The Risks of Commencing a Contract Before it is Signed

Entering into and negotiating contracts can be a long and detailed process. Disagreements over what should or should not be included are common, with each party seeking to protect their position and level of liability. It is not surprising that on occasion parties begin to perform a contract before terms have been finalised; sometimes under a letter of intent or heads of agreement. This raises the issue of whether a legally binding agreement is in place - an issue which, in the past, the courts have looked at with considerable leniency. 

The general principle used to be that if the work had been fully performed, the courts would “bend over backwards” to find that there was a concluded and effective contract in place. They had previously stated that if the ‘parties, price, time and work scope,’ have all been agreed, it is possible to find that a binding contract is in place and all other terms of the contract are inessential. However, several recent cases have upturned this approach and highlighted the risks involved in starting to perform a contract before all the terms have been properly negotiated. 

In situations where lengthy negotiations are required, heads of agreement or letters of intent are often used to set out the general nature of what has been agreed. They can resemble a contract, although they are not usually legally binding on the parties, enabling them to negotiate the actual terms from the general principles. However, the courts have held that a letter of intent can amount to a legally binding contract, even where there has been no express indication by the parties of their intention to be bound by it. If a letter of intent is considered sufficiently certain and complete, contractual force can be placed on it, regardless of the intention. If a formal contract is not drawn up there is a danger that terms remain unfinalised and the parties find themselves in a potentially vulnerable situation, placing the ongoing viability of the contract in jeopardy. 

Conversely, the courts have also found that letters of intent stipulated to be subject to contract could prevent a contract being regarded as arising from the conduct of the parties. This only applies if the parties have not negotiated to waive that requirement while they have started to perform the intended contract, and no formal contract is subsequently signed (RTS Flexible Systems v Muller - the Supreme Court, 10 March 2010). 

The case of Whittle Movers Ltd v Hollywood Express Ltd involved a distribution and warehouse service provider (Hollywood) which intended to sub-contract its services to Whittle. The tender process was stipulated to be subject to contract. The period for the supply of the distribution services commenced before the parties had concluded their commercial negotiations or formal contract. Whittle began to perform the distribution services on the basis that a long-term contract would be drawn up; neither party sought to finalise the contract and the arrangement continued for 15 months. Hollywood then tried to terminate the ‘contract’ by giving 6 months' notice but Whittle argued that as they were already performing the services the long-term contract had been entered into and 6 months’ notice was insufficient. Hollywood disagreed and argued that during negotiations the parties had entered into an interim contract, which could be terminated by 6 months’ notice. Initially the court agreed with Hollywood, but on appeal it was held that there was no contract in place, interim or otherwise. 

The court stated that there was no binding contract without a formal, written and signed document in place. As to whether an interim contract existed, the court concluded that while the terms of the final contract were under negotiation, no interim contract could be entered into, as there was no agreement on what the terms should be. 

This case emphasises the importance of ensuring contracts are properly negotiated and executed before any performance of the contract takes place. The fine line as to whether a contract does or does not exist could mean you end up without limitations on your liability or the payment or notice provisions that you had expected.