NEC3
Formality & Contract Formation

© Daniel Atkinson 2008 03 February 2008

Construction Practice

The creation of a contract is a non-confrontational step.  The parties are free to agree how they will conduct and complete the joint enterprise which is the subject of the contract.

The freedom of contract extends to the procedure and manner in which the decision is taken for work to proceed. Many construction projects proceed with no formality and with little regard to the terms of the contract. The following are examples of common practices in the construction industry.

• Not infrequently the employer simply requests the contractor to carry out work and the contractor’s response is to immediately start on site. There is no discussion on terms of the contract and even on price for the work.
• On a small building project the builder may state a price for the building work and the owner requests him to proceed to do the work, with no discussion on the terms of contract or by a simple reference to a standard form of contract.
• More often the employer and contractor may exchange communications in writing setting out matters of specification, programme and payment. The terms of the contract will usually be by reference to a standard form with a list of amendments. A common procedure is for the employer to issue tender documents, followed frequently by amendments and clarification of matters raised by the bidders. The contractor completes the tender adding additional documentation which he submits as his bid for the work. The contractor may qualify his bid or suggest alternative design or programmes to the tender. Communications and meetings may follow seeking clarification and in some cases modification of the bid.  Frequently the decision to proceed is made in a meeting following discussion.
• During discussions on the main works the need for an early start to achieve completion may result in the contractor starting part of the work on site on a simple request or letter, even though discussions on the main works have not been completed. As discussions continue or difficulties arise in concluding the main contract, the contractor may be requested to carry out greater parts of the works. At each stage reference may be made to the intended main contract terms which are not concluded. The project may even be administered following the procedure in the referred unconcluded main contract terms.
• Subcontracts are a common feature of construction projects. It is common practice for the contractor to invite bids from subcontractors making reference to the main contract and his own conditions of contract or to a standard form with his own amendments. The invitation is usually a proforma which is required to be completed by the subcontractor. The subcontractor submits his bid often omitting to provide the information requested by the contractor and making reference to his own conditions of contract or another standard form. Contractors will often hold meetings with the subcontractor to clarify the bid and negotiate its terms. The contractor may then issue a subcontract order which may or may not record any agreement. Frequently the subcontractor will have commenced work on the project whilst discussions are still proceeding.

Each of the above examples of practice in the construction industry may cause difficulties. If the parties’ agreement is wholly oral or partly oral and partly in writing, then it may be difficult to establish the oral statements. It may be difficult to determine which of the many documents were intended to be part of the agreement.

In order to achieve commercial certainty good commercial management requires that there should be some formality which defines the formation of a contract and which allows the terms of the contract to be identified. The formality should be a procedure which reduces the terms of the contract wholly to writing. This is the best practice procedure which is evident from the standard forms of contract. Many standard forms of contract are drafted on the basis that any contract is to be wholly in writing and imply a manner in which a contract is to be made.

If the procedure for formation of contract stated or implied in a standard form is not followed, this does not mean that the terms of the standard form may not be the terms of the construction contract. For instance, in the case of a contract such as FIDIC which incorporates a Form of Agreement a contract can be made other than by the formal signing of the Form of Agreement. Depending on the facts the contract could be made by a sufficiently clear oral acceptance of an appropriate written proposal Ove Arup & Partners International Ltd v Mirant Asia-Pacific Construction (Hong Kong) Ltd [2003]CA [2004]1 BLR 49

In the examples above of the practice in the construction industry, the parties may simply refer to the standard form with the intention of incorporating its terms in any concluded contract.

If a procedure for formality is not followed, then it will be necessary to examine all the correspondence and the circumstances to determine whether or not a contract has been made and if so its terms.

The Legal Requirement for Formality

The requirement of formality may prevent a contract being formed. First, a particular formality may be required by law because of the the type of transaction or because of the status of one or both parties. Second, any or all the parties may make clear that unless a particular formality is adopted then no contract can be concluded.

There is no general rule in English Law that a contract should be made in a certain form. There are exceptions, which now all depend upon statutes which deal with specific types of contracts, particularly relating to transactions in land and for guarantees which require the formality of writing.

A construction contract will not usually involve a transaction in land. The contractor is simply granted a licence for the use of or possession of the site for the period of construction, and no lease or sale of land is involved. A construction contract therefore will not usually need to be in writing.

It is common in construction projects for the employer to require the contractor to procure a guarantee in the form of a bond in the employer’s favour for the contractor’s performance. Since the bond is often procured after formation of the main contract, the bond is not only required to be in writing but also in the form of a deed, since there will be no consideration for the bond.

A deed was formerly always a document executed under seal. Following the Law of Property (Miscellaneous Provisions) Act 1989 S1(1)(b) this no longer applies to deeds executed by individuals, for which a seal is no longer required. The formality required for a deed executed by an individual is that it is signed in the presence of a witness who attests the signature and that it is described or expressed to be executed as a deed. The formality required of a deed by a company is now found in S.36A of the Companies Act 1985, having been amended by S.130 of the Companies Act 1989. S.36A(3) allows for execution by two directors or a director and secretary and for the document to state it is a deed.

