First principles of contract formation

Publication | March 2018

In business, there is great emphasis on building a network of contacts and developing those relationships. This often leads parties to discuss and negotiate potential deals and ventures in settings other than the boardroom. This article examines three cases that were heard in the course of 2017 that considered the basic principles of contract formation (and in particular the intention to create legal relations) in the context of informal discussions and meetings in social settings such as a restaurant or a public house.

Although oral contracts can be made, there is a risk associated with proceeding in this way and these cases highlight the uncertainty that can come with negotiating commercial contracts in informal surroundings, and of failing to evidence them in writing.

In summary, although these cases do not change the position under English law they nevertheless provide an important reminder of (i) the steps the courts will take when considering whether an oral contract has been formed, (ii) the challenges for a claimant in making such a claim and (iii) the practical steps parties should take to manage risks in circumstances where they may later need to rely on purported agreements concluded orally in an informal setting.

Elements of contract formation

A legally binding agreement requires the four elements of

  • Offer
  • Acceptance
  • Consideration and
  • Intention to create legal relations

In determining whether an agreement has been made, what its terms are and whether it is intended to be legally binding, English law applies an objective test. There are a number of important principles relating to the intention of the parties to create legal relations, in particular

  • Where there is an express agreement, in an ordinary commercial context, the burden of disproving an intention to create legal relations is a heavy one.
  • Where there is no express agreement, the party claiming that a binding agreement has been made has to prove the intention.
  • The degree, or lack, of precision in expressing the alleged agreement may be a relevant factor to the issue of contractual intention – the more vague and uncertain the alleged agreement is, the more likely the court will come to a conclusion that the parties did not reach any agreement at all.

The cases

MacInnes v Gross [2017] EWHC 46 (QB)

This case concerned a claim for €13.5 million pursuant to an oral contract alleged to have been made over dinner in a Mayfair restaurant on March 23, 2011. Mr MacInnes claimed that the parties agreed at dinner that the he would leave his employment with an investment bank and would personally provide services to the defendant with the purpose of maximising the defendant’s return on the sale of his business. In return, he would receive remuneration calculated by reference to a formula which gave him 15 per cent of the difference between the “strike” (or target) price of the business and the actual sale price. Following the dinner, Mr MacInnes said in an email to Mr Gross, that there was an agreement “on headline terms” but crucial elements relating to Mr MacInnes’ remuneration had not been set out.

The Court held that there was no intention to create legal relations and therefore on this (and other grounds) no binding contract had been made over dinner.

The fact that the key discussion took place over dinner did not, of itself, prevent the making of a legally binding contract. Coulson LJ noted that “a contract can be made anywhere, in any circumstances”, but the fact that the alleged agreement was made in a highly informal and relaxed setting meant that the court should look closely at the claim that, despite the setting, there was an intention to create legal relations.

The following factors were relevant to the judge’s decision

  • No agreement on the important issue as to the nature of Mr MacInnes’ remuneration: “the terms of the alleged contract were both too complex and too uncertain to be enforceable”.
  • No binding agreement as to the relevant parties or the relevant scope.
  • In this particular case, because the discussions took place in English, which was not the defendant’s first language, the Court noted that a “further note of caution” should be required when considering whether or not the discussion led to a binding agreement.
  • Neither party had told anyone else they had reached a binding agreement and the claimant had not produced any written contract or draft, an omission that the court regarded as critical. Its absence was the final reason for the court’s decision on this issue.

Blue v Ashley [2017] EWHC 1928 (Comm)

The question that was considered by the court in Blue v Ashley was whether, as a result of a conversation in the Horse & Groom public house in central London, a contract was formed between the claimant, Mr Blue, a financial consultant, and the defendant, Mr Ashley. Mr Blue claimed that such a contract had arisen and as a consequence of the subsequent rise in the Sports Direct share price, Mr Ashley owed Mr Blue a £15 million bonus.

