Commercial Contracts- A Guide


22 Apr
22Apr

Introduction

If you're running a business, big or small, you will inevitably get involved in commercial contracts.

Not everyone is aware of the law of contract, however familiar they may be with the sort of terms and conditions (T&Cs) to expect to see in their own business field.

A supplier of pet food will not have the same T&Cs as a chiropodist but, the basic law relating to how their contracts are formed and whether they can enforce them, are broadly the same whatever the trade or industry.

This blog offers general guidance on English contract law (but is not legal advice), and on some its familiar terminology and idiosyncrasies. 

It also debunks some of the myths surrounding commercial contracting. Whenever in doubt, we recommend getting legal advice from a specialist lawyer.

Plus, there is a wide range of business and commercial contract templates ready to download and use on our sister platform LawDocs4All.com, with explanations and guidance on how to use them.


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A valid contract requires the presence of three essential requirements:

  • An agreement created by an offer and an acceptance;
  • An intention to create legal relations: this is an intention to form a legally binding relationship, and;
  • Consideration: i.e. payment in money or in kind.

Contracts do not have to be in writing to be legally enforceable, with one important exception: a contract for the sale (or other disposition) of land or property must be in writing and contain all the terms agreed, otherwise it is not enforceable.


Offer

Whether an offer is capable of being accepted as part of the formation process of a legal is not always clear.

Sometimes, a communication, like an advert, is nothing more than an inducement to look at or consider a product, service or some goods, prior to deciding on whether to buy. These types of communication amount to what is known in the legal trade as an 'invitation to treat' and are not offers which, when taken up, result in a contract.

Offers in respect of business contracts (i.e. those between traders or service providers), to be capable of a resulting in binding and valid acceptance, need to be clear, state as clearly as possible what is being offered and on what terms.

If a communication about a 'deal' is succeeded by a negotiation on matters such as price, delivery, quantity, quality etc., then it is very unlikely a contract will come into being until all those matters have been finally hammered out.


Acceptance

An offer must be accepted by the person receiving it (offeree) for a contract to be made and for an acceptance to be valid it must:

Be communicated to the person making the offer (offeror)- so it's no good if the acceptance is given or sent to a third party rather than the offeror or to an intermediary who is not authorised to receive the acceptance on behalf of the offeror;

Must precisely match the terms of the offer- so if a new condition is added or a term that has been offered is removed or qualified by the offeror in the acceptance communication, that becomes a counter-offer and does not result in a contract. A counter-offer can be accepted by the original offeror or a new round of offers started;

Be in respect of terms that are certain- so if any of the terms in the deal are unclear or ambiguous there is a significant risk that a contract will not be formed. For example, if the payment terms are not clearly spelled out or if the delivery conditions for goods are not included, a contract may well fail to be formed.

If there is no acceptance that meets these necessary criteria, then there will be no contract, leaving the parties unable to enforce their rights against one another. Whether a legal contract is actually formed can ultimately be determined by the courts looking at the all the relevant facts.

An offer can be withdrawn by the offeror at any time before it is accepted and a contract then cannot be formed. The withdrawal notice does need to reach the other party for it to be effective.


Intention

In commercial contracts, there is what is known as a 'rebuttable presumption' that there is legal intent between traders and businesses. The presumption can be overturned if it can be shown from their inter-actions that the traders actually had no such intention.

A party claiming that there is no legally binding contract must to prove this and the required standard of proof is "a balance of probabilities".

In a dispute over whether there was legal intent, the court will need to look at the objective conduct of the parties along with the relevant circumstances. It can also consider the parties' behaviour after it is alleged that a legally binding contract was created to decide whether or not it is legally binding.


'Binding'

Contracts and their terms are frequently referred as being, or not being, 'binding'.

We enter into legally binding contracts every day. Buying food in a supermarket shop is a legally binding contract between the consumer and supermarket. Purchasing a piece of software or hardware for a business creates a binding agreement with the supplier.

What does 'binding' mean?

It means that a valid contract has been created or entered into between two or more parties- see this page on how contracts are formed- and that they are 'bound' by its terms to perform their respective obligations under it.

Perversely, it is possible for some terms of a contract to be binding and others not so. This can happen if a term is shown to be excessively onerous or illegal, for example requiring a party to perform an illegal act.

