Effective and enforceable contracts are the lifeblood of any successful enterprise. Contracts with customers, service users, suppliers, employees, landlords, business partners and insurers all make up the matrix of payment flows, risk allocation and risk management tools which allow an enterprise to manage its cash flow, generate surpluses and remain solvent. Properly drafted contracts which are clear and unambiguous are a vital protection for your organisation. With over 21 years’ experience of advising public, private and third sector organisations on their contracts, I have seen many examples of good and poor practice. Start-ups in particular often don’t give this area the attention it deserves. In this piece, I summarise the key points to watch out for in your contracts.
1 Know your customer, supplier or partner
Who are you actually contracting with? It is important to be precise about the entity or organisation you are contracting with. Businesses may have similar names or may be part of a wider group of organisations. Take care to identify precisely the organisation or individual you will be dealing with and state this clearly in the contract documents – e.g. company name, number and registered office address. If something goes wrong, you will need to be sure that you are dealing with an entity that has assets and substance, so carry out some due diligence on the other party. For example, a free search can be obtained from Companies House website.
If you are dealing with an organisation or body that is not incorporated (i.e. it is not a company, charitable incorporated organisation or limited liability partnership), then you will effectively be contracting with the officers of that organisation in their personal capacity. As partners in a business, or members of the management committee, they will be acting as agents of the organisation. But if the organisation does not have sufficient assets or cash to fulfil its obligations, they may become personally responsible to discharge the debt or liability. If that’s the case you may want to satisfy yourself about their means to do this. Services are available from commercial providers like Experian and Equifax. In such cases, the agents may need to call upon insurance to meet any claims, so consider checking their insurance details. They may also seek to limit their liability to the funds available in the organisation.
2 Is it really a contract?
Under English law, a legally binding contract can only exist if there are four critical ingredients:
- an offer
- acceptance of that offer
- an intention to create legal relations
A valid acceptance of the offer only exists where there is an unqualified acceptance of all the offered terms. The acceptance must be brought to the attention of the offeror which can be verbal, electronic or in paper form. Sending out standard terms and conditions in itself may not be enough. Ideally the person with whom you are dealing should either sign or confirm their acceptance in writing – although the terms may state that the offer can be accepted by conduct (i.e. proceeding with the work, services or goods).
Consideration exists where there are reciprocal obligations on the parties to a contract. Both parties must receive something of value for their side of the bargain for there to be an enforceable contract. Even a nominal £1 payment or a lease for a ‘peppercorn’ can be sufficient, as can a promise to do something in exchange for payment. An exception to the requirement for consideration is where the contract is signed as a deed – this extra formality, usually involving signature in front of a witness or applying a seal, provides evidence beyond doubt that the signatory intends to be legally bound, useful in a unilateral arrangement, such as a grant or donation. (Note: signing a contract as a deed also extends the standard limitation period for breach of contract claims from 6 years to 12 years).
In business dealings there is a presumption that the parties intend documents to create legal relations, unless the document specifies otherwise. (Social and domestic arrangements are presumed not to create legal relations- despite a recent case where a mother threatened to sue another child’s parents for failing to show up to a children’s party!) But beware of documents entitled ‘service level agreements’, memorandum of understanding or ‘comfort letters’- they may not be legally enforceable if the right formalities have not been followed, unless that is what the parties intend.
Of course a valid contract can also be made orally or through a course of dealing, but if the terms are not written down the participants will struggle to provide evidence of what was agreed if there is a dispute.
3 Do they have the power to enter into this contract?
What if the organisation’s constitution does not allow it to enter this type of contract? I recently advised on a contract involving a housing association which had a constitution which required it to operate in Greater Manchester, but it wished to bid for a contract in Cheshire. A contract which is outside the organisation’s permitted purpose or powers could be struck down as invalid, leaving the other side out of pocket. In this case the constitution had to be hurriedly amended to provide the necessary comfort.
The Companies Act 2006 provides protection for third parties dealing with a company by stating that the validity of a company’s acts is not to be questioned by reason of anything in that company’s constitution (section 39).
However, extra care is required when dealing with other types of entity, particularly charities. In the case of a person dealing with a charitable company, the contract will be valid, even if not formed in accordance with the constitution, but only if the person gives full consideration in money or money’s worth and does not know the act is beyond the charity’s powers, or does not know the company is a charity. However, for an unincorporated charity, no such rule exists: the trustees can only exercise the express or implied powers in their constitution, so there is a risk that a third party dealing with them may not be able to enforce the contract if they have acted outside their powers. (Registered charities with an income in excess of £10,000 are obliged to state on all their documents and orders that they are a charity.)
A subsidiary question is whether the person who purports to sign the contract on behalf of the organisation actually has the authority to do so. When dealing with companies, partnerships and LLPs, the counterparty is entitled to assume that a person with actual or ostensible authority is empowered to enter into binding contractual commitments on behalf of the organisation, unless that counterparty has been specifically put on notice that contracts can only be entered into in certain ways or by certain people.
