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Beware! Informal negotiations can create binding agreements
It is a widely held misconception that the term “contract” only refers to a fully executed document containing detailed terms of an agreement.
However this is not always the case and in certain circumstances informal negotiations can create binding agreements.
In today’s fast paced and technology driven world it is commonplace for parties to engage in pre-contractual and informal negotiations (often via email) and prior to entering into a formal and written agreement. It is important to know what they have written is a binding contract, even if it is said emails (for instance) are “subject to contract” or “in principle terms“.
It is useful to go back to some basic principles. At common law there are four elements required to form a contract:
- Offer and acceptance.
- An intention to create legal relations.
- Sufficient certainty of terms.
This article will deal with element number three, the parties intention to create legal relations. The analysis of this element of contract formation involves the application of an objective test.
Masters v Cameron and beyond
In Masters v Cameron  HCA 72; (1954) 91 CLR 353 (Masters Case), the High Court of Australia considered whether an agreement signed by a vendor and purchaser with respect to land constituted a binding and legal contract. The agreement contained words to the following effect:
“This agreement is made subject to the preparation of a formal contract of sale & which shall be acceptable to my solicitors on the above terms and conditions.”
A deposit was paid but no subsequent contract of sale was entered into and the purchaser failed to complete. The vendor sued the purchaser arguing that the agreement was binding. The purchaser argued that the relevant clause contemplated the signing of a formal agreement and until that had occurred there was no binding contract.
Ultimately the High Court agreed with the purchaser and held that a binding contract had not been created by the parties. In reaching its decision in the Masters Case, the High Court held that signed “contracts” can be one of three types:
- the parties have reached finality in arranging all the terms of their bargain and intend to be immediately bound to the performance of those terms, but at the same time propose to have the terms restated in a form which will be fuller or more precise but not different in effect;
- the parties have completely agreed upon all the terms of their bargain and intend no departure from or addition to that which their agreed terms express or imply, but nevertheless have made performance of one or more of the terms conditional upon the execution of a formal document; or
- the intention of the parties is not to make a concluded bargain at all, unless and until they execute a formal contract.
According to the High Court’s analysis in the Masters Case the first two categories create a legally binding agreement. The third category, does not.
The existence of a possible fourth category has received some judicial scrutiny over the years. Most notably, McLelland J of the New South Wales Court of Appeal in the decision of Baulkham Hills Private Hospital Pty Ltd v G R Securities Pty Ltd and Others (1986) 40 NSWLR 622 commented as follows:
“…There is in reality a fourth class of case additional to the three mentioned in Masters v Cameron, as recognised by Knox CJ, Rich J and Dixon J, in Sinclair, Scott & Co v Naughton (1929) 43 CLR 310 at 317, namely, …”one in which the parties were content to be bound immediately and exclusively by the terms which they had agreed upon whilst expecting to make a further contract in substitution for the first contract, containing, by consent, additional terms…”
Despite the comments made by the Court of Appeal in the Baulkham Hills Case regarding the existence of so called fourth category, the Court of Appeal did not adopt the classification of this category as a “fourth category.” Instead, the Court of Appeal held that:
“…the decisive issue is always the intention of the parties which must be objectively ascertained from the terms of the document when read in the light of the surrounding circumstances…”
The putative fourth category has proved controversial over the years. Arguably, as the fourth category has yet to considered by our High Court, it cannot be considered as settled law but commetators have said that is not important. The question remains one of intention.
Recent case law
In the recent decision of Vantage Systems Pty Ltd v Priolo Corporation Pty Ltd  WASCA 21 (the Vantage Case) the Court of Appeal of Western Australia had to consider whether preliminary agreements between a landlord and a tenant were binding, despite the fact that no formal documents had been executed.
The tenant, Vantage Systems Pty Ltd (Vantage) leased commercial premises in West Perth from the landlord, Priolo Corporation Pty Ltd (Priolo) pursuant to a lease dated 6 August 2003 (the original lease). The original lease expired on 30 June 2006 and Vantage exercised its option to renew as provided in the original lease for a further term of three years commencing on 1 July 2006 and expiring on 30 June 2009.
The original lease contained a holding over provision which provided that if Vantage remained in possession of the leased premises after the expiry of the original lease, Vantage would be a monthly tenant. This tenancy could be terminated by either party giving one month’s written notice to the other.
In May 2009 and prior to the expiry date of the original lease there were discussions between the parties concerning the possibility of entering into a new lease of the premises upon expiry of the original lease. Following those discussions, Priolo emailed Vantage a proposal for a new lease and amendments were then negotiated via several email exchanges. Vantage asked Priolo to prepare lease documents for execution by the parties even though some minor terms had not yet been agreed upon. Ultimately, Vantage did not sign the lease documents and sought to terminate its tenancy.
The original decision
On 18 October 2013 in the District Court of Western Australia, judgment was entered in favour of Priolo on its claim against Vantage for breach of agreement to lease. Vantage was ordered to pay damages to Priolo in the sum of $271,117.26 together with interest on those damages and the costs of the District Court proceedings.
The Court of Appeal’s decision
The critical issue before the Court of Appeal was whether Priolo as landlord and Vantage as tenant made a concluded and binding agreement to lease in respect of the leased premises for a term of three years commencing on 1 July 2009.
The Court of Appeal dismissed the appeal and found that the parties agreed to be bound immediately by an agreement to lease when Vantage accepted Priolo’s proposal for the new lease. The Court of Appeal made this decision despite the fact that certain clauses in the lease remained in contention and no formal lease was ever executed. The Court of Appeal held, inter alia:
“…It is irrelevant that the revised proposal was not executed or signed by or on behalf of Vantage. A concluded and binding agreement was formed upon Vantage accepting the revised proposal and [the emails] of 10 June 2009 together constituted a contract and, also, an instrument that was capable of rectification…”
Take care when negotiating terms of an agreement.
Remember that a court may find that a binding contract has been made despite the fact that no formal document has been executed.
To avoid being bound when negotiating the terms of an agreement, the following practices should be adopted:
- Think carefully about the intended effect of each piece of writing.
- Consider whether you are committing to be bound by the agreement or whether further negotiation is intended. If further negotiation is intended, make that clear in the exchange.
- If you do not wish to be bound, insert words to the following effect in each email containing negotiations as to terms: “I do not intend there to be any binding agreement between us until a formal contract is is proposed and signed, even if we have agreed any of the commercial elements of the deal.”
- Remember that the use of the words “subject to contract” may not be enough to persuade the court that a binding agreement has not been reached.
For further information, please contact ERA Legal.
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