In-Site. Letters of intent

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1 Summer 2010 Authors: Kevin Greene +44.(0) Robert Hadley +44.(0) Inga Hall +44.(0) Becky Rowell +44.(0) K&L Gates includes lawyers practicing out of 36 offices located in North America, Europe, Asia and the Middle East, and represents numerous GLOBAL 500, FORTUNE 100, and FTSE 100 corporations, in addition to growth and middle market companies, entrepreneurs, capital market participants and public sector entities. For more information, visit Welcome to the Summer 2010 edition of In Site. This edition covers the following topics: Letters of intent and counterparts clauses in RTS v Müller; Pay-when-paid clauses; Frustration; Fraudulent misrepresentation in BSkyB v EDS; The Bribery Act 2010; and Judicial support for collateral warranties in the Scottish Widows case. For more information on any of these articles, or on any other issue relating to construction and engineering law, please contact any of the authors or your usual K&L Gates contact. Letters of intent Letters of intent are commonly used as a means of getting a project underway before the formal contract terms are fully agreed. As such, letters of intent are often a practical necessity, but they can create considerable confusion when it comes to determining if, when, and on what terms a legally binding contract comes into existence. Much can depend on the wording of the letter of intent, as well as the subsequent conduct of the parties. The complexity of the legal issues which can arise was well illustrated in RTS Flexible Systems Limited v Molkerei Alois Müller Gmbh & Co KG [2010] UKSC 14. Müller engaged RTS to supply an automated packaging system in January 2005 and work commenced under a 4 week letter of intent whilst the parties negotiated the contract terms. The letter of intent stated the parties intention that the final contract would incorporate the MF/1 model form terms (as amended). The letter of intent expired in May 2005, but RTS continued to work on the project and, although most terms were agreed by 29 June, it was not until 5 July 2005 that the parties had agreed all the contract terms. Although agreed, the contract was never signed. When a dispute later arose, the parties disagreed as to whether the contract was based on the 29 June or 5 July terms. The material difference was that the 5 July terms included a schedule ( Schedule 1 ) setting out the MF/1 terms, which included a counterparts clause stating that the contract " may be executed in any number of counterparts provided that it shall not become effective until each party has executed a counterpart and exchanged it with the other. The particular drafting of this counterparts clause meant that it was effectively a subject to contract clause. The judge in the first instance decided there was no binding contract on the 5 July terms because the counterparts clause prevented a contract coming into existence on those terms in the absence of a signed agreement. The judge held that a different contract had come into being between the parties after the letter of intent had expired based on the 29 June terms (which did not include the counterparts clause).

