20th July 2017

When is a Contract a Contract?

When you’ve signed on the dotted line, right? Wrong! You could be tied into legally binding agreements before the terms of a formal contract have been agreed and signed.

Legendary Hollywood mogul, Samuel Goldwyn, quipped that ‘A verbal contact is not worth the paper it’s written on’. Funny, he may have been; legally correct, he was not. A verbal contract is generally as good as a written one (as long as it can be proved that there was a verbal contract).

Unsigned contracts

It has long been established that parties can be bound by unsigned contracts, where their actions appear to accept the terms of a draft contract. If two organisations start working together as anticipated by a draft contract, the courts will be unlikely to rule that there is no legal relationship.

Terms of contract not finalised

You can be bound by the terms of a contract even before they have been agreed. An example of how this can work in practise is a case involving the purchase of cotton. Although the buyer did not sign the purchase contracts, they did initiate a pricing mechanism, provided for in the proposed contract. The court held that the purchaser’s behaviour indicated that they had accepted the terms of the contract unequivocally, and so were bound by it.

Of course, in such circumstances, one of the terms that was not agreed might be very important to one of the parties. In such situations, the courts adopt the following approach: “An objective appraisal of their words and conduct may lead to the conclusion that they did not intend agreement of such terms to be a pre-condition to a concluded and legally binding agreement”. In other words, the courts will examine the actions and words of the party to determine whether they indicated that the term was a pre-condition of any agreement.

The exception

Most rules have an exception; in this case, you can’t be held to a verbal contract where a written one is a legal requirement, for example to enforce a guarantee.

What verbal contracts mean for your business

Of course, the nature of business often means that work is started while contracts are still being negotiated. If this is a familiar situation, it is important not to rely on the phrase “Subject to contract”. The examples above demonstrate that this waiver can be meaningless if your behaviour and actions indicate that you intended to accept the contract.

One practical alternative is to produce a letter of intent; this should cover the basic elements of the contract on an interim basis, as well as giving provision for what should happen if the parties fail to reach agreement, including unwinding the relationship successfully to minimise losses for both sides.

Understanding the implications of unwritten contracts can help prevent your business getting bound by expensive or onerous obligations. But if you have any doubts about your obligations, it is important to seek expert legal advice as early as possible.

Alex Lee
Partner