Authors' note: signposts, not analysis
Dear readers: we have kept this bulletin brief. Our aim is to signpost some developments, rather than analyse them. If any of you would like more detail – factual or legal –by all means contact us. Thanks to our colleagues, associates Ben Hughes and Isabelle Paton, for their comments on the draft of this bulletin. Andrew White with Esther Johnson, January 2014.
The impact of good faith cooperation clauses
Written good faith cooperation clauses in commercial agreements have been legally enforceable for a while (see for instance Berkeley Community Villages v Pullen (2007)). The issue is how they inter-relate with other clauses in a commercial arrangement. In Compass Group v Mid-Essex NHS Trust (March 2013), the Court of Appeal held that a 'good faith cooperation' clause in a long-term catering services agreement was in principle enforceable. But on a close interpretation of the clause, and the surrounding facts, it held that the customer was not in breach. More importantly, the Court warned that a written good faith clause should not be interpreted in a way which potentially cuts across other written provisions of a commercial contract, and any contractual safeguards which expressly apply.
Within weeks that message was heeded by the High Court in TSG v South Anglia Housing (2013), when a party's right to terminate a long-term building maintenance contract in accordance with its written terms was held not to be constrained by a "duty to cooperate" clause elsewhere in the contract. The parties had "freely negotiated" the termination arrangements, and the Court held that the general cooperation clause should not be applied in a way which cut across that termination regime. This lesson is relevant across all types of B2B agreements.
An implied term of 'honesty' in business-to-business agreements
By not being open to an implied term of 'good faith' in certain commercial contracts, English law is "swimming against the tide", said Mr Justice Leggatt in the February 2013 High Court decision of Yam Seng v ITC. The judge held that an implied term of good faith, in the sense of honesty, should be read into a 2½ year distribution agreement for branded fragrances and toiletries which had broken down. Such an implied term would "reflect the shared values and norms" of the parties, and would help to bring English law into closer alignment with other countries. But when should such a term be implied? The judge said: "in long-term contracts such as some joint ventures, franchise and distribution agreements". This is not an exhaustive list. By extension, we believe that the term could apply to other long-term agreements which are relationship-based, and require ongoing communication and cooperation between the parties. The impact of this is likely to be explored further in 2014. In October 2013 the High Court held (in Boots v Hamsard) that a short-term agreement for the supply of stock to a retailer by a supplier in acute financial difficulty was not a "relationship-based" agreement in which good faith could be implied.
'Good faith' and contractual discretion
It is well-established that a genuine discretion under a commercial contract must be exercised in "good faith" and not in a way that is "arbitrary", "capricious" or "irrational" (see the Court of Appeal in Socimer v Standard Bank 2008 - just one of a trail of decisions). The Court of Appeal took this principle for granted in another aspect of the Compass Group case mentioned above, though on the facts, the NHS Trust was held not to have abused its discretion. In the last five years there has been a flurry of cases demonstrating this principle, mainly in the finance sector. In 2014, we expect more such cases, including in non-financial contexts.
Contract interpretation: the continuing impact of the ICS rules
Interpreting a contract requires experience, intuition, knowledge of the facts and context, as well as awareness of key legal principles. The Supreme Court (then the House of Lords) distilled these principles in ICS v West Bromwich in 1997. Our research, using the main legal information databases, shows that since 1997, the ICS rules have been relied upon over 1,000 times in reported decisions. In 2013 this trend continued as the ICS rules were again cited many times as the courts' starting point for resolving interpretation disputes. ICS, combined with the Supreme Court decisions in Chartbrook v Persimmon(2009) and Rainy Sky v Kookmin Bank (2011), have extremely powerful influence. As at September 2013, the Rainy Sky case, on giving ambiguous clauses a "commercially sensible" interpretation, had itself been cited over 300 times in later court decisions.
Does leaving matters "to be agreed" make a contract unenforceable?
An obligation to deliver products can be legally enforceable even if significant aspects of the arrangement are "still to be agreed" by the parties. That was the conclusion of the Court of Appeal in February 2013 in MRI Trading v Erdenet. Why wasn't the obligation to deliver too "uncertain" and therefore an unenforceable "agreement to agree"? Because, in essence, the context of the obligation was a package of previously concluded contracts which were unquestionably binding and which the parties had performed. The Court of Appeal held that the parties' intention was to perform a series of delivery contracts and to utilise agreed contractual machinery to resolve matters still outstanding (ie "to be agreed"), rather than refusing to deliver on the grounds of uncertainty.
In this latest case, the Court of Appeal and the High Court each concluded that the expert arbitrators who had originally heard the case got the law "obviously wrong". Anyone who thinks that the law on contract formation is basic or predictable should read this case. It shows the vital importance of distinguishing the different legal principles which apply, on the one hand, to the pre-contract phase and, on the other hand, to concluded long-term arrangements. Many businesses are not yet drawing that distinction.
