ABE Principles of Business Law 2008-1

Contract Law 1: Fundamentals and Creation 105

Contracts of guarantee must, by the Law Reform (Enforcement of Contracts) Act 1954, still be either in writing or evidenced by it. A contract of guarantee is one whereby one person agrees to "answer for the debt, default or miscarriage of another person" – e.g. A promises that if B does not pay the debt, he will. These must be distinguished from contracts of "indemnity", where a party promises to prevent loss falling on another from the results of a transaction into which he has entered at the request of the person who promises the indemnity. A contract of indemnity does not have to be evidenced by writing.

Classification of Contracts

There are two classes of contract – contracts under seal (or specialty contracts) and simple contracts.

(a)Contracts under Seal

These form an overriding exception to the rule that, unless a contract is required by statute to be in writing or evidenced by it, it is equally valid if merely oral. Contracts under seal were, originally, those of a more important nature, and the formalities required of "signing, sealing, and delivering" were designed to impress on people the solemnity of the transaction. Nowadays, these formalities have largely disappeared, but such a contract should still contain the words "signed, sealed and delivered ", and it is usual (but not necessary) to impress on it a red adhesive wafer in place of the seal.

Contracts under seal, usually called "deeds" – technically "specialties" – can be used for any contracts but they must be used for:

Contracts where there is no "consideration" – e.g. a gift is legally enforceable only if it is given under seal;

Conveyances of land;

Leases of over three years.

The limitation period for taking action in respect of contracts under seal is 12 years (Limitation Act 1939) – that is, the law will not enforce a contract unless an aggrieved party takes action within a certain time after any cause of action arises. This is called "the limitation period".

(b)Simple Contracts

These are all other contracts, whether in writing or parol (i.e. verbal). The limitation period for simple contracts is six years.

Contracts "Uberrimae Fidei"

Contracts "uberrimae fidei" (of the utmost good faith) are those in which it is essential that there is a complete and honest exchange of information of all material facts between the parties. The best examples of such contracts are those relating to insurance. Here, the insurer must be supplied with all the material facts by the insured party before he/she accepts the risk.

Other examples of such contracts are those relating to title in contracts for the sale of land (as regards title only), contracts to subscribe for shares in companies, contracts of family arrangement, and contracts made between persons who have previously entered into contracts of suretyship and partnership.

If full disclosure of the facts is not made, the other party has the right to rescind the contract, and damages may be claimed for any negligent misstatements.

The case of Woolcott v. Sun Alliance & London Insurance Ltd (1978) illustrates the principle of uberrimae fidei in insurance contracts.

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106 Contract Law 1: Fundamentals and Creation

The claimant, Mr Woolcott, who had a conviction for robbery, was in September 1972 granted an advance of £12,000 by the Bristol and West Building Society, to whom the defendant insurers had issued a block policy of fire insurance. No question was asked by the building society about Mr Woolcott's moral character.

The advance having been granted, the names of the society and claimant as mortgagee and mortgagor, respectively, were noted in separate record sheets which, as between the building society and the insurers, were declared to be incorporated in, and to form part of, the policy. A fire occurred on 16 August 1974, as a result of which the property was destroyed. The defendant insurers satisfied the building society's claim of £12,000, the amount of their interest as mortgagees, but refused to meet Mr Woolcott's claim on the ground that he had not disclosed either to the insurers or to the society material facts known to him, namely his previous convictions.

The court accepted the evidence of the underwriters called to give evidence, that the

"criminal record of an assured can affect the moral hazard which insurers have to assess".

On the duty to disclose, the court relied strongly on the judgment of J MacKenna in Lambert v. Co-operative Insurance Society Ltd (1976), where the learned judge said:

"Everyone agrees that the assured is under a duty of disclosure and that the duty is the same when he is applying for a renewal as it is when he is applying for the original policy .... There are, at least in theory, four possible rules or tests which I shall state. One, the duty is to disclose such facts only as the particular assured believes to be material. Two, it is to disclose such facts as a reasonable man would believe to be material. Three, it is to disclose such facts as the particular insurer believe to be material. Four, it is to disclose such facts as a reasonable or prudent insurer would have treated as material."

The court held that the proper test in the case was the fourth test: the claimant had a duty to disclose his criminal record, and that duty was not affected by the absence of a proposal form.

In St Paul Fire and Marine Insurance Co. (UK) Ltd v. McConnell Dowell Constructors Ltd (1996), the defendant company were building contractors and had entered into a contract for the construction of new Parliament buildings for the Marshall Islands, a group of islands in the Pacific Ocean. The claimants were their underwriters who were providing construction works insurance for the project. The insurance risk had been accepted by the underwriters on the defendant's assurance that the buildings would have piled foundations: in the event, and without notifying the claimants, the defendant used spread foundations, which were shallower and less expensive than piled foundations. The buildings accordingly sustained subsidence damage in the course of their construction.

