Boilerplate in contracts - The Parties

David Lowe: Thank you for joining us for our session on boilerplate contracts. This is part of an occasional series on different aspects of boilerplate contracts. My name is David Lowe, I lead our Commercial Contracts team and I am a non-contentious lawyer, so I focus on drafting and reviewing contracts.

Sean Adams: My name is Sean Adams, and I am a Partner in our Commercial Disputes team, and I see these contracts from very much the other side and see them when they go wrong and when people are falling out and looking at termination or disputes. So, hopefully between the two of us you get something of a balanced view across one of these issues.

David: Of course boilerplate is relevant to every contract and often it becomes really important when there is a dispute which is why you have the perspective from me drafting the contract and Sean's perspective in what happens when it goes wrong. In this session today, we are going to focus on The Parties and by that we mean who are the parties to the contract and how it can be changed through assignment or novation and also how you can use third parties and agency.

So Sean, let us start at The Parties. Now it is pretty obvious to me as a drafter of a contract that you have got to be clear who the parties are. So why are we even mentioning this?

Sean: Yes absolutely and I am glad it is clear and it is always in your contracts David which is great, but you would be surprised how many times the client comes to us that ended up with a dispute with a supplier or a customer and they send you through the contract which is five years old and you open it up and actually it is not entirely clear who the parties to this agreement were, even at the outset. That might be as simple as people have only put in a name and they have used a trading name rather than a legal name, it might be that the party that existed five years ago when this was entered into, has now changed its name two or three times. There might be all sorts of other complexities that we will come on to around variations and novations and assignments and that sort of stuff, but actually when you get to a dispute, when you get the end, the last thing you want to be having any sort of satellite dispute over is who on earth am I in a contract with here because it just adds another layer of complexity. It adds another layer of cost. So I think my top tips from that perspective are it is really easy when you are going into contract with somebody to identify who it is you are contracting with. You will be doing all sorts of other commercial things like diligencing your counterparty and making sure you are going into business with them. So just put a bit more detail in that parties section of your contract to make sure that is beyond doubt for evermore.

Using things like company numbers where you are dealing with a corporate, which even if somebody changes their name you can then track back and find exactly which corporate entity we are talking about. That is really helpful. Things like addresses can also be helpful, again they change but you can tie somebody at a point in time to a place. That helps. Where you have got variations, novations things like that, make sure you are keeping a nice clear record of those and that probably applies to all changes not just to the parties. Where that is getting more complex I think you often see a conformed copy of an agreement that sort of sweeps in two or three years' worth of variations and I know from a drafting perspective you will look at some change control and things like that around how that is monitored.

Think about it from the perspective, whilst hoping you never get there, of if I end up in litigation over this and I have to send Sean my contract in order for him to tell me whether I am in the right or not, how can I make that as straight forward as possible and stop the exercise and having three or four rounds back and forth as we try and work out what the contract is and who the parties are.

David: I think you know if you vary the contract it is good practice to record, oh is this third variation of it because that gives you a clue then that there are more variations to ask for. I recently had that myself where there were five variations and I was only given three. So because one variation referred to how was the fifth variation, I knew to ask hey there much be two more out there. So constantly doing that and having an eye to what happens if I have to bring together the whole contract is really important.

Sean: I completely agree with that. Shall we move on to assignment and novation?

David: Yes, so it is very common isn't it to have in a contract and the boilerplate clause that says something like this, a party may not assign any of their rights, responsibilities under this agreement. So there is often a debate about, is that appropriate? Should there be a restriction assignment? Can there be assignment within a group so that you could move the contract round a group, so you might say parties may not assign it except that they can sign it freely within their group. Or, a party may not assign it without the other party's consent not to be unreasonably withheld or delayed. They would be your common variants. But, often what is missed is actually assignment actually only has a limited role because assignment can only transfer the benefit of a contract. They do not transfer the burden and the only way in which you can transfer the benefit and the burden is through a novation. So, I am often asked by people about assignment clauses when actually what they want to do is transfer the whole contract, benefit and burden. I then point out that the assignment clause is not going to give them the complete answer. It only gives then part of the answer because we can only transfer the benefit.

What do I mean by the benefit of a contract? Let us imagine that I am supplying window cleaning services to Sean. If I assign the contract to a new supplier I transfer the benefit of my contract with Sean to that supplier and the benefit is the right to be paid. So, I have not transferred the burden. The burden being the obligation to clean Sean's windows. So the assignment, all I have done is transferred the benefit, the right to receive payment and not the obligation to do the services.

Now I can build on that and I can then go to the new supplier, oh can you also go and clean his windows and therefore create some kind of collateral contract but now we are getting complicated and messy when all I wanted to do was transfer the contract. So how do we go about this? Sean we have got a slide with some pictures on haven't we? Here they are.

Sean: It makes it easier to understand hopefully.