Contract abandonment, customer 'walkaway' and exclusion clauses
What's the consequence of abandoning an entire long-term contract mid-way through, in deliberate breach? It's well-established that the liability of the defaulting party can in principle be subject to a strong exclusion clause in its favour. It depends ultimately on contract interpretation. This issue has caused controversy: see the High Court decision of NetTV v MARHedge (2009), and the explicit criticism of that decision by another High Court judge in AstraZeneca v Albemarle (2011). In February 2013 this issue surfaced again, this time in the Court of Appeal in Kudos Catering v Manchester Central Convention Complex. In this instance the customer, which abandoned a 5-year exclusive catering deal with 20 months still to run, was held unable to rely on an exclusion clause in its favour in the face of a damages claim by the service provider. It wasn't for a reason of public policy but because the Court of Appeal interpreted the clause narrowly, in all the factual circumstances, so as not to apply to the customer's own refusal to perform the remainder of the contract. It's important to see the Kudos decision in the current economic climate. With many contracting parties looking to exit long-term arrangements early, the legal consequences of doing so will continue to be a major factor (though often not the key one) in their commercial calculations. Kudos is an illustration of what can happen; not a precedent for what will happen.
The law on penalties is steadily evolving: a milestone corporate case
In the last 10 years, the law on penalties and liquidated damages has steadily evolved. And the 2013 Court of Appeal decision in Talal El Makdessi v Cavendish Square has accelerated that trend. Cavendish have applied for permission to challenge the decision in the Supreme Court. And indeed the Court of Appeal decision may be reversed on the facts. But the legal principles which are being applied have unquestionably developed. Whatever the final outcome, this case is already a milestone.
It used to be necessary to show that a pre-payment clause for breach was a "genuine pre-estimate of loss" to be valid and enforceable as liquidated damages. Otherwise the payment was a penalty. Nowadays, however, the courts apply a "more modern approach". If the payment arrangement is "commercially justifiable", and its "dominant purpose" is not to deter breach by the other party, then the clause may be enforceable even if the clause is not shown to be a genuine pre-estimate of loss.
In the Talal El Makdessi case, the seller of a business stood to forfeit as much as $44m of the sale price of a media business in the Middle East, for having breached covenants post-completion restricting him from competing with the sold business. (The seller would also forego certain post-sale options). The High Court held that these mechanisms were valid and enforceable. But in November 2013 a unanimous Court of Appeal reversed that decision and held that the provisions were a penalty, and unenforceable by the purchaser. Firstly, the financial sum forfeited was "way beyond" the maximum damage that the purchaser could have recovered via a contract damages claim. But that was not the end of the matter. Taking issue with the High Court, the Court of Appeal held that the mechanism was not "commercially justified" and that its primary purpose was to deter breach. The clause therefore failed to satisfy either the old-established test for valid liquidated damages, or the more "modern" approach. Therefore it was legally unenforceable.
Corporate lawyers in particular should take note of this case. It would be a mistake to confine it to the specific facts, and clauses. Rather, it should be read as a vivid reminder that normal contractual principles apply even to fully negotiated payment arrangements in corporate transactions, entered into with the support of experienced firms of lawyers. There may be drafting solutions to reduce risk – indeed the Court of Appeal hints at this. But the biggest question is – on what basis should the English courts intervene in these types of disputes in the first place?
Non-reliance clauses and pre-contractual representations
Finally, a word on non-reliance clauses. These are the so-called "boilerplate" statements which providers of products, services and facilities often use to minimise the risk of being held liable to their clients or customers for pre-contract misrepresentation by their sales teams. An important 2010 High Court case called Henry Boot v FoodCo set out several reasons why such a non-reliance clause could in principle be considered reasonable under the Unfair Contract Terms Act 1977. In November 2013, in a case called Lloyd v Browning, the Court of Appeal endorsed the reasoning in Henry Boot. Of course, the enforceability of non-reliance clauses will ultimately depend on the facts and context. But this development provides important support to non-reliance clauses, generally speaking, in the B2B context.
Trend-spotting: the growing use of visual tools
An authoritative recent survey of international contracting trends by the IACCM (International Association of Commercial Contract Management – www.iaccm.com) has revealed that 62% of the 2000 businesses which responded expect an increased use of "visual techniques" in contracting. This is our "trend of the year". Contracts are global tools. And people think in ever-more visual terms. So visual techniques are an inevitable result. Of course, no amount of visual techniques should diminish the need for clarity and certainty in contract drafting. But we have a message for connoisseurs of flow-charts, mind-maps, colourful tables and obligation matrices to support contract negotiation and management. These are no longer fringe activities. The market trend shows that your moment has arrived…..!!