People often believe that to be binding a contract has to be in writing or that a formal document must be prepared and signed. This is not correct. Business contracts, while usually in writing, can be made by word of mouth. It is important to take great care in negotiating the terms of a contract.
To create a legally binding contract there must be:
- an offer;
- acceptance;
- consideration; and
- intention to create legal relations.
While it is common for contracts to be wholly written, they can also be wholly oral, partly written and partly oral, or even implied from the parties’ actions. Some contracts by reason of law must be in writing, such as those involving a sale or other disposition of land.
Negotiating parties may find themselves bound by a contract without one of the parties intending to be bound. You should always be careful when negotiating the terms of a contract that you make it clear to the other party if you do not intend to be bound by the contract until a specified point in time, e.g. a written contract signed by the parties.
Pre-contractual negotiations between parties can fall foul of the rules of offer and acceptance unless a party is careful to show there is no intention to enter a contractual relationship on the terms set out.
In Masters v Cameron the High Court outlined three situations that commonly arise when one party alleges a binding contract has come into existence in advance of execution of formal documentation.
The parties have finalised the terms of their bargain and intend to be bound immediately to perform 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 on all the terms of their bargain and intend no departure from those terms 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 concluding bargain at all, unless and until they execute a formal contract.
In the first two cases there is a binding contract. In the first there is a contract binding the parties immediately to perform the agreed terms whether the contemplated formal document comes into existence or not, and to join (if they have so agreed) in settling and executing the formal document.
In the second case, there is a contract binding the parties to join in bringing the formal contract into existence and then to carry it into execution.
There is no binding contract in the third case. The terms of the agreement are not intended to have, and therefore do not have, any binding effect of their own.
While Masters v Cameron outlines only three situations, a counter situation has been identified "in which the parties were content to be bound immediately and exclusively by the terms in which they had agreed upon whilst expecting to make a further contract in substitution for the first contract, containing, by consent, additional terms." That is, all the terms of the proposed transaction may not be finally agreed between the parties and accordingly changes might be made in the terms proposed and new terms could be introduced. In such a case, there is a contract between the parties.
Whether or not a contract is binding will depend on the circumstances of each case. Factors which may indicate there was no intention by the parties to be legally bound before any formal documentation is exchanged include:
- correspondence that shows the parties contemplated an exchange of contracts;
- the magnitude and complexity of the transaction;
- the subject matter;
- vagueness in any documentation, such as guarantees;
- tentative terminology in draft contracts; and
- particularly in property matters, if the parties intended a deposit be paid and whether stamp duty had been paid.
These factors may appear to be of varying significance. The basic test is always whether a reasonable person would regard themselves bound by what they said and did, in light of the admissible surrounding circumstances to show a bound contract.
A case in point is Ebenezer Mining Co Pty Ltd v Seppanen. On 7 February 2002, Ebenezer Mining Co Pty Ltd ("Ebenezer") offered JNJ Earthmoving ("JNJ") (the defendant’s business name) the option to tender for a quantity of bentonite and the related property. JNJ accepted and negotiations commenced. Several offers were made and rejected, the final offer said to lapse on 1 March 2002. On 13 March, JNJ made a counter-offer. Further negotiations continued until this offer was said to have lapsed. JNJ then purported to accept the sale price of $220,000.00 conditional upon finance. A draft contract was submitted on 24 June 2002 and amendments followed from both parties. On 12 September 2002, Ebenezer terminated negotiations because of the absence of finance. On 13 September 2002 JNJ refused Ebenezer access to the bentonite and sought legal advice regarding Ebenezer’s breach of contract. Ebenezer told JNJ it would remove the bentonite.
On 23 September 2002, JNJ said it would have finance confirmed the following week. Proof of finance was provided on 2 October 2002. Ebenezer was not willing to change its mind, as the offer was still conditional. Ebenezer then sought an injunction to stop JNJ’s access to the bentonite, based on breach of agreement.
The Court held that the parties failed to reach agreement on the sale of the bentonite. There was neither a definitive offer, nor an unqualified acceptance in the correspondence.
On examining the dealings, there was nothing more than a process of negotiation which had failed to achieve a consensus. It was clear the parties had not intended to create a binding agreement while there was no signed formal agreement encompassing the terms enclosed in the various drafts of the contract.
While the principles of law in this area are well settled, the difficulty lies is applying the principles to the facts. It is recommended parties, if it is their intention, make clear in their correspondence that they do not intend to be legally bound until formalities (such as the exchange of signed contracts) have been completed. One down side to expressing such an intention is it allows the other party to pull out at any time even after an oral agreement is reached until the written contract is signed. It is recommended that as soon as the terms are agreed the parties proceed to execute formal documentation quickly to prevent any uncertainty about the contractual position.
For further information, please contact Leneen Forde on +61 3 9608 2243 or l.forde@cornwalls.com.au
or Geoff Denton on + 61 3 9608 2125 or g.denton@cornwalls.com.au
