Recent Developments in the Law of Contract

This month we are considering a recent Supreme Court case and whether it affects the Law of Contract. The Law of Contract is covered in Unit 2 of ILSPA’s Legal Secretaries Diploma course, where the elements of what makes a legally binding agreement are considered. As with any area of law, there are continual developments which your regular reading of the Legal Secretaries Journal and News section of our Membership area should help you keep up to date with.

Formation of a contract

One of the first things every Student of Contract Law learns is what elements make up a legally binding agreement. You will have learnt about offer & acceptance, consideration, intention, capacity, correct form and the effect of illegality on a contract. The next case may appear surprising because not only was it heard in three different courts but it also dealt with a basic and fundamental contract question: “Have the parties entered into a contract?” The case was RTS Flexible Systems Ltd v Molkerei Alois Müller GmbH (2010). 

The facts: On one side was RTS, a British company that makes automated machinery for factory assembly lines. The other side was a German company that produces a range of dairy products, including the well-known Müller yoghurts and rice puddings. In January 2005 RTS won a tender for a £1.68 million project to supply Müller with new packaging machinery for its yoghurt pots. The machinery was needed urgently, so RTS started work developing the machinery before a formal written contract was signed. What the parties had agreed to was something called heads of terms which set out the broad ideas of how the parties would work together, but these heads were not in themselves an agreed contract. What was agreed was that RTS could start the work immediately and spend up to an agreed limit of cost. The heads of terms were to last one month and then be replaced with a finalised and signed contract.

When trying to finalise the contract, the parties were able to agree on nearly all the terms except for some important points such as what damages would be paid if the contract was breached (known as a liquidated damages clause). No final contract was signed and in place when the heads of terms came to an end one month into RTS starting work. When problems arose with the equipment and the parties fell into a dispute, the first question the High Court had to answer was whether there was a contract between the parties and if so, what terms applied. 

The High Court’s decision: The Court ruled that the parties were in a contract, but it did not accept that the terms of this agreement should be the ones contained in the nearly completed written contract. This contract was to be ignored because the parties had included a clause stating the agreement was “subject to contract”. The effect of this was that until the parties signed the agreement it would be considered that the parties had no intention (one of the legal elements of any contract) to enter into a legal relationship.

The Court of Appeal: RTS appealed this decision, as they were not happy with the possibility that Müller might not pay them fully for the work carried out. They were also concerned about what terms would apply. The Court of Appeal decided that in relation to the terms, these should be implied, so in effect the provisions of the Sales of Goods Act 1979 (as amended) would apply. The Court also confirmed that the principle of quantum meruit applied, which meant that as Müller had received something of value, they should pay RTS a reasonable sum for the services they had supplied. It was not necessary for a written contract to be in place for this rule to apply.

The Supreme Court: Just to demonstrate how difficult a ‘simple’ contract question such as “Is there a contract?” can become, Müller appealed the Court of Appeal decision to the Supreme Court, which decided that the nearly completed agreement was a legal contract! The Supreme Court decided that the existence of a ‘subject to contract’ clause was not enough to decide whether the parties had intended to enter into a legally binding relationship and factors such as what the ‘reasonably honest businessman’ would have thought about the relationship should be taken into account.

So far so confusing? This case does not change the law on intention and the formation of contract, but it does show how difficult it sometimes is to tell whether a contract has been formed and if so, on what terms. The basic rules about offer and acceptance, intention, and consideration you will have learnt on the Legal Secretaries Diploma course will still apply, but as is clear from this case, it is not always so easy to apply the legal principle in the real world!