Just because a particular term or clause is held not to be binding, it does not necessarily mean the whole agreement in which it appears then falls down, provided that the remainder is not so completely undermined by the non-binding elements that its rendered incapable of being performed.

Commercial contracts will often include a provision that if a clause becomes non-binding for any reason (i.e. because of a subsequent change in the law), the rest of the agreement will nevertheless continue to stand.


'Consideration'

As long as the other elements are present, for a contract to be formed there must be a 'consideration' paid by the offeree to the offeror.

Consideration usually takes the form of paying a price in exchange for goods or services. It can also be a promise to do (or not to do) something.

As long as it is treated as having value as between the parties, consideration can be almost anything.

In barter deals, consideration is the exchange of an item or commodity in return for the thing that has has been offered.

Consideration must be ‘sufficient’ and adequate; however, it does not have to be of market value. It cannot be illegal (i.e. stolen goods or the proceeds of crime) and it must be given by the offeree and cannot be given by a third party.


Terms and Conditions

The T&Cs, as they are often referred to, warrant an entire help desk of their own, but the basics are highlighted here.

Commercial contracts come in all shapes and sizes and cover a huge range of deals and situations, too numerous to cover. The purpose of this section is therefore to highlight their key components - what the average commercial manager would expect to find in the draft he is sent for his approval.

'Contract' and 'Agreement' are synonymous and there's no practical distinction between them.

'Heads of Terms', 'Memorandum of Understanding (MoU)' 'Term Sheet' and other similar names are frequently used to mean documents that outline, sometimes in very sketchy and at other times in quite a lot of, detail the essentials of what the parties are trying to agree. Unless expressly stated to be binding, these types of document are essentially a pre-cursor to more detailed negotiations and do not give rise to legally binding commitments.


Express Terms

These are terms that are written down in the contract documents and form the largest part of any commercial deal.

Contracts usually have a main body containing the fundamental elements of the agreement i.e. Parties : Start Date or Commencement Date : Recitals (statements of fact leading to the agreement) : Definitions : Substantive Terms (contract subject matter, price, delivery, quantities, service levels, KPIs, payment terms, default provisions, termination, etc.).

Further information on express terms can be found on our LawDocs4All.com site which contains numerous individual business templates and template collections that are ready-made for business use.


Implied Terms

Implied terms are those that are not written into a contract but which have, in commercial contracts, become part of the agreement through fact, law or custom or a combination of these.

Sometimes, time being of the essence may be implied into a commercial agreement (see below).

It is best to try avoid having implied terms because they can catch out a party who was less aware of the term and finds itself being held to a term that is not in black and white.

For this reason, many commercial contracts expressly exclude any implied terms in order to create certainty and a level playing field.

It is usually not possible to exclude the operation of statute law from a contract.


Contract Schedules

When there are a number of things to be agreed about the performance of the contract and that would clutter up the main body, it is not unusual for agreements to include schedules which have the nitty gritty, such as details and specifications of products or services, customer lists, intellectual property, delivery and payment schedules etc.

It is vital that schedules are expressly stated to be included as forming part of the agreement, otherwise there could be a risk that one of the parties says they were merely illustrative and that it was not bound by them.


Pre-Contract Statements

Statements made in writing (and this includes entire documentsorally by one of more of the eventual parties to a contract, before it has been finalised, can become binding terms. Mere representations are not actionable as breaches of contract if it turns out they were untrue.

What distinguishes a representation from a contractual term is essentially the intention of the parties. If this is in dispute, the decision is likely to have to be made by a court or via some form of alternative dispute resolution process, such as mediation.

Actions, words and behaviour can imply an intention to make a statement a term of the contract, as opposed to mere thoughts which won't, so it is the former that will be tested.

If a reasonable bystander would honestly believe that the intention of the parties was to make a statement a term of the contract this will satisfy the test of intention.

The risk of unintentionally incorporating a pre-contract statement as a term can be eliminated by some careful drafting to ensure that the agreement reached is clear that only the words included in it are terms and binding and that any other statements are excluded.


Representations

Before parties finalise a contract, it is very common for there to be discussions, sometimes lasting for days or even months. These can be conducted across the boardroom table, online by email, by phone and informally in the bar or a combination of all of them.