2 RTS successfully appealed that decision to the Court of Appeal in It argued that there was no contract between the parties at all and that therefore it would have a quantum meruit claim. The Court of Appeal was of the view that the counterparts clause in Schedule 1 applied to the whole of the draft contract, not just to the 5 July terms. As such there could be no contract, on 29 June terms or otherwise, after the letter of intent expired. The case finally made its way to the Supreme Court in 2010 when Müller appealed the Court of Appeal s decision that there was no contract. The Court unanimously allowed Müller s appeal and agreed that it was unrealistic on the facts of the case to suppose (as the Court of Appeal had) that the parties did not intend to create legal relations. Equally however, it made no commercial sense to hold (as the judge at first instance had) that the project was carried out on some, but not all, of the 5 July terms. The Court held that the parties had reached a binding agreement on the 5 July terms and had waived the subject to contract provision by continuing to perform. Lord Clarke said in the judgment that the different decisions in the courts below and the arguments in this court demonstrate the perils of beginning work without agreeing the precise basis upon which it is to be done. The moral of the story is to agree first and start work later". We all know that in practice this is not always possible. However, this case is a warning about what could happen if a contractual relationship is not formalised: parties should be aware that courts will look at factors such as communications and conduct to decide the nature of the relationship between the parties, and in particular whether the protections offered by a subject to contract clause have been waived. When a letter of intent with a stated duration expires, it is in both parties interests to agree on what basis work is, or is not, to continue. Pay-when-paid clauses The case of William Hare Limited v Shepherd Construction Limited [2010] EWCA Civ 283 shows the importance of regularly reviewing standard form contracts to ensure that they deal with any legislative changes. The 2008 sub-contract between the parties was based on a standard form that Shepherd (the main contractor) had been using since around It included a term that Shepherd would not be obliged to make any further payment to William Hare (as sub-contractor) where the employer under the main contract was insolvent. The subcontract definition of insolvency was, however, based on outdated wording. Section 113(1) of the Housing Grants, Construction and Regeneration Act 1996 ( the Act ) outlawed pay-when-paid clauses in the construction industry unless it could be shown that the third-party employer was insolvent. The relevant part of the definition of a company s insolvency originally included in section 113(2)(a) of the Act (and mirrored in Shepherd s standard terms) was limited to the making of an administration order by order of the court. Shepherd s standard form wording was not updated to reflect the fact that the Enterprise Act 2002 (Insolvency) Order 2003 amended the definition of insolvency in section 113(2)(a) of the Act to include self-certifying routes as well as court orders. When the employer on the project went into administration by a self-certifying route, Shepherd sought to rely on the pay-when-paid clause to withhold from William Hare substantial sums otherwise due to it. William Hare successfully disputed this on the basis that the insolvency of the employer did not fall within the terms of the pay-when-paid clause in the subcontract. As such, Shepherd's withholding notice was invalid. Given that the mis-drafted clause worked (even if a reasonable person may suspect there was an error) there is little reason for the courts to intervene. This decision shows that Shepherd should have updated its pay-when-paid clause to take account of the amended legislation, or drafted the definition of insolvency sufficiently broadly in the first place to take account of changes in the law. Can a recession frustrate a contract? Gold Group Properties Limited v BDW Trading Limited (formerly known as Barratt Homes Limited) [2010] EWHC 323 (TCC) is a rather extreme example of how the construction industry has dealt with the economic downturn. It is a reminder to anyone thinking of arguing that a contract has been frustrated by the difficult market conditions to think again: frustration of contracts operates in very few circumstances. Gold (as landowner) and Barratt (as developer) entered into a development agreement in 2007, Summer

3 under the terms of which sales revenue generated by the sale of the units on the developed land would be split between the parties. A schedule of minimum sales prices for the units was included in the agreement. When the property market took a turn for the worse, Barratt realised that the minimum sale prices for the units were unlikely to be achieved and Barratt eventually wrote to Gold making the case that the contract had been discharged by frustration. Barratt put the keys to the site through the letterbox in the hoarding and wrote to Gold claiming monies owing for work allegedly done on site. The Court looked at previous decisions regarding frustration, including Pioneer Shipping Limited v BTP Tioxide Limited (The Nema), where the Court said that frustration is "not likely to be invoked to relieve contracting parties of the normal consequences of imprudent commercial bargains". Frustration only occurs if there is a serious event which is both unexpected and beyond the control of the parties and which will make the performance of the contract in the changed circumstances fundamentally different from performance under the contract which the parties originally entered into. The court in Gold v Barratt held that the agreement was not frustrated for four reasons: the parties foresaw the possibility that the property market would drop; as a result, the agreement made express provision for the possible reduction in the minimum sales prices; there was no injustice to Barratt in obliging them to progress the works while renegotiating the minimum prices; and there was no supervening frustrating event as the drop in the market had been envisaged. In short, there was no need for the court to intervene and dissolve the agreement. The hard, but simple, lesson from this case is that the courts will not allow parties to escape from a bad bargain simply because of a recession. Fraudulent misrepresentation In order for an action for fraudulent misrepresentation to be made out, it is necessary to establish that a false representation has been made knowingly, or without belief in its truth, or recklessly as to its truth (Derry v Peek (1889)). An absence of honest belief is needed to succeed in such an action. In contrast, an action for negligent misrepresentation will be made out if the false statement is made carelessly, or without reasonable grounds for believing its truth. The computer case of BSkyB Ltd and anor v HP Enterprise Services UK Ltd (formerly t/a Electronic Data Systems Ltd) and anor [2010] EWHC 86 (TCC) emphasises that the distinction between negligent and fraudulent misrepresentation is a significant one. Contractual liability caps are not effective to limit liability for fraudulent misrepresentation, but will limit liability for negligent misrepresentation. A well-drafted entire agreement clause can exclude liability for negligent pre-contract misrepresentations, but not fraudulent ones. Ramsay J found in this case that EDS (an IT supplier) made fraudulent misrepresentations about its ability to deliver a project within the agreed timescale, and in particular that it had falsely represented that it had carried out a proper analysis of the time needed to deliver the project. The judge found that EDS s intention in making those claims was to induce BSkyB to award the 48 million contract to EDS and as such the case for fraudulent misrepresentation was made out. Accordingly, all losses flowing from the fraudulent misrepresentation were recoverable, and the 30 million contractual liability cap in the contract did not limit EDS liability (assessed on interim basis to be in the order of 200 million). Commenting on the dishonesty of the bid team leader (whose state of mind was attributable to the company) Ramsay J said that he acted deliberately in putting forward the timescales knowing that he had no proper basis for those timescales. At the very least he was reckless, not caring whether what he said was right or wrong. The case is therefore a reminder of the importance of ensuring that bid team members do not make statements during contract negotiations that cannot be backed up, and of keeping copies of working documents such as draft programmes and resource calculations to show that, even if mistaken, statements were not made negligently or fraudulently. This case is also a caution for the drafters of entire agreement clauses. EDS had also made a negligent misrepresentation about its assessment of required resources. Unfortunately, however, for EDS, the Court held that the entire agreement clause in EDS s contract did not have the effect Summer