A deed extends the right of action on a contract from 6 years on a simple contract to 12 years from the date of the breach of contract.  As a matter of interpretation of a warranty deed the parties may intend and agree not to create an obligation which lasts longer than the underlying obligation it supported but rather, to create obligations and causes of action under the building contract together with collateral obligations and causes of action under the warranty deed, which crystallise simultaneously, and take effect by the same period of time Northern Shell plc v John Laing Construction Ltd [2003] EWCA Civ 1035.

Since the usual longer limitation period is perceived to be an advantage to an employer, many construction contracts are required by employers to be executed as a deed even though the formality is not required as a matter of law. In order to ensure that the construction contract is executed in the form of a deed, employer’s frequently include statements in tender documentation that unless and until agreement is made in the form and manner exhibited in an attached proforma, no contract can be concluded.

Even if the construction contract is not required to be in the form of a deed, the employer may specify that the procedure for formation of the contract shall only be by signature of a written agreement. The advantages of certainty leads many contractors to stipulate the requirement of the formality of writing, particularly where there are extensive negotiations and numerous technical documents and different versions of the proposed contract terms.

If a party is consistent in its requirement for formality before a construction contract can be concluded, then the failure to satisfy this requrement will prevent the formation of a contract even if all terms have been agreed.  A distinction is made between an executory contract in which work has not yet been carried out and an executed contract in which the work has been completed.  If the work has been commenced or carried out in accordance with the agreement, despite the absence of the required formality, then this may be evidence of a waiver of the formality and a contract may be implied on those terms.  Even then, if the parties continue to insist on formality in clear terms then no contract will have been concluded  The relevant authorities for this principle of law are as follows:

1. If a purported acceptance is expressed to be `subject to contract', or some other words are used which show that further negotiations or events are contemplated, there is no concluded contract Cranleigh Precision Engineering Ltd v Bryant [1965] 1 WLR 1293.
2. Even if the parties have reached agreement on all the terms of the proposed contract, nevertheless they may intend that the contract shall not become binding until some further condition has been fulfilled. That is the ordinary "subject to contract" case Pagnan SpA v Feed Products Ltd [1987]2 Lloyds Rep 601.

3. If the project is an important one and it was `commercially improbable' that the parties would commence the project without concluding a formal contract, then there may be a concluded contract despite the offer being expressed to be `subject to contract' Fraser Williams (Southern) Ltd -v- Prudential Holborn (1992).

4. Where a transaction has been performed on both sides, it will often be unrealistic to argue that there was no intention to enter into legal relations.  The term “the Contract will be executed as a deed under seal” is a requirement that unless the contrary was either expressly agreed between the parties or arose between them by necessary implication, any contract would have to be under seal. There was nothing to prevent the parties from agreeing to dispense with the requirement for a contract under seal. If both sides continue to refer to the preparation of or need for formal contract documents and there is no evidence of waiver of the formality then there is no concluded contract J. Jarvis & Sons plc v Galliard Homes Ltd [1999]CA.
5. In general, except in a very strong and exceptional case, the effect of the words “subject to contract” in an agreement prevents an executory contract from coming into existence.  The words are taken to mean that until a further contract has been executed neither party is to owe the other any contractual obligation. The agreement is not executory if the parties did those things that the agreement contemplated that each should do for the benefit of the other.  In that case the parties are taken to have entered into an implied binding contract on the terms of the agreement The Rugby Group Ltd v Proforce Recruit Ltd [2005] EWHC 70 (QB) overturned on appeal but not on this point.

Construction Industry Best Practice

The developed best practice of the construction industry can be seen in the manner in which the standard forms of contract define the term “contract” and assume the manner in which the contract will be formed. The best practice evidenced by the standard forms is first that the contract is reduced to writing, second that it is identified by reference to listed documents and lastly that the date of formation is marked by a signed agreement or by the exchange of documents, such as a letter of acceptance.

