Contract formation

At what point may a binding contract arise in the course of business negotiations over the terms of engagement?

A question that most businesses are likely to have considered at some stage is that of avoiding the need to start work inadvertently and later discovering that you may not get paid for it. The High Court, in the case of Fenchurch Advisory Partners LLP v AA Ltd recently handed down a ruling that business organisations ought to be aware of.

Background

A claim for fees was bought by the claimant, Fenchurch Advisory Partners (“the claimant”), in respect of the advice and assistance it provided in the potential sale of the insurance division of the AA Ltd (“the defendant”). After the terms of engagement had been presented, extensive negotiations began but the defendant never actually signed the engagement letter and the sale of the insurance division did not go ahead.

Despite the above, while negotiations around fee levels were ongoing, the claimant carried out a significant volume of advisory work on the potential sale project: attending working meetings, scoping the various workstreams, co-ordinating the work of other advisers, assisting in the preparation of a financial model and drafting important documentation. Once the decision was made to retain the business and not sell it, a dispute arose as to whether there was a binding contract that the defendant would pay the claimant’s fees for work already done over an extended period.

The claimant argued that the combination of the exchanges (mostly by email) and the carrying out of the work agreed in those exchanges gave rise to a binding contract.

The defendant, on the other hand, contended that a binding contract should only come into being when contractual documents were signed by the parties. The defendant argued that the way the engagement letter was negotiated envisaged the requirement of signatures and drew the court’s attention to the fact that there was an entire agreement clause. This reinforced their case that the parties wanted a written agreement which set out all of the terms of their bargain.

The decision

The two main issues for the court to decide upon were whether a binding contract had been agreed between the parties and, if not, whether there was an implied contract.

In considering the first of the two main issues, the court accepted the defendant’s case that not all of the terms of the contract had been agreed by the time that the project was dropped. Whilst it was obvious both parties intended and expected a binding legal agreement to be reached sooner or later and whilst it is possible for parties to reach a binding agreement when there are still unfinished negotiations, this was not true in the present case. Based on the evidence produced to the court, there were two workstreams – the commercial element and the legal element – to be negotiated. The expectation was that both workstreams would be completed prior to the final engagement letter being signed and there was no other external sign that the parties were taking a different course to a legally binding agreement.

The court therefore concluded that there was no binding agreement between the two parties.

In respect of the second issue, the claimant stated that there existed an implied contract that it would be paid a reasonable fee for its services. The claimant further stated that it was ‘commercially absurd’ to suggest that it was acting on the basis that it did not expect to be paid should negotiation of the contract breakdown.

The High Court also rejected this argument.

However, this did not mark the end of the matter. The claimant succeeded in its claim in restitution for unjust enrichment. The court concluded that the defendant had received a benefit (a financial gain or saving of expense) as a result of the claimant’s services, knowing those services were not intended to be free. Further, both parties fully expected to agree terms around the fees.

The claimant was entitled to payment for its work which the court valued at £350,000 plus expenses. However, importantly, this did not include any success fee element and was limited to a ‘progress payment’ in relation to the services provided.

What is the significance of this decision?

As it is not uncommon for a party to start performing some of its obligations before a written agreement is signed, the importance of clarity during negotiations is crucial. In some circumstances, it may seem sensible and expedient to begin work pending a final agreement but this case illustrates the risk of carrying out work without payment terms being agreed.

In such cases, a simple binding contract ought to be considered, setting out the parties’ rights and obligations around work done in anticipation of the final terms of engagement.

If you have any queries on this article or require any advice in respect of any commercial contracts, please do not hesitate to contact a member of the Commercial team.