The claimants sought a declaration from the court that they were entitled to avoid the insurance policy because of material misrepresentation and non-disclosure.

HELD: The declaration sought by the claimants would be granted. The type of foundation constituted a material consideration by any prudent insurer in estimating risk, and on the evidence the claimants would not have effected insurance cover on the same terms if they had been notified of the change in the type of foundation. The court stated:

"... there is no general obligation upon a contracting party to disclose even material facts to the other party (provided the non-disclosure does not make any positive representations misleading) whereas contracts of insurance, being of the utmost good faith, ... do give rise to such duty ...."

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Contract Law 1: Fundamentals and Creation 107

B. THE AGREEMENT

As we have seen, in order to have a contract there must be an agreement, a "consensus ad idem" – there must be an offer, and an acceptance. However simple or however complicated the contract may be, this rule is invariable. For example, at one end of the scale you may say: "I will sell you this book for £1". The other person replies: "OK". Offer has been followed by acceptance – hence there is a contract. At the other end of the scale, a civil engineering contractor may submit tender documents for the construction of a dam for £200 million. After months of negotiation, all the details will finally be accepted. Once again, an offer has been made and accepted. A contract exists.

As you can imagine, a number of rules have grown up to regulate and decide on whether a valid offer or acceptance has been made.

The Offer

An offer is an expression by one person (the "offeror") that he/she is willing to contract with another (the "offeree") on specified terms. If it is to form the basis of a contract, the offeror must intend that legal consequences shall result.

An offer can be made to one or more specified people, or it can be general, made to "the world at large". It can take a number of forms – as follows.

An offer made to a specified person, either verbally or in writing. This is straightforward.

An offer made to the "world at large". This is where a person announces that he/she will do so and so, if anyone who cares to accept will do what is required by the offer.

For example, a person puts an advertisement in the newspaper: "£5 reward will be given to anyone who returns my lost dog, Fido". That is a valid offer to anybody who finds Fido, and duly returns him.

If the offer is in the form of a promise by the offeror to do or pay something in return for some act by the offeree, then the performance of the required act is in itself an indication of acceptance of the offer. The famous case which illustrates this principle is

Carlill v. Carbolic Smoke Ball Co. (1893).

The company manufactured a patent "smoke ball" which, it claimed, prevented influenza. It advertised in the press that it would pay £100 to anyone who contracted influenza after taking one of its smoke balls. Mrs Carlill read the advertisement, bought a smoke ball from the chemist, and used it as directed. However, she promptly got influenza, and she sued the company for the promised sum of £100. The company claimed that it was a "mere puff", and not meant to be taken seriously.

HELD: The promise to pay £100 was a valid offer to the world at large. Mrs Carlill had accepted by complying with the conditions, and was entitled to the money.

Of course, only one person can return a dog; the smoke ball situation is different.

An offer can be inferred from conduct. This type of offer is very frequent in everyday life. For example, if you board a bus, you are offering to pay the fare if it takes you to your destination. Or if you go into the newsagent, pick up a copy of a paper and hold out the correct money, you are offering to buy the newspaper for the price printed on it.

However, even in more complicated transactions, an offer can also be inferred from conduct. Three cases illustrate this.

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Contract Law 1: Fundamentals and Creation 109

or cashier constitutes an offer to buy (at the named price, unless otherwise stated in the offer). Ringing up the price on the till, for example, constitutes acceptance.

In Spencer v. Harding (1870), it was held that "an invitation to tender is not, normally, an offer, unless accompanied by words indicating that the highest or lowest tender will be accepted".

However, in Blackpool & Fylde Aero Club Ltd v. Blackpool Borough Council (1990) it was held that an invitation to tender could constitute an offer to consider the merits of the tender – along with any other tenders. This was accepted by anyone who submitted a tender on time. Thus the council could be sued for refusing to consider a tender even though it had been submitted by the specified date.

At an auction, a bid constitutes an offer. As with other offers, this can be withdrawn at any time before the fall of the hammer, which constitutes acceptance (Sale of Goods Act 1979, Section 57(2)).

Despite the phenomenal growth in trade over the Internet and other modes of commercial dealing, it is a sad reflection on the current law that it appears to be unable to keep abreast of these developments. The area of e-commerce continues to be beset with the usual problem of deciding upon which elements of the transaction made on a website constitutes the "offer" (possibly an unilateral one),and which the "invitation to treat".