David: Yes. So the red line is what happens on an assignment in that the benefit is being paid. So if I merely assign a product all I have done is transferred the right to be paid and that means as you can see from this services assignment blue line, your obligation to provide the services sticks with me and as you can see that if you novate the contract then you transfer the entirety of the contract. Your obligation is to provide the services and the right to be paid.

Now how do you do that? Now the best practice way of doing a novation is to have a three way agreement between customer, old supplier and new supplier which says, hey the old contract is no more. There is now a new contract on identical terms with the new supplier and it may then deal with, what about handover and what about transfer of liabilities. It might deal with varying the contract. You know maybe the charges have been changed because there has been a passing of time. That is all pretty normal novations and many of you will be familiar with novations but the problem with a novation is, well firstly it is administration. Somebody has got to sit down and write out the novation and work out who is what and write it out and it is only a very short agreement typically but somebody still has to do it. So that causes administration and that causes delay. But an even more important reason is you need the customer to sign it. So if the customer is a helpful customer this might be all really straight forward and the customer simply signs it and job done. But often customers hesitate. They will either go, well I am not going to sign something until I have got my lawyer to check it. Time. Money. Delay. Or worse, the customer goes, I will agree to it, but only if you cut your prices by 5%. Or, I will agree to it but only if you reduce the term. Or, introduce some other variation and the customer will then use it as leverage knowing that you want to transfer the contract and therefore you are going to try and find a way to agree with the customer. So none of this is very attractive. We do not want the customer having control and nor do we want the, time, delay, hassle of the admin.

So, what you can do is something called novation by conduct. This is something that you are not taught about at law college and therefore people do not have an understanding of what novation by conduct is not to miss it. Basically what the Courts say is if the old supplier has written to the customer and said I am transferring the contract to the new supplier and here is the new supplier's details, please pay the new supplier to new bank details and the new supplier will now issue new invoices and the customer does not object, and then the new supplier provides the services, issues the invoices and the customer pays the new supplier. Then eventually the Courts could say, well even though nothing has been written down in that there is no formal novation, there is a novation by conduct. It just happens. Now the problem is, it is very difficult saying exactly when has that happened. It definitely has not happened on day zero when you have just told the customer but broadly when you look at the case law once a couple months of payments have gone through, a couple of invoices have been paid to the new bank account, the supplier has provides services for a couple of months, then almost certainly the Court will say novation by conduct has happened. So all routing business sales for example, where there might be hundreds of projects that need to be transferred, this is how it is done. This is normal. People do not bother with hundreds of novation agreement. They just do novation by conduct and cross their fingers and hopes the customers do not object because the problem is if the customer receives the initial notification and object, then the customer can stop that novation. In my experience the customer very, very rarely objects.

Sean: I think the only thing I would add to that David is it brings with it an obligation to be vigilant. So depending on which side of this chain you are on, if you receive one of those notices that someone is sending you, hoping you will ignore it, if you do not want to ignore it you are going to need to act. You cannot just fall into this new pattern. So make sure you are live to that and also I think for your business critical contracts they are probably the ones where you need to think about a more formal approach. I think as you said in a routine business sale where you have got hundreds and hundreds of contracts it is probably not practical but I suspect in those, by the time you have dug into them, there are a few where you actually want more certainty than that and will need to apply closer scrutiny so that you are not relying on some of the law. The law is there and it will ultimately protect you if you are in one of these scenarios where that novation by conduct goes through but you are going to have that slight uncertainty for a period and similar to the points we were discussing about parties, it depends on whether you can wear the risk of that uncertainty and that is going to turn on what the contract is. What is for. How it affects your business etc.

That was all I had on that one. I mean I think another approach. We have got a slightly different which blissfully was easier to put together but another way to deal with this exercise where you have different parties involved in the ultimate supply is you look at a sub-contracting arrangement of some sort.

So if we move on to that. So you have got there your supplier customer relationship and it is possible that the subcontractor even behind the supplier, they are two different contracts. Is that something you see when you are putting together these structures David? Is that more common? Less common that assignment novation?

David: Yes sub-contracting is common. Obviously all business are reliant on other businesses to be able to supply their services so to some degree every business is involving other parties in order to allow it to fulfil the services. What we mean by sub-contracting though is for example in my window cleaning contract with Sean, the fact that I rented my van off someone. Bought the paperclips in the office, they are not sub-contracts really. I am not passing down to somebody the obligation to provide the services or part of the services are provided to Sean. But if I had a new supplier Sean would object to the novation and go, no David Lowe I chose you, I wanted you and then unless the contract says to the contrary, I am allowed to sub-contract freely to somebody else and get them to go along and clean Sean's windows. Now Sean has to, if he is unhappy with all of this, deal with me. His contract is with me. He would sue me ultimately if it got that bad. I have to invoice him. He has pay me and then I have to separately deal with the sub-contractor. So Sean and the sub-contractor do not actually have a direct contractual relationship and I am stuck in the middle. So that is why it is not ideal if you in reality wanted to use this way of transferring the contract but it is better than not being able to do it at all.

