Beware - a contract can be varied orally or by conduct - even if the contract says otherwise!

25 April 2016


Although obiter, the Court of Appeal has provided some very helpful guidance on the law relating to contract variations. In Globe Motors Inc & others v TRW Lucas Varity Electric Steering Limited & another, the Court of Appeal clarified that even if an agreement contains a clause which provides that it can only be varied if the variation is in writing and is signed by all parties, the agreement can in fact be varied orally or by conduct.

Background

Globe Motors Inc (Globe) entered into a long term exclusive supply agreement with TRW Lucas Varity Electric Steering Limited (TRW) in June 2001 (the Agreement). TRW produces electric power-assisted steering (EPAS) systems and, under the Agreement, TRW agreed to purchase from Globe electric motors to be used in the production of those systems ('Products').

For a number of years Globe supplied products known as 'Gen 1' motors to TRW under the Agreement. Those Gen 1 motors were included in the EPAS systems supplied to TRW's manufacturing customers. Subsequently a second generation, 'Gen 2', motor was developed but TRW purchased those 'Gen 2' motors from a third party, rather than from Globe.

Globe claimed damages for breach of contract from TRW, asserting that TRW was contractually obliged to purchase the Gen 2 motors from Globe under the Agreement. TRW argued that it was not required to source Gen 2 motors from Globe, but even if it was, Globe had only suffered minimal losses - it had transferred manufacturing to its subsidiary, Globe Motors Portugal (Globe Porto), so that any losses sat with Globe Porto, with whom TRW did not have any contractual relationship.

Globe claimed that the Agreement had been varied by conduct and that Globe Porto became a party to the Agreement as a result. TRW argued there had been no variation - the Agreement contained a clause which provided that it could only be amended in a written document that was signed by all parties (Article 6.3).

First Instance Decision

At first instance, the Judge held that TRW was in breach of the Agreement by purchasing Gen 2 motors from a third party. The Agreement included Products and any other items that could and would have been developed as a result of Globe making 'Engineering Changes' to Products. A motor that had not actually undergone an 'Engineering Change' would also fall under the Products umbrella if it hypothetically could have done so.

The Judge also found on the basis of the 'overwhelming' evidence before him that the Agreement had been varied by the conduct of the parties, such that Globe Porto was a party. Products had been supplied by Globe Porto, there were many day-to-day dealings between TRW and Globe Porto, and Globe Porto had invoiced and been paid by TRW.

TRW was therefore held to be in a contractual relationship with a much less financially stable subsidiary of its parent company. TRW had argued that it would never have agreed to such a variation, and that doing so took away all the financial protection that TRW had by being in contract with a substantial organisation like Globe. By contrast, Globe Porto had a weak balance sheet such that, in the event of delivery or quality issues, TRW would have had no or limited redress.

The Judge acknowledged the value of 'no-variation' clauses such as Article 6.3, which he said should be upheld unless the evidence of variation or waiver is clear. Whether variation or waiver has occurred will be a question of fact, but it must be possible for variation or waiver to occur - to decide otherwise would be inconsistent with the principles of freedom of contract.

TRW appealed to the Court of Appeal.

Court of Appeal Decision

The Court of Appeal held that TRW had not been in breach of contract by ordering Gen 2 motors from a third party. They did not accept that Gen 2 motors fell within the Products umbrella. It was not enough that Gen 2 motors could - hypothetically - have become Products through the Engineering Change process. The Agreement did not oblige TRW to propose Engineering Changes to Globe.

Clarification of the law relating to contractual variations

Having decided that TRW was not in breach of the Agreement, it was not necessary for the Court of Appeal to address the 'no-variation' clause. However, in view of the fact that there were competing authorities on the issue, and having heard full argument on the point, the Court decided to address the issue in an obiter judgment.

TRW argued that there were sound reasons for recognising the efficacy of such clauses: no-variation clauses promote commercial certainty and avoid false or frivolous claims of an oral agreement. In any event TRW argued the conduct relied upon in support of Globe's assertion that the contract had been varied was not unequivocal.

The Court of Appeal confirmed the general principle in English contract law that parties have freedom to agree whatever terms they choose to undertake, and they can do so in a document, by word of mouth or by conduct. The fact that an agreement may include a clause requiring any variations to be in writing will not prevent parties from later making a new contract varying the contract by an oral agreement or by conduct. The Judge at first instance was right to have found that the Agreement had been varied orally and by conduct.

There are some common law restrictions on the freedom of contracting parties to agree the terms of a contract - for example, penalty clauses and restraint of trade clauses. There is, however, no such common law principle precluding an oral agreement where its subject is another agreement which contains a 'no variation unless signed in writing' clause.

In the absence of statutory or common law restrictions the parties have freedom to agree whatever terms they choose to undertake and can do so in a document, by word of mouth or by conduct. In principle therefore, a clause requiring any variations to be in writing will not prevent a subsequent variation that has been agreed orally or by conduct.

The Court of Appeal acknowledged TRW's concern about manufactured allegations of oral agreements that vary written terms. He accepted that difficulties of proof may arise whenever it is claimed that a contract has been made orally or by the conduct of the parties - the facts will need to be determined on the basis of the evidence before the court.

However, even where there is a no-variation clause, an oral variation or a variation by conduct could be effective where the evidence establishes - on the balance of probabilities - that the variation was agreed.

There were two competing Court of Appeal decisions on the issue - as a result it was entitled to decide which one to follow. They preferred the approach which recognised the principle that a contract containing a no variation clause can in fact be varied by oral agreement or by conduct.

As a result, the Judge at first instance was entitled to conclude that, on the basis of "open, obvious and consistent" dealings over a long period there was no other explanation but that the parties intended to add Globe Porto as a party to the Agreement.

Comment

TRW thought it was in contract with a substantial financially stable company. It was totally surprised to find that over many years through the conduct of its employees, and without any reference to its legal team, it had ended up in contract with a subsidiary of Globe that had a significantly weaker balance sheet.

While clauses requiring any variations to be in writing and signed by all parties do have a value - if there is clear evidence a variation has occurred and the parties have agreed to it the clause may not have the effect it was intended to have.

The Court of Appeal has confirmed the general principle of freedom of contract, but at what price to commercial certainty for contracting parties?


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