When does a contract, either verbal or written, become legally binding?

By February 24, 2017news

The law of contract can be complex. In the recent court case, MacInnes v Gross (2017), the court held that an agreement made over dinner was not legally binding. However, the judge also stated that a legally enforceable contract could come into existence over a discussion. So exactly what are the criteria that make a contract legally binding?

Contract Formation – Intention to Establish Legal Relations

To form a legally enforceable agreement (a legal contract) there must be:

  • An intention to create legal relations.
  • Certainty of terms.
  • “Consideration” for the promise is usually an exchange of money for goods or services.
  • During the offer and acceptance, the parties must intend to be legally bound.

If any of the above are missing the contract cannot be enforced in law.

In MacInnes v Gross (2017) the Claimant (M) sought a Court order for payment of E 13.5 Million.

The key meeting had taken place between the two businessmen over dinner in a restaurant.  M said it was agreed at the meeting he would leave his employment with an investment bank and provide services to the Defendant Gross (G) with the aim of maximising G’s return on the sale of his business.  M also said he would receive a payment sum calculated by reference to the amount of the difference between the actual sale price of the business and the target price.

The following day M e-mailed G saying what he considered to be their agreement, which he said was “on headline terms”.

After nine months, when a possible sale of the G’s business began to materialise, M emailed saying they needed to make a “proper contract”.

The Court dismissed the claim.  It said although a legally enforceable contract could come into existence over a discussion, the informality of the setting (evening dinner) required a careful examination of whether the parties had an intention to create legal relations.

The Claimant’s use of “on headline terms” was a strong indication at that point in time there was no such intention.  It indicated that the preparation of a more formal written contract was anticipated.

Comment from John Cato

Often parties will produce pre-contract documents which they assume are not enforceable.  These include Letters of Intent, Memorandum of Understanding, Heads of Agreement and Heads of Terms.  These documents are frequently used when negotiating commercial transactions such as outsourcing arrangements, mergers and acquisitions, joint ventures and project financing.

The parties commonly believe the heading of the document gives rise to such significant doubt about their intention to create legal relations, that they are not enforceable.

This is not always quite so straightforward.  For instance a “letter of intent” might mean:

  • I perhaps intend to do somethings; or
  • I do intend to do it.

All of these pre-contract documents may be subject to the Court’s interpretation, and there is no absolute rule that documents described as above are framework documents and cannot be contractual, particularly if the documents are signed by the parties.

Solicitors often use the expression “subject to contract” to rebut any contractual intention.  These words do create a strong presumption the parties do not want to be bound, but whether they are effective to deny the party’s intention to create legal relations is a question of fact for the Court.

Parties also use phrases such as “subject to shareholder approval” which are ambiguous in a Court of Law.  It may indicate the parties do not intend to have a binding obligation until that happens, or, depending on the form of words used and subsequent performance, it may indicate a legally binding contract which is subject to a condition.

In the event of a claim, the Courts will always assess the parties’ words and their conduct in the whole factual matrix to decide if a contract has been formed, so the phrase is not fool proof.

I would always advise parties to make the position completely clear and spell out their intention expressly.

I will often mark the document “Subject to Contract” but will also include a clause like: –

           These [heads of terms] are not intended to be legally binding between the parties.

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