“Subject to contract” agreements and Good Faith

On the issue of when a contract is formed in the case of “subject to contract” agreements, the leading Indian contract law textbook notes that what needs to be determined is, “… whether the formal document is of such a nature that it was the very condition of the contract or whether it was commemorative of the evidence on the point…” (Pollock & Mulla, 12th edn., page 213). While on the face of it the test might appear to be clear, applying this in particular facts can be a cumbersome exercise. Niranjan had previously discussed in detail the judgment of the UK supreme Court in RTS Flexible, on issues related to contract formation. The principles in that case have been discussed and applied in a judgment by the England & Wales High Court, in Benourad v. Compass Group. The law on the point as arising from that judgment may be summarized thus:
1. The fact that a draft contractual document contemplates that a party would obtain legal advice before signing, are indicative of the fact that the parties do not intend to be bound until the document is signed.
2. While parties may have intended at the initial stage that an oral agreement was not legally binding until a formal written document was executed, if “it can be objectively ascertained that the continuing intention of the parties changed“, then the requirement for a written document does not matter. The parties will be bound nonetheless.
3. Where the case is not of a “subject to contract” agreement, the fact that services have been performed is a particularly important factor in determining whether the contract has been formed. Where the agreement is “subject to contract”, the issue will turn on whether “all the essential or important terms” have been agreed. If they have, and if services are rendered, a Court is likely to find that there is a contract without the necessity for a formal written agreement.
4. Where certain terms of commercial/economic significance have not been agreed, the parties may be held to have agreed “to be bound now while deferring important matters to be agreed later“. The more important the un-agreed term, “the less likely it is that the parties will have left it for future decision
In this connection, a recent decision of the ICSID – Azpetrol International Holdings v. The Republic of Azerbaijan – may be interesting. Prof Andrew Newcombe has posted a note on the decision here; and he says:
“The question before the tribunal in Azpetrol was whether an exchange of emails between counsel for the parties resulted in a binding settlement agreement. Applying English contract law principles, the tribunal found that there was a binding settlement agreement. As a result, the tribunal held that it lacked jurisdiction under Article 25(1), ICSID Convention, because there was no longer a legal dispute between the parties. The award serves as a cautionary tale for counsel negotiating settlement agreements.” The decision is available here; and the relevant analysis of the Tribunal is found from page 24 (paragraph 67) onwards. The Tribunal noted:
“(The Tribunal) is not persuaded that the term “agreement in principle” is inevitably used in English law and in the practice of English lawyers to refer to a non-binding agreement. The Claimants did not produce any authority which went that far. The authorities on which they relied (Attorney-General of Hong Kong v. Humphreys Estate, [1987] AC 114; Cobbe v Yeoman Management Ltd., [2008] UKHL 55) show that the term can be used in that way but those cases concerned agreements for the sale of land, one of the rare cases in which English law provides that a contract must be evidenced in writing in order to be binding, and they do not suggest that the term is invariably used in that way. Similarly, the leading commentary (Chitty on Contracts) does not, in the Tribunal’s view, sustain the broad principle advanced by the Claimants.”
A connected issue in this regard pertains to pre-contractual liability in general. What liability arises in pre-contractual negotiations? Is there a duty in common law to negotiate in good faith? The Harvard Law Review recently published an article in this regard authored by Professors Alan Schwartz and Robert Scott – “Precontractual Liability and Preliminary Agreements“. in an extreme form, the contents of this duty might be expressed thus:
“A party who manifests a willingness to enter into a contract at given terms should not be able to freely retract from her manifestation. The opposing party, even if he did not manifest assent, and unless he rejected the terms, acquires an option to bind his counterpart to her representation or charge her with some liability in case she retracts…” (Omri Bin-Shahar, Contracts without Consent: Exploring a New Basis for Contractual Liability, 152 U. Penn. L. Rev 1829)
Common law is unlikely to recognise such a broad formulation of the duty. Indeed, since Routledge v. Grant (1828), it is settled law that a party is free to withdraw its offer, unless there is a consideration for the offer being kept open. Further, in Watford v. Miles [1992] 1 All ER 453, specifically, the House of Lords held that there could be no duty to negotiate in good faith for an undefined amount of time. This position is distinct from the position in many civil law countries – under civilian systems, offers cannot easily be revoked, unless they are made expressly subject to revocation. Civilian systems are, then, more likely to impose an obligation to conduct negotiations in good faith (this is covered within the civilian doctrine of ‘culpa in contrahendo’). The Convention on the International Sale of Goods (CISG) – born out of a compromise between common law and civil law systems – also recognizes such a ‘good faith’ obligation in Article 7. On the role of good faith in international sales transactions under the CISG, see John Klein, Good Faith in International Transactions.
Nonetheless, it may not be entirely true that common law refuses to recognise any good faith obligation whatsoever. For instance, an Australian case – Renard Constructions v. Minister for Public Works (1992) 26 NSWLR 234 – suggests that a duty to negotiate in good faith can be imposed on grounds of reasonableness. Restitutionary remedies may also arise. The England & Wales High Court noted on this point that restitutionary obligations are likely to be imposed where the defendant has received an “incontrovertible benefit” as a result of the plaintiff’s services; or where the defendant “has requested the claimant to provide services or accepted them (having the ability to refuse them) when offered…” For restitutionary claims to arise in this latter instance, the defendant must have acted with the knowledge that the services were not intended to be given freely. No restitutionary remedies will be possible if the plaintiff took a risk that he or she would only be reimbursed for his expenditure if there was a concluded contract.
Broadly, the Court appears to have taken a view that while the formation of a contract is to be ascertained objectively, the permissibility of a restitutionary remedy is to be ascertained subjectively. This appears to broadly fit into the common law understanding of the role of good faith as well.

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Mihir Naniwadekar

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