Now, if you contract is silent then you can freely sub-contract. The only exception is if it is a personal contract and the caselaw is sort of like personal tailors and butlers and so forth so in the business world it is unlikely to be relevant. So if your contract says nothing about sub-contracting then the supplier can sub-contract. That is why it is common in contracts, particularly more substantial contracts for there to be some kind of control over sub-contracting. The customer has chosen the supplier. Has carried out due diligence of the supplier, so is comfortable the supplier can do it. The customer does not want a supplier to sidestep all that and get somebody else involved. At least not without the customer's involvement. So it is common to say you cannot sub-contract without the customer's consent. Not to be unreasonably withheld or delayed. Or you cannot do any material sub-contracting or some other controls over that approach.

Sean: No that makes a lot of sense particularly as for all sorts of different reasons in the current day and age people wanting some degree of control over what their supply chain looks like and their ability to understand what is in there as much as making sure the party they are in a direct contract with, is the one they see the ability to substantively go after if it all goes wrong.

So very briefly I think there are a couple of other options we just wanted to touch on in terms of achieving similar things?

David: Yes I wanted to touch on third parties because we all know that in a good boilerplate contract typically there is a clause about third parties made with specific mention of Contract Rights of Third Parties Act and the reason for that is Contracts Rights of Third Parties Act 1999 allowed the parties to a contract, to allow a third party to enforce and have the benefit of the contract if they are nominated in the contract or otherwise identified or a class of people. So that legislation opened the door to the potential risk that a third party might have rights over a contract. So for a normal standard contract the parties probably do not want any third parties to have anything to do with it. It is a contract just between A and B and we do not want party C do have anything to do with it. So that is why it is common to have in the contract a clause saying no third parties have any right to make absolutely sure there can be no argument that that third party can get involved.

And so that is why it is quite an important clause to make sure there is no argument. In fact quite a lot of the case law is where the contract has been silent and there is a debate about whether a third party has a right or not.

So good practice is to have a clause saying that no third parties have any rights.

The big but though is I think people just blindly put in a clause saying no third parties can have any rights without thinking about actually might it be useful to grant third party rights because the legislation was introduced to allow for people to allow third parties to have rights and therefore hopefully cut out some of the admin.

The classic example is in group procurement. One company in a group is buying goods or services but it is for the benefit of somebody else in the group. Well granting that other member of the group third party rights helps cut out putting in place contract or putting in place some acrobatic contracts and try to sort of be between two parties but with another party which are often done badly.

So I do urge you to think about whether you should use the Third Parties Right Act for your advantage and grant those rights to third parties. But if you do that you do need to make sure the drafting is right and you also need to expressly deal with the rights of terminating vary. The first time you do it it is well worth checking that the drafting right before you do it.

Sean: I am glad you added the note of caution there David. At least if someone excludes all the third party rights it is relatively clear they are doing. When they include them they then have a very short clause you can walk into trouble with some of those bits hidden down in the Act. Certainly worth having that wording reviewed, if that is the route you are going down.

And the last one I wanted to just briefly touch on is agency, because it is sort of connected to some of these things, albeit doing something different, but the law of agency is far too complex for this very short video, but you quite often see a clause in a contract which says something like this contract is not creating an agency relationship, it is not creating a partnership. Two things I wanted to mention, first if you are going to put that clause in though make sure it is right and you not in substance creating an agency relationship because that can cause untold problems. Secondly, just be careful of agency generally because what is happening when you have an agency relationship is you have got effectively someone with the power to bind a third party to the contract but the contract you are creating is between the principal and the third party of the agent being something of a middle man and acting on behalf of its principal.

All sorts of different obligations wrapped up in that and it can create some real complexities particularly in a contractual scenario which generally if a dispute happens and you have got agents involved the whole thing gets a bit messy, relatively quickly. So if you see the word agency in there it still carries a lot of legal weight, it is doing a particular thing and just make sure you understand what is happening and you know who you are contracting with and in what capacity.

David: Yes I agree. I mean, agency can be really useful again a way of cutting through things, much like third parties can be really useful, but it is to be done with care, in particular if you are going to appoint someone as an agent I would definitely strongly advise that you make sure the authority of the agent is clear, you may for example make it clear that the agent is not allowed to enter into a contract on your behalf to try and reduce the risk of them going on a frolic on their own.

Sean: I think that is done on that. It has been a relatively whistlestop tour of some quite big topics I think there. But thank you for taking the time and listening to us. Our contact details are on the screen, so if you have got any questions please just feel free to reach out and let us know. Also as you may have seen from the reference at the bottom there it is ThinkHouse. This is the sort of topic we quite often cover in our seminars, usually around commercial contracts and updates and various things like that. You will be delighted there will be link next to or near this video should you want to sign up if you are not already on the mailing list for those, we look forward to seeing you at some point in the future.

David: Goodbye.