We're agreed for now

When negotiations are finished and firms reach an agreement adding the words subject to contract will prevent it from becoming legally binding, writes Daniel Atkinson.

WHEN companies want to do business with each other they invariably have discussions and, if things go well, sign a contract.

As with any other deal there is often intense negotiation and an element of compromise on either side so that the contract records an agreement that is something short of what each party was hoping for.

Occasionally the companies will record their agreement but will not wish it to be legally binding. Various devices can be used to achieve this but the magic words "subject to contract" are often used. The effectiveness of those words depends upon the circumstances.

If there is a contract and disputes arise, then one of the parties will usually wish to use the pre-contract discussions to explain the meaning of the contract.

Whether this is allowed again depends upon the nature of the discussions.

Both these points cropped up in a recent court case of Rugby Group v ProForce Recruit.

Since 1997 Rugby had used employment agency ProForce to supply temporary workers at its various cement works.

In July 2001 ProForce and Rugby signed a document that provided that the agreement was to be for a two-year period and that during that period ProForce would hold preferred supplier status. The document included the term "subject to contract" When in November 2001 Rugby went to another company to provide its additional personnel requirements ProForce protested, claiming that Rugby was in breach of the agreement.

ProForce said that the words "preferred supplier status" meant that during the two year period Rugby was obliged to offer ProForce the opportunity to supply contract labour and hire equipment in preference to other suppliers.

This meant that Rugby was not allowed to engage other suppliers of contract labour and hire equipment without first having offered ProForce a reasonable opportunity of meeting Rugby's requirements.

To support its case ProForce referred to discussions that led to the agreement.

Rugby argued that the words "subject to contract" meant that the agreement was not an enforceable contract and therefore ProForce's claim must fail. Rugby also said that the words "preferred supplier status" only meant that if it had a list of preferred suppliers, ProForce would be on that list.

As for the discussions ProForce referred to, Rugby argued these could not be relied on because they were part of the pre-contractual negotiations.

The judge, Mr Justice Field, decided that except in a very strong and exceptional case, the effect of the words "subject to contract" in an agreement prevented a contract still to be performed from coming into existence.

The words were to be taken to mean that until a further contract has been executed neither party was to owe the other any contractual obligation.

But in this case after the agreement was signed the parties did those very things that the agreement contemplated each should do for the benefit of the other.

The judge said that in this case the parties had entered into an implied contract on the terms of the agreement - and that contract was binding.

Having established that Judge Field then considered whether or not the precontract discussions were relevant to understanding the contract. That meant looking at the agreement in relation to the 'matrix of fact' surrounding it. He would not try to probe the real intentions of the parties but to look objectively at the meaning of the contractual language in its proper context.

Since it is only the final document that records the agreement, the pre-contract negotiations do not count as part of this matrix of fact. Neither do the parties' subjective declarations of intent.

Apart from these exceptions the matrix of fact includes absolutely everything that would have affected the way in which the language of the document would have been understood by a reasonable man.

But as the pre-contract discussions ProForce was quoting all constituted negotiation, they were not part of the matrix of fact and so they were irrelevant.

As for the words "ProForce will hold preferred supplier status" in the agreement, the judge agreed that this simply meant that if Rugby chose to operate a system of contracting only with preferred suppliers, ProForce would be treated as being one of those preferred suppliers. The words did not mean that Rugby was obliged to contract only with ProForce during the term of the agreement.

At the time the agreement was signed Rugby was considering introducing a preferred supplier system over the ensuing two years but, as it happened, Rugby did not adopt a preferred supplier system during the contractual term.

Instead it looked to a number of suppliers of labour that did not have the status of preferred supplier to satisfy its requirements. And in acting this way Rugby was not in breach of the agreement. So Judge Field threw out ProForce's claim and gave judgment in favour of Rugby.

The decision illustrates that in law as in any other walk of life, you cannot have your cake and eat it. And it emphasises the importance of clearly setting out the agreement of the parties and particularly whether, when and how an agreement will have legal effect.

Key points

Except in exceptional cases, the effect of the words "subject to contract" in an agreement prevent a contract still to be performed from coming into existence

In the event of a dispute, one of the parties is likely to want to use the pre-contract discussions to explain the meaning of the contract. The relevance of these discussions will depend on the circumstances surrounding them

The exact meaning of terms such as 'preferred supplier' need to be carefully defined and understood by both parties.