Commercial Contract Law - David Lowe & Clark Sargent - ThinkHouse September 2016

Clark Sargent: Today, we're going to have a look at some recent developments in contract law. We have got David Lowe, who is a contract draftsman par excellence here at Gowling WLG, and I am Clark Sargent.

With the contracts that David has drafted, if they get into any kind of commercial difficulty as they develop and progress, then I come along and try and help put them back on track. We are going to start with the interesting topic that is arriving on our shores: wilful default. 

David Lowe: That's right Clark, I think you and I are both seeing more commonly in contracts references to wilful default.

We didn't used to see that five or ten years ago but now we are seeing that, if a party has acted in wilful default, they have unlimited liability, the liability cap doesn't apply. I am worried about that because I think that undermines the contract.

We are not really very clear what wilful default is. I mean there was that case, wasn't there, 20 years ago, which said wilful default means an intentional reckless default but what does that really mean? And then I worry about the court having to look behind the scenes at what was the party's intention, it just seems to open the door.

Clark: You're right, the courts don't like doing that, do they, and for a long time they struggled with the concept of gross negligence, which pretty much in English courts they would like to say is just negligence, and we have looked at wilful default and we had the Albemarle and AstraZeneca case a couple of years ago, the courts saying we don't like the idea of having a concept of deliberate breach which follows on from photo productions hundreds of years ago which said we don't like the idea of fundamental breach and now we have got a wilful breach, a wilful default or a wilful breach, so the English courts are pushing back on it all the time.

But you're right, it's appearing in the contracts more and more and the courts might have to take that on, therefore, and that's one of the reasons why you might want to push back on it, (1) because we don't really know what it means yet, and (2) because actually somebody is going to have to take it through the courts, you know through the Court of Appeal and up to the Supreme Court to get a final determination on it, and nobody wants to be the party involved in that long running, expensive case.

David: So it sounds like you agree with me that the courts might apply a narrow interpretation.  It might be very limited to very particular deliberate types of breach or they might apply a broad one and none of us know and therefore …

Clark: We don't know, do we, and that might take you back into, you know, looking at Arnold and Britton, which we were talking about a year ago, you know, the idea the courts look more closely at the words.

So actually if you're going to use wilful default, if you can get some kind of idea into the contract around, you know, what you have in mind by what wilful default means, and what the consequences of wilful default means, and the clearer you are, you know, the more likely you are of controlling and helping the Judge to come out with the conclusion that you had in mind when you were putting the contract together.

David: So talking of making sure the contract is clear, one of the things I have seen come up is, of course, most of my contracts have a clause saying you can't vary the contract except in writing but we all know in reality that isn't what happens.

They have seen some developments there, haven't they?

Clark: Exactly and there now, here we see for once the courts absolutely not doing what it says on the paper.

OK, so we have had two cases on that very recently, we were involved in the first one and were successful in it actually, which was great, at the Court of Appeal, Globe Motors and TRW. In that case actually TRW won in the Court of Appeal on the fact of no liability at all under the contract, so never had to get onto the oral variation point, but what the court there said, the Court of Appeal said was, this is all about party autonomy so if the parties agree on day one that they want to have variations only in writing, in fact on day five they can change their minds because they have party autonomy and agree to have a variation by conduct or orally, and actually it is implicit in that oral variation that they are orally varying at the same time the requirement for writing.

That is party autonomy.  Now, as I say in that Court of Appeal case, the point was obiter but it was literally followed a couple of days, weeks later by the MWB and Rock Advertising case, and in that case it was square on the point because the issue was it was a rent agreement and the tenant was in arrears and had they or hadn't they done an oral agreement to defer some of the rent? That was the point in the case, so bang square on, and there was in the rental agreement exactly that - no variations except in writing - clause, and the court followed Globe and TRW and said, yes they can vary the contract. So in fact in that case they could have varied the contract, they did vary the contract and therefore the claimant landlord was unsuccessful because there had been a deferment.

David: Right, OK. I think though I should still keep that clause in, shouldn't I?

Clark: I think you should keep that clause in and, actually, it is quite interesting in the Court of Appeal, they do um and argh about whether this is a good idea.

The reason for keeping that clause in is twofold. First is, if you actually write that contracts should only be varied in writing, that might actually encourage the parties to only vary the contracts in writing and that would help, wouldn't it, because it gives a certainty, and of course they would bring the contract back to you for the re-draft which is always helpful getting the re-draft right.

And secondly, there is this idea about, well, how much agreement do you need for the oral agreement? You know, are we going to get frivolous cases about, you know, I met him down the pub on Tuesday and, you know, after eight pints we agreed.

And it's absolutely about that evidential certainty, so it's an evidential point, but if you have written that clause into your contract you clearly need a pretty clear oral variation or a pretty clear fact of conduct.

David: Yes, so keep the clause in, encourage your teams to vary in writing and not rely hopefully on what they said on a phone call.

Clark: Yes

David: Got it.  And what about implied terms?

Clark: Ah, what about implied terms?

We've had a big case here which doesn't change the law officially but sort of does, which is the Marks & Spencer case, which talks to us about how you imply a term into a contract.