4 of excluding liability for negligent misrepresentation (although liability for such misrepresentations was subject to the 30 million liability cap). The safest course of action in such a situation is usually to refer expressly to the parties intention to exclude liability for negligent pre-contract misrepresentation when drafting such clauses. The Bribery Act 2010 The UK has fragmented and complex bribery offences at common law and in the Prevention of Corruption Acts 1889 to These will be replaced with the Bribery Act 2010, which will provide a more effective legal framework to combat bribery in both the public and private sectors. The Act received royal assent on 8 April 2010 and is expected to come into force later this year. A detailed examination of the provisions of the Bribery Act is beyond the scope of this article, but the Act creates two general offences covering the offering, promising or giving of an advantage, and the requesting, agreeing to receive or accepting of an advantage in connection with someone's "improper" performance of his duties. There is also a specific offence relating to bribery of a foreign official. That offence in particular has implications for what would generally be regarded as ordinary corporate hospitality. The Act also creates a new offence of failure by a commercial organisation to prevent a bribe being paid on its behalf. This will mean that any UK company will commit a UK criminal offence if any person providing services on its behalf anywhere in the world commits bribery, the company s offence being a failure to prevent the bribery. It will be a defence if the organisation has adequate procedures in place to prevent bribery. At present those adequate procedures are undefined, although the Act does require the Secretary of State to publish guidance about procedures that relevant commercial organisations can put in place to prevent bribery on their behalf. These guidance notes are expected to be published shortly. As well as criminal prosecution resulting in unlimited fines and/or up to 10 years imprisonment, conviction for a corruption offence can also lead to debarment from public contracts in the EU in the future. For UK companies, and foreign companies carrying on any business in the UK, especially those operating in difficult jurisdictions or in high-risk industries, the risk of being subject to UK process if representatives abroad should cross the line will increase significantly and not to have proper anti-corruption policies/procedures in place is asking for trouble. For more information on the Bribery Act 2010 please contact Robert Hadley on or at robert.hadley@klgates.com Collateral warranties Supporters of collateral warranties will welcome the Scottish case of Scottish Widows Services & Anor v Harmon/CRM Facades [2010] ScotCS CSOH 42 in which Lord Drummond Young gives clear judicial support for the commercial intention behind collateral warranties. This case concerned a collateral warranty given by the main contractor to a beneficiary and subsequently assigned to Scottish Widows, and Scottish Widows ability to recover the costs of remedying defects from the main contractor under that collateral warranty. Lord Drummond Young said: Such warranties are an important feature of modern practice in the construction industry. In my opinion they must be construed in such a way as to further their essential purpose, namely to ensure that the party who suffers loss has a right of action against any contractor or member of the professional team who has provided defective work. He went on to say that the fundamental purpose of collateral warranties is to provide a right of action to a person who is liable to suffer loss as a result of defective performance of a building contract or a contract for professional services in connection with a building project. The views expressed by Lord Drummond Young in this case should give pause to detractors of collateral warranties who argue that they are not worth the paper they re written on. Welldrafted collateral warranties, covering the right things, given by the right people, continue to have a role to play. Summer

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