As noted above, care needs to be taken not to accidentally allow comments and statements made during negotiations to become contested on whether they form a term of the final contract.

Three concepts will be considered when a court is deciding whether a statement is a term of the contract or a mere representation.

The importance of the statement

The reliance on the statement by all parties involved, and

The relative knowledge of the parties.

If it is clear that a particular statement is treated by the parties a definitive term of the contract then the courts will determine it as such. If a party can show that it has unquestionably and reasonably relied on the statement in entering into the contract, it is likely to be treated as a binding term. The statement is more likely to be treated as a term if the party who is in the best position to know its purpose considers it to be a term.

Other than drafting the agreement in a way that excludes all pre-contract discussions to ensure they do not become terms, it is always worth considering stating in writing at their outset that all negotiations are 'subject to contract'.


'Subject to Contract'

Most often these three words appear in house sale deals, but they also have a significant role to play in commercial deal making as well.

What do they mean?

To mark a document or correspondence 'subject to contract' puts the parties to negotiations (and their advisers and other third parties) on notice that a binding contract has not been formed and that preliminaries are still being discussed.

When included, the phrase will prevent documents, letters, email etc on which it appears being accepted by a party as forming a binding agreement.

For example, it is possible (and this frequently happens in commercial negotiations) that a draft of an agreement or even a letter contains all the elements of the deal and could be accepted in its entirety by a party thereby creating a binding agreement. If the three words 'subject to contract' are included this cannot happen.

There are cases of businesses being caught out by the omission of the words.


'Without Prejudice'

This is a term much mentioned but seldom understood.

Where and how to use 'without prejudice' is perhaps more common when discussing dispute resolution, but it has a place in commercial negotiations as well.

The legal definition of “Without prejudice” is that it is without abandonment of a claim, privilege, or right, and without implying an admission of liability.

When it's used in a document or a letter, 'without prejudice' means that what follows (in the document etc):

Cannot be used as evidence in a court case

Cannot be taken as the signatory’s last word on the subject matter, and

Cannot be used as a precedent.

It is therefore very useful to enable parties to talk freely and this usually helps when negotiating a settlement of a contentious or difficult commercial deal that may contain sensitive information, such as the terms of a settlement agreement.

It is important to realise that merely labelling a document “without prejudice” will not afford a document protection if the communication does not form part of a genuine attempt to settle an issue or dispute.

All communications that contain a sensitive concession or an admission must be clearly marked ‘without prejudice’, whether they are made in a letter, e-mail or document, and any discussions (including by telephone or online) or any meetings held on the subject matter requiring protection, must be formally agreed to be 'without prejudice' before they are held.


Breach of Contract- the practical stuff

The words 'you're in breach of contract' can strike fear into anyone.

What is a 'breach of contract'?

A validly binding contract will contain terms as to its performance by the parties. These are contractual obligations that are required to be performed.

Each contracting party has the legal right to expect and to demand that the other party or parties who have committed to perform those obligations in its favour do so correctly and in accordance with the provisions laid out in the agreement.

A number of conditions may be specified in the contract as to the actions required by a party to fulfil the performance of its obligations.

For example, in a building contract, the builder will have to to construct a building in accordance with the detailed specifications set out as to quantities, structural integrity, shape and finishes and within a set period of time. A breach of contract will occur if the builder fails to deliver the finished building on time or without a secure roof on it.

In simpler contracts, obligations may only amount to payment of a price of goods. It would be a breach of contract if the payment is made late or in the wrong amount.

In general, a breach of contract will give rise to remedies in favour of the party who is owed the obligation- the developer (in the case of the builder) and the seller (in the case of goods).

The remedies that are open to the innocent party can vary and include the following:

Voluntary correction by the party in breach of contract- the best solution and likely the most costs-effective too

Exercise of specific rights set out in the contract by the wronged party- this might be applying interest to a ate payment until the full price is settled

Claiming 'liquidated damages'- this can only happen where the contract contains a specific provision setting out how much the damages will be for a breach e.g. delays in completion or delivery

Calling on a contract security- this could be under a guarantee or an on-demand bond (see above)

Serving a notice of default on the party in breach terminating the contract with immediate effect or on a specific amount of notice- this might also include a demand for damages to be paid for the breach

Alternative dispute resolution- this might include arbitration if that is expressly provided for or a mediation

Court proceedings to recover the losses and damages suffered as a result of the breach- this is likely to be the last resort in view of the costs and administrative headaches that bringing legal proceedings involves.


