Subject to Contract

In the recent case of Farrar v Rylatt, the Court of Appeal upheld the High Court’s decision that there was no binding profit share agreement in circumstances where the relevant clauses were part of a document that specifically stated that it was ‘subject to contract’.

Background

The case dealt with two different agreements concerning two different developments. It was argued that, in relation to the first development, there was an oral agreement for a profit share in place, but based on the evidence before it, the Court held that there was simply no oral agreement.

The more interesting point is in relation to the second development. It was argued that there was an agreement for a profit share in place in relation to the second development contained in a Heads of Terms document. The Heads of Terms specifically stated that they were ‘subject to contract and without prejudice’. They also provided that the defendants entered into a joint venture partnership with the first claimant, involving a 50-50 split of the proceeds. This is of course a fairly common scenario in property development.

The Court made clear that the usual effect of the words ‘subject to contract’ is that they mean that the document is not a binding agreement. There are rare circumstances where the parties’ course of dealings could back-up the existence of a binding agreement in a document labelled ‘subject to contract’. However, this would mean that the parties would have to fully adhere to the clauses contained in the ‘subject to contract’ document (by making payments that complied with the terms for example) where no other binding agreement was subsequently executed.

The Court also made it clear that where ‘subject to contract’ is set out on the front of a document, that phrase applies to all the terms contained within it. The only way that this could be avoided is if the specific clause itself made clear that it was meant to be binding on the parties, regardless of what was said on its face.

Why should I take notice?

This case raises the importance of understanding the effect of the words ‘subject to contract’. In particular, parties to a proposed contract need to be clear on when they should be used to protect a party’s negotiating position. Often, parties use the term in negotiations without understanding its implications.

Contract formation – A health warning

It is important to quickly consider what makes a legally binding agreement before going any further.

You will usually have a binding contract with these ingredients:

1. Offer & Acceptance
2. Consideration
3. Intention to create legal relations

These points are separate areas of law with hundreds of cases discussing their interpretation and meaning. It is always fact specific as to whether these apply. For the purposes of this article, if parties to a prospective contract agree on a project, the price is essentially agreed and money moves between them, it is generally clear that they intend to do business together. This means that and a contract can be in place, even without the final documentation recording everything being signed by the parties, especially if works start before pen is put to paper.

When to use ‘subject to contract’

Commonly, ‘subject to contract’ is used in the context of Heads of Terms agreements, like those detailed in the Farrar v Rylatt case above. Heads of Terms are a set of principles set out in a written agreement that usually set the tone of the contract negotiations and end up in the ultimate, formal, signed contract. They are often referred to as the road map to the final contract and then end up being legally binding by their inclusion in the final document.

Whether or not a Heads of Terms document is legally binding or not depends on the intention of the parties and how it is read (or constructed). In order to avoid the Heads of Terms being binding on the parties from the outset, they are often labelled ‘subject to contract’. This is important to ensure that neither party is bound by key commercial terms until the parties enter into a completely negotiated formal contract.

However, just including the wording ‘subject to contract’ on the Heads of Terms is not necessarily a guarantee that a court would determine it is not binding on the parties. Each case will turn on its own facts. It is advisable to specifically state in the Heads of Terms what is to be legally binding and what is not, rather than just relying on the statement ‘subject to contract’ being placed on the front of it.

Conclusion

Although the protection offered by using ‘subject to contract’ appears to be quite comprehensive, care still needs to be taken during the negotiation process. Due to commercial realities, projects can start long before an agreement is actually finalised and this can lead to uncertainty as to what terms of the agreement are binding on the parties and what terms are not. This is especially the case if works have started and the relationship breaks down before an agreement is concluded. Obviously, it is always better to have a signed written contract in place recording all terms agreed as soon as possible. This way, even if there is a disagreement later down the line, any ‘subject to contract’ documents will be irrelevant. Nonetheless, using ‘subject to contract’ is still best practice and its effectiveness is demonstrated in Farrar v Rylatt: just don’t expect it to always provide a get out of jail free card, as there may already be an enforceable contract in place.

Article submitted by Mark James, Partner in the Real Estate group at Coffin Mew.

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