The judge outlined eight main reasons for concluding that, objectively, there was no intention to make a contract

  • The meeting took place in the pub. Although a contract could theoretically be made in an informal setting, the judge said “an evening of drinking in a pub with three investment bankers is an unlikely setting in which to negotiate a contractual bonus arrangement with a consultant who was meeting them on behalf of the company”.
  • The purpose of the occasion was to secure the services and enthusiastic support of a potential new corporate broker for Sports Direct rather than to discuss an incentive for Mr Blue.
  • The nature and tone of the conversation was not serious but more akin to “banter”.
  • The lack of commercial sense for Mr Ashley to offer to pay Mr Blue £15 million as an incentive to do work aimed at increasing the Sports Direct share price.
  • The incongruity with Mr Blue’s role in that it would have been an “inherently absurd” and “fanciful” idea that Mr Blue alone could just “get” the share price to double.
  • The alleged offer was too vague for it to be seriously meant.
  • The perceptions of the three witnesses was that the offer was not a serious one.
  • Mr Blue probably did not perceive the agreement as serious as he did not think it necessary to make any written record and waited nearly a year before mentioning the agreement to Mr Ashley.

The Court concluded that no reasonable person would have thought the agreement was a serious one which intended to create a legally binding contract and no one who was actually present did in fact think so at the time.

Leggatt J commented at the end of his judgment: “They all thought it was a joke. The fact that Mr. Blue has since convinced himself that the offer was a serious one, and that a legally binding agreement was made, shows only that the human capacity for wishful thinking knows few bounds”.

Wright v Rowlands and another [2017] EWHC 2478 (Comm)

The case of Wright v Rowland, in which judgment was handed down in October 2017, also concerned a financial consultant claiming breach of an oral agreement although this time the setting for the alleged agreement was a rather more glamorous setting than a public house – a yacht.

Mr Wright provided consultancy services to various Rowland family businesses. He alleged that in 2008, he was responsible for the introduction of the Rowlands to the former Chairman of Kaupthing Luxembourg (the distressed Luxembourg arm of the collapsed Icelandic banking group, Kaupthing Bank), and that he then worked as a senior member of their deal team to negotiate, structure and close an acquisition of the bank. The transaction involved the demerger of Kaupthing Luxembourg into a private bank called Banque Havilland S.A. (BH).

It was contended by Mr Wright that at a party on July 20, 2009 on board the Rowlands’ yacht in the south of France, an oral agreement was reached between himself and the Rowlands that (amongst other things) granted him an option to purchase up to five per cent of the shares in BH for the same proportionate price that the Rowlands had paid to acquire the entire issued share capital of BH, i.e. €50 million. The Rowlands subsequently denied that they had made any such agreement with him.

The Court rejected the claim that money was due on the basis of an oral contract because there was no evidence of the parties’ intention to create legal relations, as well as a lack of certainty in relation to certain other fundamental terms which militated against the existence of a binding contract.

Mr Christopher Butcher QC, sitting as a High Court judge, said he was “entirely unpersuaded that there was any commitment” given by the Rowlands to Mr Wright on the yacht and had “Mr Rowland said what Mr Wright alleges or something approximating to it, with a firm commitment on a series of points, I consider that it would have been documented. Had such words been spoken, I consider that it is likely that Mr Wright would have put them in an email, or at least to have made a contemporaneous note”.

Conclusion

These decisions highlight (i) the dangers of informality in contractual dealings especially when the subject matter is of considerable value to one of the parties and (ii) reaffirms the objective test to be applied when looking at whether there is an intention to create legal relations.

It is clear from these cases that the courts will not lightly infer the existence of a contract unless they can conclude with confidence that the parties intended to create legal relations.

Practically speaking, without a written agreement, there is a heavy burden of proof on the party seeking to assert the existence of a contractual relationship. Parties should ensure that they have a written document/contract (or at the very least a contemporaneous note of the discussions) to accurately reflect the parties’ positions to avoid disputes arising later.


Contacts

Nadia Evans

Nadia Evans

London