1. FIDIC Red Book 1^stEdition 1999 is published by the Federation Internationale des Ingenieurs-Conseils for use on building and engineering works designed by the Employer and intended to be for international application. The “Contract” is defined in terms of the Contract Agreement, the Letter of Acceptance, the Letter of Tender, the Conditions, the Specification, the Drawings, the Schedules and the further documents listed in the Contract Agreement or the Letter of Acceptance. The Contract Agreement is required to be executed within 28 days of the Contractor receiving the Letter of Acceptance. The Form anticipates that there may be no Letter of Acceptance but only a Contract Agreement and in that case defines “Letter of Acceptance” as the Contract Agreement and the date of receiving the Letter of Acceptance as the date of the Contract Agreement.
2. ICE 7^thEdition Measurement Version is published for and approved by the Institution of Civil Engineers, the Association of Consulting Engineers and the Civil Engineering Contractor’s Association and is used in connection with works of civil engineering construction. The term “Contract” is defined as the Conditions of Contract, Specification, Drawings, Bills of Quantities, the Form of Tender, the written acceptance of the Form of Tender and if it has been completed the Form of Agreement.  The Form of Agreement is annexed to the Conditions and the Contractor is required to execute the agreement if called upon to do so.
3. IChemE 4^thEdition 2001 Lump Sum (The Red Book) is published by the Institution of Chemical Engineers and is used for any process plant not only chemical processes. An Agreement is bound into the standard form and at Article 1 the term “Contract” is defined by a list of documents which include the Agreement. The Agreement is required to be dated and is required to be signed by the Parties.
4. JCT 2005 SBC/Q is published for the Joint Contracts Tribunal Limited and is used extensively in the UK building industry. An Agreement is bound into the standard form. The Agreement is required to be dated and is required to be signed by the Parties. The Contract Documents are defined in the Conditions as the Contract Drawings, the Contract Bills, the Agreement, the Conditions together with where applicable the Employer’s Requirements, the Contractor’s Proposals and the CDP Analysis. The Contract Particulars attached to the Agreement are required to be completed by the Employer
5. MF1 (Rev 4) 2000 Edition is published by for the Joint IMechE/IEE committee on Model Forms of General Conditions of Contract by the Institution of Electrical Engineers and is used for the supply and erection of electrical, electronic or mechanical plant.  The contract between the parties is defined in terms of a Tender and any agreed amendments or variations and a Letter of Acceptance from the Purchaser.

NEC3 ECC and ECS Contracts

The NEC third edition (“NEC3”) published Engineering Construction Contract (“ECC”) is a bound document comprising the following parts:

1. Schedule of Options;
2. Core Clauses;
3. Main Options A-F Clauses;
4. Dispute Resolution Options W1 and W2;
5. Secondary Options X1-7, X12-18, X20, Y(UK)2, Y(UK)3 and Z Clauses;
6. Schedule of Cost Components;
7. Shorter Schedule of Cost Components;
8. Contract Data part one and part two proforma.

There are also separate publications for each of the Main Options A-F which combine the Core Clauses (“CC”) and Main Option Clauses (“MO”) for that Main Option together with the other parts above.

The published Engineering Construction Subcontract (“ECS”) is a similar publication to the ECC, but there are no separate publications for each Main Option.

ECC does not refer to an agreement and there are no provisions which depend upon the execution of an agreement. There is no express provision in the published ECC which requires the method of formation of contract to be the completion and signature of an agreement. The published documents do not imply that an agreement is the only method of contract formation and do not limit the creation of the contract to the completion and signature of an agreement.

As described above it is possible for parties during their dealings to make creation of the contract conditional on the formality of a completed signed agreement. The employer may do so in the instructions to tenderers, or by separate letter or even in the documents issued to the contractor. The contractor may also stipulate the method of contract creation.  The effect of such statements preventing creation of a contract other than by the formality of execution of an agreement will depend upon the circumstances.

ECC does not refer to a tender or letter of acceptance.  There is no express requirement in the published ECC that the method of formation of the contract is to be by exchange of written communications or the formality of written offer and acceptance.

Although the ECC does not address the method of formation of contract, there are numerous references to the existence of a contract. The term “this contract” is used throughout the published documents. There are numerous references to actions which “this contract requires”. There is no express definition of the term “contract” either in terms of a list of documents or a document which includes a list of contract documents. There is no express statement of the manner of creation and whether or not it is limited to exchange of documents.

The definition of “Contract Date” at ECC CC 11.2(4) refers to the date when “this contract” came into existence, but there is no indication of the manner in which any contract is to be created. The definition, without further detail, shows that ECC was not intended to prescribe or limit the method of formation of contract adopted by the Parties.

ECC Contract Data part one proforma states that the data is to be provided by the employer and provides italicised terms to be defined by completion of the proforma. There is no statement or indication of the manner of creation of the contract. The Contract Data part one is not specific to any contractor but is intended to be issued as part of the invitation for tenders or bids. There is for instance no identification of the contractor in the Contract Data.

ECC Contract Data part two proforma states that the data is to be provided by the contractor and again provides italicised terms to be defined by completion of the proforma. The Contract Data part two is intended to be an offer, tender or bid by the contractor. There is no statement or indication that a contract cannot be made by simple acceptance of the offer, either orally or in writing.

The ECC does no require a contract to be created in a particular manner. There is no express provision in the published ECC preventing the method of formation of the contract being by by oral communication or by conduct or performance.

The published ECC does not include guidance notes, but a separate document entitled “guidance notes” is published which states that one of the purposes is to provide guidance on how to use the ECC. The guidance includes statements on the creation of a contract based on ECC.  The guidance notes confirm the above conclusion that there is no intended formality for creation of the contract.

1. The guidance notes state that frequently negotiations are necessary to clarify intentions or agree amendments.
2. The guidance notes state that the contract can be created by acceptance of a tender or revised tender, but does not state how that may be achieved. A suggested form of agreement is attached at Appendix 3, but as stated in the guidance notes that records the agreement already made. The proforma agreement lists the documents forming part of the agreement which includes a letter of acceptance.  There is also provision for listing other documents which form part of the agreement.

The above conclusions in relation to ECC apply equally to ECS and the creation of the subcontract between contractor and subcontractor mutatis mutandis.