Breach of contract- the legal stuff

This is where matters can become complicated because of the way English law has developed. It's beyond the scope of this Help Desk to go into all areas in great detail, so we include the basics here and direct you to places where more information and guidance can be found.

In the end, the best outcome may be to get legal advice to sort out the contractual issues.

A breach of contract has potential consequences- both for the innocent non-breaching party- and also (for the lack of a better expression) the guilty party who is in breach.

What those consequences might be depends broadly on the following factors:

What the contract itself says happens if there is a breach (see above on the practical stuff), and

What common law remedies are available (this is the developed law of the land)

Dealing with the what common law remedies are available is what this section covers.

If the breach is of a minor or less important provision (what is known as a 'warranty') i.e. one that is not critical to the performance of the contract, then the innocent party can only claim damages that directly result from the breach and the contract as a whole remains in place.

The level of damages is assessed by the courts in the context of the claim as a whole, while having regard to other terms of the contract. The general rule is that the damages awarded are to place the innocent party in the same position had the contract been performed according to the its terms.

A claim for more than nominal damages will be subject to the rules of remoteness, mitigation and penalties. That means that damages that are found to be 'too remote' from the breach cannot be claimed. Remoteness is assessed on the facts of the case. See below on mitigation and penalties.

If the breach is of a major or more important provision (what is known as a 'condition') the remedies are rather different.

The innocent party has the right to terminate the contract and claim damages from the guilty party. In that situation, the contract does not actually cease to exist. Instead, upon the innocent party electing to treat his own obligations as at an end because of the breach of condition, the primary obligation of the guilty party to perform his side of the contract is replaced by a secondary obligation to pay damages to the innocent party for the loss arising from the breach.

Deciding whether a term of a contract is a condition, warranty or some intermediate term, can be difficult.

The courts have regard to the express terms of a contract and if the parties have identified a term as a condition or warranty, the courts will generally treat it as such. Where things are less clear cut, the courts usually call them intermediate and take account of the surrounding circumstances to work out if the breach is sufficiently serious to justify termination.

A word of warning: treating a breach as one of a condition (as opposed to a warranty) and terminating the contract, can land the otherwise innocent party in trouble.

If it is found that the provision breached was not a condition, the innocent party can instead become the one in default, and liable for a wrongful termination. If in doubt seek legal advice before reaching for the pen and paper to claim termination and damages for breach of a condition.

Terminating Contracts Under English Law- Ashurst


Mitigation

This is a word that tends to get bandied about quite a bit nowadays: 'in mitigation, he felled the forward in the penalty box because he got pushed from behind'. We know the pundit is trying to excuse the defence player's action in giving away a needless penalty.

What does it mean in the context of a commercial contract?

An injured party cannot recover damages for any loss (whether caused by a breach of contract or breach of duty) which could have been avoided by taking reasonable steps. The claimant is said to have a "duty to mitigate".

However, this is not a duty enforceable by anyone, rather it is a recognition that if the claimant fails to do so its damages recovery will be affected by that failure.

The English common law imposes a duty on an innocent party to a contract who has suffered loss as a result of a breach to take reasonable steps to minimise that loss. What are reasonable steps is generally a question of fact.

The burden of proof is on the guilty party to prove that the innocent party has failed to mitigate the loss suffered.

In a commercial context, if a buyer defaults on payment for goods ordered, the seller cannot simply assume that he, she or it can sue for the value of the contract.

Generally, the seller will be expected to attempt to sell the goods to an alternative buyer for a reasonable price. If the seller recovers some, but all of the original price, then the buyer can be pursued for the balance.

Mitigation will have happened and the seller ought to succeed on the balance claim.

If in doubt seek legal advice .


Penalties

Many commercial contracts include specified sums to be paid to the innocent if a provision is breached.

This type pf provision is generally enforceable by the innocent party, but only if it is a reasonable pre-estimate of the losses actually suffered for that particular breach.

The common law will not enforce what amounts to a penalty, it will only grant damages for breach that replaces that which has been lost as a direct result of it happening. A penalty is where the innocent party would be receiving more than is reasonable to compensate for the severity and actually quantifiable value of the losses shown to arise directly from the breach itself.