Despite the intervention of statute (The Electronic Communication Act ,2000) and European Directives on the issue (Electronic Commerce [EC Directive] Regulations, 2002), it still remains a contentious issue, although the received wisdom is that such a website display constitutes merely an invitation to treat. Such a view is supported by the problems recently experienced by Argos Stores who, by mistake, displayed on their websites TV sets worth £300 on sale for just £3. The issue, however, was settled by reference to the principles of mistake (see Unit 6), which were brought to bear to decide the issue in Argos’s favour.

Communication of Offer

In order to be effective, an offer must be communicated to the offeree – or, at least, he/she must know about it. This is not quite as obvious as it sounds, because, if a person does something in ignorance of the offer, he/she can neither reap the benefit nor be bound by any obligations. To revert to our example concerning "offers to the world at large", if Fido had had his owner's address on his collar, and the finder returned the dog without knowing about the offer of a reward, he/she would not be entitled to it.

The motive for accepting is not relevant but the offeree must be aware of the offer. In Williams v. Carwardine (1833), a reward was offered for information leading to the arrest of a murderer. P knew about the reward but she gave the information "to ease her conscience". It was held that she was entitled to the reward.

Perhaps an odd result of the rule that an offer must be communicated is that two identical cross-offers, each made in ignorance of the other, do not constitute a contract. In Tinn v. Hoffmann & Co. (1873), both parties independently wrote to the other on the same day – one offering to buy, and the other to sell, 800 tons of iron at £695 a ton. The letters crossed in the post, and both were in ignorance of the other. Notwithstanding that there was an obvious intention to contract for the same thing at the same price, it was held that no contract resulted.

Termination of Offer

An offer, once made, does not remain open for acceptance indefinitely. It can terminate for a number of reasons and, once terminated, it is no longer capable of being accepted. An offer terminates in four ways:

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Contract Law 1: Fundamentals and Creation 111

Ramsgate Victoria Hotel Co. v. Montefiori (1866)

On 8 June, D offered to buy shares in the company. No answer was received until 23 November, when the shares were allotted to him. D refused to accept them.

HELD: The offer had lapsed during the delay, so Mr Montefiori was not bound to accept the shares.

On the Death of either Party before Acceptance

The death of the offeree always terminates an offer. His/her personal representative cannot accept on his/her behalf. There is some doubt as to whether an offer can be accepted if the offeree is not aware of the death of the offeror. One view states that the death of the offeror automatically terminates the offer, and that knowledge of it is immaterial. The better view is, probably, that it is terminated only if the offeree is aware of the fact, unless the personality of the offeror is an essential ingredient of the matter.

Acceptance

The cardinal rule to remember is that the acceptance of an offer must be absolute and unqualified. Offer and acceptance must correspond in every particular.

If a purported acceptance alters or qualifies the offer in any way, it constitutes a rejection of the offer, followed by a counter-offer. The counter-offer is then open to acceptance or rejection in the same way as the original offer.

Hyde v. Wrench (1840)

A offered to sell a farm for £1,000. B said he would pay £950, which A refused. B then agreed to pay £1,000. A then refused this.

HELD: The original offer having been refused, B's purported acceptance to pay £1,000 amounted to a counter-offer, which was validly rejected by A.

We can see from this case that alteration not only constitutes a rejection followed by a counter-offer but that it also serves to destroy the original offer.

If an offer is made in alternative terms, the acceptance must make it quite clear which alternative is being accepted.

Peter Lind & Co. Ltd v. Mersey Docks and Harbour Board (1972)

The company submitted a tender for the construction of a freight terminal (the tender was the offer). This tender quoted alternative methods of pricing, either "fixed cost" or "cost plus" price. The board accepted the tender but did not specify which price it was accepting.

HELD: No valid contract came into existence. (It is interesting to note that, even as recently as 1972, two very large organisations could make such a nonsense of a multimillion pound project!)

If an offer is accepted but the acceptance introduces additional terms not contained in the offer, this also constitutes a rejection (Jones v. Daniel (1894)).

An acceptance does not have to be express – it can be inferred from conduct. An offer to buy goods is accepted by supplying them (Harvey v. Johnson (1848)).

As in the case of an offer, an acceptance must be communicated to the offeror, otherwise it is not effective.

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Contract Law 1: Fundamentals and Creation 113

HELD: As the nephew had not signified his acceptance, no contract for the sale of the horse to F arose. Bindley was not, therefore, liable for conversion (conversion is dealing wrongfully with the goods of another).

