Getting down to specifics in contract law

Michael Luckman: Hello, I'm Michael Luckman Chair of our ThinkHouse events and I'm here with our co-founder David Lowe, who's going to be bringing us up to date on contractual matters.

David, Mike Ashley, Sports Direct and his power drinking, he's been in the news, so what's he been up to?

David Lowe: It's great isn't it contract law is on the front pages of the tabloids and of course we've all been diligently following the story because of the contractual law implications and nothing to do with stories of him vomiting into chimney places and how he can drink 14 pints. But yes it was a contract law case and it's quite interesting how the judge came to his judgement and issued it within two days of the conclusion of the case, which shows that he was able to quickly form his view on the legal merits. It was all about what was a contract form. Had Mr Blue entered into a consultancy contract? Which if he raised the Sports Direct share price by a certain amount he would get paid tens of millions of pounds. We would all know the challenge of that, the verbal contract is in theory possible to be a binding contract, but you've got to prove it was said and of course everyone has different memories after the event. But to be fair to Mr Blue he was able broadly to prove, even though Mike Ashley had no recollection of the conversation possibly due to the amount he'd had to drink, but other people in the room were able to confirm that this conversation had happened. So he was able to clear hurdle one that this conversation actually happened, but he fell over on intention to enter legal relations. The court said you can't expect to be in a pub drinking lots of beer and think that you've just created a contract when you haven't even bothered to write it down or there had been no serious attempt. Although everyone recollected this conversation happening, they also recollected how they laughed at the proposal and he just said there is no intention of entering legal relations therefore there is no contract, Mr Blue you lose and you pay the costs.

Michael: All I can say is thank goodness for that, reflecting on a few conversations I've had in the pub lately.

But these cases on contract formation they're still quite common. What lessons can we learn from them?

David: Yes, so the Mike Ashley case is not one that is going to trouble any of us, none of us would seriously expect that to be a contract. But what is really worrying is that every year when I review the contract cases, there are lots of ones where lawyers have been involved, where contracts have been negotiated, haven't quite been finished and then of course there's a dispute and there's an argument. Well do I have a contract at all and if I do have a contract what's in it? So that you know we had yet another one of those, this time it was a building case where the Court said well look there's lots of different terms and conditions washing around, I think you've got a contract but these terms and conditions I don't know if any of them apply.

So it just comes up again and again every year. There's an estate agency contract where the estate agent agreed the commission but he didn't agree what the trigger was. When did he get paid, on exchange, on completion, some other date and the Court said well we're not going to fill in the gaps for you and therefore the whole contract collapses. So it's worrying isn't it, that businesses who are doing what's really important to them, creating value in their businesses, entering into contracts to secure that, but aren't seeing it through to making sure the contract is closed. What's really important is for people to realise that it's better to have a contract in which you compromise a bit to achieve finalisation than to not have a contract at all and people need to take them seriously and bring some pace to it to close in and compromise them.

Michael: You've talked about when contracts are formed but of course even when they are formed we have issues of interpretation. Now of late we've had some view that we might be drifting towards a more purposeful construction. So where are we on contractual construction?

David: Yes, so we've had a series of Supreme Court cases over the last five or six years where some of them are going no it's the words on the page that matter regardless of the outcome. While others said well hang on, we need to just look at the context and go what was the intention, what did the contract say and so the academic debate is being are we becoming more purposeful or not. We've had a case this year, Wood and Capita it was all about an indemnity in a share purchase agreement where that question came up. I won't bore you with the facts but if you understood the facts you could understand why the indemnity just didn't quite work, but you could understand what quite they were probably trying to achieve. So Capita is saying come on Court you knew what we were trying to do, we should get the benefit from this indemnity and Wood were of course saying the opposite. The Court said, it's not about text or context, these are things that together you take into account and it's the weight you give to them and they said if it's a sophisticated contract in which lawyers have been involved then you are going to be more inclined to look at the pure words and ignore the context. While if it's an unsophisticated short contract with no lawyers involved then you're going to be more likely to take out the broader context of the agreement and therefore in Wood and Capita they sided with Wood and said no we're going to read the indemnity exactly as it says the words on the page. I'm sorry Capita, we can see that's probably not what you intended, but that's the words on the page and we're going to stick to it.

Michael: Sounds to me like a very common sense approach but of course sometimes even common sense doesn't get you into the right place and I seem to recollect we had a case recently about fit for purpose and a specification and how the two fitted together. What case was that and what was the outcome?

David: So that's the E.ON case, it was all about wind turbines, off shore wind turbines which had been built and weren't fit for their purpose of operating for 20 years at a certain maintenance cost. The consequence for that is a cost of circa €20,000,000 and it's gone all the way up to the Supreme Court. It was difficult because in the front of the contract it said we want this kit to be fit for its purpose for 20 years, while hidden away in the specifications is a reference to an international specification and there was an error in the formula of this international specification which nobody realised until the wind turbines went wrong. So the Court was faced with how shall we read this contract? Should we read it narrowly and take the specification and take this standard, which although it's wrong that's what the contractors supply and they did supply and therefore E.ON should pay, or shall we sort of look at what the overall point of the contract was and take account of this fitness for purpose. How do we read these two things against each other? And the outcome was that the Court decided that the fitness for purpose trumped the standard. They said when you read it all together, that fitness for purpose 20 years is meant to mean something and it shouldn't be sort of held back by a detail of a formula in international specification which has gone wrong, that is a risk for the contractor.