Back in Attorney General of Belize, back in 2009 I think it was, we had Hoffmann saying implying a term into a contract is all part of contract interpretation. So it's about objectively viewed, what should reasonably be within the contract taking into account the factual matrix at the time?

That was the test that we had and there was a sort of view that that was a bit of a loosening of the tests of implied terms and in Marks & Spencer, the courts are clear that they are not changing the law but they are reaffirming that it's a hard test for implied terms, so they say, first, it's not a matter of contract interpretation because contract interpretation is of course about the words that you've written into the contract, so you look at those express words.

When you imply a term having interpreted what you've written in the contract you can then come back and think about what you need to fill in the gaps that are missing and there they say OK, so it's not just about, you know, objectively viewed, but it's about what is necessary to give the contract business efficacy, the tests that we grew up with 25 years ago, so it's back to business efficacy and it's almost like the contract won't work without it.

David: Yes, so that gives us more confidence that what is written down in the contract is king, it's less likely the courts are going to go off and make something up.

Clark: Absolutely, and they're very clear and actually, to be fair, in Attorney General of Belize, but reaffirmed in Marks & Spencer and the cases that have followed it, the courts are very much saying implied terms is not about the court looking, you know, with the benefit of hindsight and deciding what is it the parties should have agreed, that isn't implied terms. It's back to business efficacy.

David: I guess we couldn't close a contract law update without at least touching on Brexit, which of course we don't even know what it is and when it will be and what impact it will have, but we know something is going to happen.

Clark, the approach I am taking in contracts with people is to encourage them usually to have break points, have shorter contracts, have regular price reviews because I'm worried that otherwise by writing a contract if there is a Brexit then, well then what? We have a chat? What happens if we have a chat and we fail to agree? Well that ends up giving a party, well we probably need to give somebody a termination right. How can we do that? We might as well just put a break clause in anyway because it's so uncertain.

Any views from you?

Clark: No, I agree with you. I think actually because you and I have looked at trying to write a Brexit clause that triggers on Brexit, but if you think Brexit means Brexit as we're being told by our politicians, you know, then Brexit's happening, so this isn't like a conditional issue, it's a fact.

Brexit is going to happen but we don't know when, but it's going to happen. So you're right, I think this idea about an annual review or an annual break or a two year break or a two year review, that's the best way to deal with it because, actually, that gives you some timeframe now with a certainty while we think about article 50 and you're going to end up with a break or a review around when the changes start to happen, you know, and we've also thought about, haven't we, whether actually you know, you shouldn't, you know if you're doing a 15 year programme or a 15 year supply contract would you want to break that into two or three year chunks or something?

Clark: It's that kind of idea to give you an ability to look at price again doesn't it, it's bound to be price isn't it?

David: Yes

Clark: Did you want to pick up in the context of price on penalties?

David: Oh yes, you're right, penalties obviously being the big Supreme Court judgment of the year and which there's been acres of alerts and commentaries by law firms about penalties.

I don't think we need to go over the facts here because they should be very familiar to everyone, but basically the Supreme Court of course has said, well, if you have something in the contract that looks like a deterrent of some description, if you park here and outstay your welcome you will get a fine, if you break this restrictive covenant then you will receive a reduction in the consideration for the deal by 50%25, if you fail to deliver on time you will pay liquidated damages.

The courts are now saying, well, as long as that's not an unconscionable amount, not a ridiculous amount, then that is probably enforceable as long as you have got a good commercial interest in it and of course in that case the parking operator did have a good reason, had an interest in running the car park, the vendor of the business in Makdessi did have a good interest in preserving the value of the business they bought.

So I look at that case and think, actually, I don't think it's really changed the way I do anything now, I think people always were reasonably sensible because they knew if they weren't sensible it would be enforceable and that basically seems to be where the law has landed.

Clark: I think you're right on that, I don't see it changing how you would draft a contract and in fact I think it takes it away from, you know, a bit away from the litigation arena, because the courts, you know before where we had the genuine pre-estimate of loss tests, that's quite narrow isn't it, you know, you've got to get it, in that you've got to get it right mathematically.

It's got to be a calculation you can justify, whereas once you move out to extortion and unconscionable you've got good room for manoeuvre and actually that's the sort of target space that is much easier to hit, so you would expect parties to have come up in their contracts with about the right sort of figure, and if you got about the right sort of figure well, apart from in Makdessi which is really unusual facts, you know, because of the ridiculous size of the numbers involved.

The courts for eight or nine years have been saying, look, if the parties have had a reasonable stab then we are pretty comfortable with that, and it comes out especially in Makdessi, doesn't it, about you know, properly negotiated contract, you know, serious long discussions and negotiations, the parties decided what they wanted and they're stuck, you know they're going to get what they agreed.

David: Yes, and so I'm seeing people drafting contracts and liquidated damages clauses, late delivery clauses, service credits clauses. Actually nobody is changing anything.

Clark: Yes, yes, more of the same. Yes. A good decision actually. OK, thank you David.

David: Thank you.