Contracts must also be signed in the correct way to be fully enforceable. For example, contracts dealing with the sale of land must be in writing to be valid. Contracts signed by partnerships or unincorporated bodies may have to be signed by all partners or officers unless, there is evidence that authority was delegated to one or more of them, for example through a board minute or power of attorney.
If you enter into a contractual commitment on behalf of your organisation without the requisite authority, you could find yourself responsible for making good the loss or liability out of your own pocket – not a career-enhancing move. Check your constitution or standing orders carefully – sometimes board approval is needed before signing on the dotted line.
For high value or high risk transactions, consider obtaining specific legal advice on these areas.
4 Does the contract comply with the law?
An increasing body of statute law and regulations dictate what terms can and can’t be included in certain types of contract. The courts have been reluctant to uphold contracts which are for an illegal or immoral purpose, which require one party to pay an unreasonable penalty should non-performance happen (in a case concerning parking penalties, the Supreme Court has recently ruled that the courts will not uphold a clause which is a secondary obligation imposing a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in enforcing the primary obligation); similarly, contracts which are in restraint of trade or anti-competitive may not be upheld. Contracts in some sectors are highly regulated, such as social care, health services, financial services and utilities.
Particular care is also required where you are dealing with an individual consumer (B2C) as opposed to a business to business (B2B) relationship. The Consumer Rights Act 2015 recently updated the law on the sale of goods and services to consumers. New rights apply for the first time to the supply of digital content such as streamed music, apps and e-books. Where the sale of goods is concerned, they must be of satisfactory quality and fit for any particular purpose which the consumer specifies and they must match the description or any samples. The consumer now has a clear right to reject goods within 30 days if they are faulty and to request a full refund. They can choose instead to accept a repair of defective goods and then have a further period to check the repair was successful, or alternatively to request a full refund, which must be paid within 14 days.
In respect of services contracts, consumers previously had no statutory remedies where services were of poor quality or defective although they had common law remedies (e.g. to claim damages for breach of implied or express terms). Under the new Act the services must be performed with reasonable care and skill (although the supplier can limit its liability, this cannot be less than the contract price). Pre-contract statements relied upon by the consumer become part of the contract; if the price is not agreed, it must be reasonable, and if a time for performance is not agreed, it must be within a reasonable time frame. If the services are not satisfactory, the consumer is entitled to require repeat performance by the supplier at the supplier’s cost (unless impossible). The consumer is also entitled to seek a price reduction or refund where repeat performance of the services is impossible; or the supplier has failed to re-perform services satisfactorily.
Terms which purport to exclude the supplier’s responsibility for certain things are particularly sensitive. The Act requires that exclusion clauses must be fair and reasonable in the circumstances; any clauses which try to exclude the statutory rights described above, or which exclude liability for personal injury or death are invalid and unenforceable. There is a specific requirement that terms should be in plain and intelligible language and that consumers should have adequate time to examine them. Separate rules apply to distance selling by online or mail order retailers. These Regulations essentially give consumers 14 days to cancel the order from the date the goods are received (even if they are not defective); the consumer must also be supplied with certain mandatory information about the identity of the seller and their rights to cancel.
Public and quasi-public bodies (such as housing associations and academy trusts) are subject to specific rules which require certain types of contract to be openly advertised across Europe and subject to a competitive bidding process. Failure to adhere to the rules can result in the contract being struck down as invalid, with potential loss to the participants involved.
On the other hand, if you are on the receiving end of a document which is not compliant, this can sometimes provide useful ammunition to get out of a bad deal!
5 How do we get paid?
Cashflow is king for most enterprises and organisations. Think carefully about the mechanics for obtaining payment. If the customer has to wait for an invoice before making payment and then is allowed another 30 days for payment, this could significantly increase the working capital your enterprise has to hold or borrow. Consider shortening payment periods, perhaps offer a discount for early payment or lump sum payments made in advance. Include explicit wording about the right to claim interest on late payments – see more on this here.
Do you have the right to increase your contract prices in line with underlying inflation? You could include a clause which states that prices will increase in line with any year on year increase in the Consumer Prices Index. If you are providing goods or services which are highly labour intensive, you may want to think about using a special index such as Index of Average Earnings to better reflect your underlying cost base. You can find out more about inflation indices on the ONS website.
6 What is the expected standard of performance?
In my experience, this is often a very fertile area for disputes. The best contracts set out very clearly and explicitly what the customer can expect from the goods or services together with any time limits for delivery or performance. This might be contained in a separate specification, or possibly in brochures or websites seen by the customer before entering into the contract. In the event of dispute, the court will look at what the participants set down in writing – if this is vaguely worded, it will normally count against the party who drafted the document. So make sure the specification is clear and unambiguous. Similarly, if you are presented with a standard draft specification which is not workable, consider challenging it and getting it amended before you sign. If you require that goods or services perform a particular function or solve a particular problem – make sure the contract documents explicitly state this, otherwise it can be difficult to argue that goods or services weren’t fit for their intended purpose.
