncertain than the existence and terms of a contract that hasn’t been formally entered into. Whilst it might be fanciful to expect businesses in the construction industry always to heed Lord Clarke’s advice, they should nevertheless be alive to the dangers that inhabit the dark areas of uncertainty.

Consistent with our policy when giving comment and advice on a non-specific basis, we cannot assume legal responsibility for the accuracy of any particular statement. In the case of specific problems we recommend that professional advice be sought.

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