In other words, the innocent party is not going to be rewarded by extra compensation above and beyond what is regarded as provable losses. By the same token, the guilty party is not being penalised for the breach and is only required to make good the losses caused by the breach and no more.

The application of interest to the principal losses awarded to an innocent is not generally regarded as pushing the award of damages into the realms of a being a penalty.


Liquidated Damages

What are they?

Liquidated damages is a term used for a provision in a contract that specifies an amount to be paid by one party (defaulting party) to another party (innocent party) if there is a breach of a contractual term by the defaulting party.

The sum to be paid for the breach must be fixed in advance and written into the contract if it is to be enforceable.

The nature of the breach must also be clearly spelled out.

This remedy is not transferable. So, it is not possible, for example, to validly claim liquidated damages for the non-delivery of some goods, when they are expressed to be payable if there is a delay in the schedule of works.

Typically, construction contracts contain a clause that allow 'liquidated damages' to be charged to the contractor by the developer/owner if the contractor is late in completing the works.

The mechanism for making the liquidated damages charge may vary, depending on the type of contract and include:

Claiming as a cash sum to be paid by the defaulting party

Deducting them from other amounts due to be paid to the defaulting party

Claiming them from a surety, such as guarantor

Calling an on-demand bond

It should be noted that liquidated damages can become unenforceable if they are in effect a penalty, rather than a genuine pre-estimate of loss.

The courts usually apply four basic tests to decide if a contractual provision is a penalty:

  1. If the sum provided for is "extravagant and unconscionable compared to the greatest level of loss that could conceivably be shown to result from the breach”.
  2. If the breach consists solely of the non-payment of money and the liquidate damages stipulate a larger sum be paid.
  3. A clause will be presumed to be a penalty if the same sum is payable for a number of breaches of varying degrees of seriousness.
  4. A clause will not be treated as a penalty solely because it is impossible to estimate in advance the true loss likely to be suffered.

For more information on liquidated damages this article by law firm Ashurst provides further insights.


'Time of the Essence'

It is not uncommon to say in an email to a supplier (probably marked URGENT) that 'time is of the essence' in order to give them the hurry-up.

What does the phrase mean in legal terms?

Saying it just in an email does not do much more than tell your supplier that you need the order expedited, but with no legal consequences.

In order for it to have some legal 'bite' on the supplier, the phrase needs to be written into a contract.

It then means that the timing or deadline for delivery or performance by the supplier in that contract becomes a condition (see above), which entitles you to terminate it, even if the deadline is missed by the supplier by a small margin.

If the phrase is not specifically used in the contract, it is probable that time is not going to be of the essence as a condition (unless it's implied- see below) and therefore you may not be entitled to terminate if the date for delivery/performance is missed.

Using phrases such as ‘as soon as possible’ and ‘within a reasonable time’ are not going to make time of the essence on their own.

An intention of the parties to make time of the essence may be implied into commercial contracts, when it is not written into the documentation.

Whether or not there is an implication, depends on the nature of the deal, the circumstances and the contract wording. The key question to be decided is; “must the parties have intended that even a slight default or delay should give rise to a right to terminate the contract?”

Examples of where a 'time of the essence' condition may be implied, include:

  • A buyer transferring completion monies late for a property may entitle the seller to terminate the sale contract and keep the deposit.
  • Contracts for the delivery of perishable vegetables, fruit, meat and fish because their late delivery may render them unsaleable.
  • Completion of the sale of a business as a going concern, where it's vital the buyer takes ownership by a certain date and time in order to continue trading.

Time is not likely to be implied as being of the essence when:

  • There's no fixed date for performance.
  • There's mechanism to extend time built into the contract, perhaps also with liquidated damages (see above) applying to delays.
  • Interest is charged on late payments which might tend to indicate that time was not of the essence for payment.

For your business legal documents please go to LawDocs4All.com where you will find templates for a wide range of contracts and related documents, with guide notes to help you use them.


What is the structure & content of a commercial contract?- redirect to our blog

 

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Note: This publication does not necessarily deal with every important topic nor cover every aspect of the topics with which it deals. It is not designed to provide legal or other advice. The information contained on this page is intended to be for informational purposes and general interest only.


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