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Dairy court case: warning over contracts

18 June 2010

The recent Supreme Court case of RTS Flexible Systems v Molkeri Alois Müller (2010) highlights problems that can arise where works are started under an agreement which is still 'subject to contract'. By JESSICA McGOLDRICK

Finalising the terms of a contract before starting work may be a painfully obvious point to make but it’s made all too often and the cost implications can be serious. If a dispute arises and the terms of a contract are unclear, parties could argue the contract was never formed; which is exactly what happened in the Müller case.

Müller, the German dairy company responsible for producing Müller yoghurts, hired RTS Flexible Systems to design, manufacture and install a series of packaging machines at Müller's factory in Market Drayton in a deal worth about £1.7 million.

Müller and RTS originally made contact in 2000 and negotiations continued during subsequent years. The parties intended that the work should be governed by a detailed contract but in 2005 the contract had still not been finalised. So work could start while the full contract terms were still being negotiated, the parties entered into a contract formed by a letter of intent on 1 March 2005.

When this expired on 27 May 2005, the contract had still not been formalised but RTS continued with the works. A final draft of the contract was produced on 5 July 2005 which provided it would "not become effective until each party has executed a counterpart and exchanged it with the other".

However, despite the fact nearly all terms had been agreed, the contract was never actually signed and exchanged. Instead, RTS continued to carry out substantial works and on 25 August, the agreement was varied in important respects.

The issue for the court was whether, after the expiry of the letter of intent, Müller and RTS had entered into a contract and if so, on what terms. Whether a contract has been formed is an objective test in English law. The court ignores the subjective views of the parties and instead looks at whether a reasonable, honest businessman would have concluded that a binding contract had been formed.

The court takes into account any written terms - but also the conduct of the parties. Therefore, a party may be held to have entered into a contract because it behaved as if it was. As one judge put it, the parties themselves are the "masters of their contractual fates".

The judge at first instance here found that after the expiry of the letter of intent, the parties had entered into a contract whereby RTS would carry out the agreed works for the agreed price but he declined to find that the contract included the final draft version of Muller's standard terms. The Court of Appeal then overturned that decision, finding no contract had come into existence after the letter of intent expired.

The case continued all the way to the Supreme Court. Müller submitted that there was a contract after the expiry of the letter of intent and that it was not on any of Müller's standard terms. RTS submitted there was no contract or, if there was, it was on all Müller's standard terms as amended in the course of negotiation.

The Supreme Court held that the clause which stated that the contract would only come into force when the parties exchanged signed copies had effectively been waived because the parties had behaved as though the contract was in place. Any other conclusion made no commercial sense.

The Supreme Court was clear each case will turn on its facts. The courts will not impose binding agreements on parties when it is clear both parties intended negotiations to be subject to contract. However, manufacturing companies should be wary of commencing works where the agreement is still at the 'subject to contract' stage as their conduct can imply they have entered into a binding contract.

Unnecessary haste at the outset may simply lead to protracted disputes later down the line. Even though a contract may have been formed it will not necessarily include the detailed or standards terms that a formal written contract might have included. As Lord Clarke stated in Müller: 'the moral of the story is to agree first and to start work later'.

* Jessica McGoldrick is a trainee solicitor at law firm Halliwells LLP

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