Tenders

This topic has to be specially considered regarding acceptance of an offer. Suppose a local authority invites tenders for the supply of specified goods to be delivered over a given period. A trader puts in a tender showing that he/she is prepared to supply at a given price; this is clearly an offer. But there may be difficulty in deciding whether subsequent action by the corporation is an acceptance. There are two possibilities, depending on the wording of the corporation's original invitation.

If the corporation states that it requires a specified quantity of the goods during a particular period, then, on "acceptance" of the tender, the trader is bound to deliver.

If the corporation advertises that it may require specified goods up to a maximum amount, deliveries to be made if and when required, the effect of acceptance is quite different. The trader has made a standing offer. There is no acceptance by the corporation in the legal sense: this will only take place when a requisition for a definite quantity of goods is made. Each requisition by the offeree, i.e. the corporation, is a separate act of acceptance which creates a separate contract (Percival Ltd v. LCC (1918)).

Incomplete Agreement

It sometimes happens that the parties to a contract will agree in principle only, leaving many details unresolved, or they will agree only certain things, or omit other necessary matters. These are called "incomplete agreements".

In extreme cases, the court will hold the whole contract void for uncertainty. However, it is reluctant to do this, and it will uphold a contract if at all possible. For example, in Perry v. Suffields Ltd (1916), the only detail agreed in a contract for the sale of a public house was the price of £7,000. Such vital matters as the date for completion and the deposit were omitted. The court upheld the sale, as it was the manifest intention of the parties that the sale should go ahead.

Such incomplete agreements tend (though this is by no means invariable) to fall into a number of categories. The three common ones are:

Stipulations for the Execution of a Formal Document

Agreement may be reached, often verbally, and the parties then state that a formal contract will be drawn up. It is a question of construction of the agreement as a whole as to whether the initial agreement constituted the actual contract, and the formal document was intended to be merely spelling it out, or whether the execution of the formal document was intended to be a condition precedent to the validity of the contract (Von Hatzfeldt-Wildenburg v. Alexander (1912), Bianca v. Cobarro (1947) and Chillingworth v. Esche (1924)).

The words on the document "subject to contract" always imply that the paper in question is not intended to be a contractual document.

Letters of Intent

Again, it is a question of construction as to whether a "letter of intent" is the contractual agreement or whether it is merely an expression of pious hope, with no contractual force.

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Terms "to Be Agreed"

It is an important principle of law that you cannot "make a contract to make a contract". Sometimes, the parties are unwilling to agree all the terms beforehand, and at other times it is actually impossible so to do. So, terms are left open "to be agreed later". That is one instance of a "contract to make a contract".

The problem, of course, is what happens if, when the time comes, you don't agree! If a mechanism for resolving such a dispute is included, all is well – e.g. by arbitration, or a price equated to the Retail Price Index, or whatever; but if there is no such mechanism agreed, the court will have difficulty. It will be reluctant, as we have seen, to declare the whole contract void for uncertainty. If, however, the term left open for "future agreement" is fundamental to the whole contract, it will have no option. If it is an ancillary term, only the particular provision may be struck out, and the rest of the contract will be upheld; or the court may imply a customary trade or reasonable solution. We can look at three examples.

Smith v. Morgan (1971)

A contract for sale of land gave the purchasers a first option to purchase adjacent land at a price to be agreed.

HELD: The vendor was bound to offer the land at the price at which he was prepared to sell.

Foley v. Classique Coaches Ltd (1934)

P owned a petrol filling station and also the adjoining land. He sold the land to D, who owned and ran coaches, on the condition that they would buy petrol exclusively from him. The agreement stated that the price of the petrol would be "agreed from time to time". D broke the agreement.

HELD: That, in default of agreement, a reasonable price must be paid.

Hillas & Co. Ltd v. Arcos Ltd (1932)

P agreed to buy timber from D, at a price equated to the "official price list". The agreement contained an option for P to buy further timber next year – but no price was mentioned.

HELD: Because of the previous dealings between the parties, and the original reference to the "official price list", the option was not void for uncertainty, and the price should be ascertained in the light of the normal practice in the timber trade.

Certainty of Terms

The terms of a contract must be reasonably certain. If they are too vague, the whole contract may, again, be void for uncertainty. For instance, in G Scammell & Nephew Ltd v. Ouston (1941), an agreement to buy goods "on hire purchase" was held to be void, as there were so many different kinds of hire purchase agreement that it was impossible to ascertain the true intention of the parties.

However, as in Hillas & Co. Ltd v. Arcos Ltd (1932), the court will always do its best to ascertain the intention and uphold the contract.

Meaningless phrases can sometimes be ignored, or disregarded as "mere surplusage" (Nicolene Ltd v. Simmonds (1953)).

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