So what are the lessons there? Well there's a sort of basic one is trying to reconcile your various parts of your contract to come up with one single specification which can be read together and with these contracts that's hard work there's often complex specifications scattered throughout the agreement. It is of course an issue in any capital equipment, the tension between buyer who wants an output and the seller who just wants a clear specification. So as a buyer be conscious of that and make sure that if you want a broad specification you make that really clear and I think you remind suppliers that you know this sort of contract could well be read against them. They are the supplier the Court in this one said it's the contractor who takes that risk, so suppliers don't be sloppy with your specifications.

Michael: So some interesting cases there. What would be your sort of top drafting tips coming out of those then?

David: Well there's been some cases that I think probably remind me, worry me sometimes, there was one case where the term practical completion was not capitalised. So throughout the contract they had capital P, capital C Completion and in a couple of places they had lower case practical, lower case completion. The Court said oh they must mean different things because if you meant it to mean the same thing you would have defined it. So the basic tip is just check your definitions, check that you've got defined terms and used them all, you know it's a quick check to do. There's another case where the table of the KPIs had been missed out, but the example table of the KPI saying this is how everyone expects them to work was there and the Court said well we might miss that in the main table, well let's use the example table well. Again if only the table was in there in the first place, they wouldn't have even had the dispute. So yeah these are things that are within our control. I mean there's many cases where it's out of people's control if something's gone wrong you know. The E.ON case, we can discuss lessons but it's out of the contractors control when something like that happens. But making sure the definitions are there, making sure the KPI tables are there are things that are in our control and I think that's probably a key contribution we can all make.

Michael: Good old basic stuff really. What's not basic of course is consequential loss, I remember having cold sweats when that came up at my lectures. Any developments there?

David: Yes so we I think with the case law over the last 20 years, we have come to a settled view, that when we refer to consequential loss in a contract and most importantly exclude it, is that what we're excluding is indirect loss and that is the second limb of Hadley and Baxendale loss which is quite remote, a party is not going to be liable for unless there is special knowledge. NEI Power Projects and British Sugar was the 1990s case that settled that. Consequential loss isn't loss arising as a consequence, it's just indirect loss. We've just had a recent case which was a shipping case, where there was an exclusion clause and wrapped up in the exclusion clause was a reference to excluding all consequential loss. There was a debate about whether the exclusion clause should be read narrowly so that it only excluded indirect loss or should be read more broadly. Now anyone watching this will be thinking well it should be the narrow definition, but actually when you read the particular clause it set out a series of exclusions of which the consequential loss was a sort of final one. And when you read the couple of sentences all together you can see that all together they meant that clauses 1 and 2, this sets out a caps and controls on liabilities, limits on the liquidated damages and all that. Then the sweeper clause was making clear that you are not liable for anything else. So therefore the Court in that case said you know what we need to read consequential loss a bit broader So it's a real reminder to us all that although the principles are quite clear, how you use the words and how you build your reliability clauses is really crucial. Which takes you back to the Wood and Capita, you know what do the words actually say? How do they all stick together? What you are creating is really important.

Michael: Moving away from contract words itself and more into contractual practice. I see that the Government is trying a bit of nudge politics and in this at the moment whereby many companies are going to have to disclose their payment practices. Can you tell us a bit about that?

David: Yes, so it's been a long form for 15, 15 years we've had late payment legislation that are meant to try and encourage people to pay when they said they were going to pay and to pay quicker and it hasn't worked. And it's a difficult issue should businesses not be free to contract on whatever terms they want to, while the small business lobby says well hang on were the small guys at the end of the supply chain, we'll get done by this.

The Government has been urged to legislate to force everyone to pay quicker and obviously that caused lots of concern so they've come up with this different approach which is they are not going to force you to do anything other than report on 0 to 30, 30 to 60, 60 to 90. What proportion of your debts do you pay in that time and allow the world out there to make their own decisions about the kind of companies they are. So as you say to nudge right behaviours, use power reputation. Look company X always pays more than 90 days but company Y in the same sector pays in 30 days. Why is there a difference and they are about to become a PR issue. Some might just call it nudge politics others might say the Government is abdicating its responsibility and leaving it to the sort of press to determine what's appropriate. For all of us though, for any in-house lawyer what this creates is a bit more admin, primarily finance admin, but no doubt you as in-house lawyers will be asked to check and make sure the systems are right, so more compliance unfortunately.

Michael: David capital D Lowe capital L, thank you very much.

David: Thank you.