7 How do we deal with changes?
The longer the contract period, the more likely that events and unforeseen circumstances will impact on the relationship and economics of the deal. For example, government policy changes or new legislation may be introduced, which can have a major impact on revenues and costs. Recent examples include the decision to withdraw the generous ‘Feed In Tariff’ in the renewable energy sector or the introduction of the National Living Wage from April 2016. Does the contract provide a mechanism to measure the impact of these changes and fairly apportion the risk and cost impact? For example, in some long-term service contracts the service provider may agree to absorb the first tranche (say) £5,000 of any cost impact in a given year, but will be entitled to additional payment if the impact exceeds this up to maximum figure (known as a ‘collar and cap’ arrangement). Similarly, if one party decides to change the nature of the goods or services (a variation), there should be a clear protocol for authorising this and adjusting the contract price accordingly. Problems can arise if more junior staff purport to make changes or waive parts of the contract and the other party later tries to rely on this – the wording should make clear who is authorised to make changes and how these must be recorded.
8 Where do risks and liability sit?
One of the functions of the contract is to allocate the risks and rewards associated with the supply of goods and services. The contract may contain warranties and indemnity clauses which should be considered carefully. Warranties are essentially promises about important matters which give the other party the right to sue for damages if they are broken. Indemnity clauses are express obligations to compensate the indemnified party by making a money payment for loss or damage. They provide an immediate entitlement to payment without the need for the party claiming to prove a breach of contract has caused loss. Open-ended indemnity clauses could be like writing a blank cheque. For example, if an accident occurs or a data breach occurs, the other party could seek to claim under an indemnity for all the losses it suffers, together with substantial legal costs. Unless there is insurance in place to cover this liability, a claim like that could be catastrophic and put the organisation out of business. Consider the balance of risks and rewards – if the rewards from the contract are not particularly generous, why not limit the risk exposure accordingly?
9 Where is the exit?
There should be clear mechanisms for either party to bring the contract to an end if the other is not performing adequately, or if one party just wants out. A protocol for raising problems, issuing warning notices, allowing ‘cure periods’ before ultimately giving a notice to terminate may be required. The consequences of terminating the relationship should be clear. Think carefully about what assets, records, data and intellectual property rights you might still need access to following the termination. If significant investment has been made by one party (for example, a leased IT system), that party will probably require compensation if the contract is terminated before the investment has been fully recovered. In the case of a service which is contracted out, if there is an organised grouping of employees carrying on an activity which subsequently comes back in-house or is re-tendered to another contractor, it is likely that the Transfer of Undertakings (TUPE) Regulations could apply. These Regulations automatically transfer the contracts of employment, and all associated liabilities, to the host or new provider. Specific clauses and specialist advice will be required on this high risk area.
10 How will we resolve disputes?
A sound mechanism for resolving disputes is essential. The recent rise in civil court fees has made bringing a claim before the courts a very expensive business. The fee for a claim in excess of £10,000 can be up to 5% of amount claimed, just to issue proceedings. Further fees are payable for hearings in addition to legal fees and the risk of paying the winner’s costs if you lose the case. In the context of long-term service contract, where flashpoints are bound to arise from time to time, instigating court proceedings is likely to be fatal to the relationship. Consider using an escalation procedure first, where senior managers are obliged to meet and discuss the issue before formal proceedings begin.
Enterprises are increasingly turning to cheaper and less hostile ways of resolving disputes using alternative dispute resolution (ADR) techniques. The use of mediation and expert determination is now popular. Mediation is a structured process of negotiation conducted through an independent third party, whereas expert determination is the use of a neutral professional to examine an issue and make a ruling (which is usually final and binding unless there is fraud or an obvious error). One useful low cost option might be CEDR Solve’s Mediation125. In some sectors the use of an ombudsman to resolve disputes is mandatory (e.g. utilities and financial services).
The contract should state which country’s law applies. I recently reviewed and overhauled some standard terms and conditions which a UK supplier had cobbled together from the internet without realising that all their contracts were governed by German law. This could have had unintended and expensive consequences.
Investing time and resource in drawing up and negotiating effective and clear contracts can save you money and time in the long run by avoiding costly mistakes and disputes. Of course the length and complexity of contracts should be proportionate to the value of the supplies and the risks at stake. With the cost of litigation escalating, there is a strong business case for getting this right. To maintain more control and consistency, you may wish to develop your own standard terms and conditions, rather than just accepting what is presented to you. A good technique is to brainstorm all the scenarios that could possibly go wrong and consider how these should be addressed in your contracts. When dealing with individual consumers, try to put yourself in the shoes of your customers or service users and use appropriate language that is user friendly and unambiguous.
Mark Johnson is an experienced solicitor and chartered company secretary working with charities, social enterprises, public bodies and SMEs to develop effective contracts and partnerships, manage risks and avoid disputes. Find out more at elderflowerlegal.co.uk
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