To contract or not to contract? - Reed Smith

TO CONTRACT OR NOT TO CONTRACT
Feature
Authors Tom Hibbert and George Hoare
To contract or not to contract
The recent case of
(1) Maple Leaf
Macro Volatility Master Fund (2)
Astin Capital Management Limited v Rouvroy
and another
[2009] EWHC 257 (Comm)
serves as a reminder of the English courts’
general reluctance to accede to arguments
based on non-enforceability and contractual
uncertainty.
Indeed, Maple Leaf
follows earlier
authorities, such as Bear Stearns Bank Plc v
Forum Global Equity Ltd [2007] EWHC 1576
(Comm), in demonstrating the English courts’
desire to hold contractual parties to their
bargain. An awareness of this approach is useful
for practitioners, as the fallout from the credit
crunch will mean the steps taken in forming a
contract will come under greater scrutiny.
MAPLE LEAF
The case involved a dispute between Maple
Leaf, a Cayman incorporated hedge fund,
and Astin, an investment manager, on the
one hand, and the senior executives of a
French drinks company on the other. The
defendants sought to raise €30m to fund
their acquisition of shares in a large French
holding company.
The parties negotiated a termsheet with
Maple Leaf as lender, which was signed by
Maple Leaf, Astin and the defendants but not
by another party to the termsheet. Following
the subscription for securities by Maple Leaf,
the defendants attempted to re-negotiate
the termsheet. This caused Maple Leaf to
seek repayment of the loan. In response the
defendants argued that the termsheet was
neither binding nor enforceable.
Smith J found that the following questions
arose:
whether the parties intended to make a
contractually binding agreement; and
whether the agreement was too uncertain
to be a contract.
Intention to create legal relations
The defendants argued that by signing the
termsheet, they did not intend to enter into
KEY POINTS
The English courts take a robust approach to arguments concerning contract formation
and contractual certainty.
Although the formation of a contract is traditionally analysed in terms of whether an offer
has been accepted, the law does not require rigorous compliance with an analysis along
these lines.
The intention to create legal relations is assessed objectively, by a reasonable man versed in
the relevant business, with the particular market practice being significant.
In the current economic climate, it is likely that parties will seek to avoid the
consequences of arrangements reached with other parties which have become
commercially unprofitable or which they are no longer able to perform. This often
leads to disputes, with one party attempting to enforce the terms of the ‘agreement’
while the other claims the ‘agreement’ reached is neither binding nor enforceable or
is too uncertain to constitute a binding agreement.
a contract as they said that such documents
were not considered legally binding.
Instead the termsheet simply signaled a
non-contractual commitment to continue
negotiations.
Under English law, an agreement merely to
negotiate is not recognised as an enforceable
contract. In Walford v Miles [1992] 2 AC 128,
the House of Lords approved Lord Denning’s
comments that agreements to negotiate are
unenforceable because they are too uncertain
to have any binding force, with the courts
applying ‘the general principle that where
there is a fundamental matter left undecided
and to be the subject of negotiation, there is
no contract’.
In Maple Leaf, Smith J declined to find
that, when they signed the termsheet, the
defendants considered they were entering into
a legal and contractual
commitment. However,
this did not assist the defendants. In deciding
whether the parties entered into a contract,
the courts normally apply an objective test.
The relevant legal principles are explained
in the judgments of Bingham J and Lloyd LJ
in Pagnan Spa v Feed Producers Ltd [1987] 2
Lloyd’s Rep 601.
The first question to ask is how a
reasonable man versed in the relevant business
would have understood the exchanges
between the parties. The fact that the parties
recognised that their agreement would be
incorporated into a formal, more detailed,
document is not inconsistent with an
intention to be legally bound. As Lloyd LJ
stated in Pagnan, ‘there is no legal obstacle
to the parties agreeing to be bound while
deferring important matters to be agreed
later’. Applying this principle to the facts of
Maple Leaf, Smith J held that, on an objective
assessment, the termsheet evinced an
intention to be bound contractually.
Agreement too uncertain
Smith J noted that the courts are reluctant to
conclude that what the parties intended to be
a commercial agreement is too uncertain to
be contractually effective (Sykes v Fine Fare
[1967] 1 Lloyd’s Rep 53; Trentham v Archital
Luxfer
[1993] 1 Lloyd’s Rep 25).
As part of the funding agreement, the
securities subscribed for by Maple Leaf
were to be transferred to a special purpose
vehicle (‘SPV’) which stood as security for
the repayment of the funding. In return,
the defendants agreed that they would
place other securities in the SPV as further
collateral.
The termsheet did not define in detail who
the members and directors of the SPV were
to be, nor how the SPV was to be prevented
from disposing of the collateral. These were
matters of such importance, the defendants
argued, that no contract could be concluded
without the parties’ agreement upon them.
Notwithstanding that these outstanding
factors were important, the judge did not
accept the defendants’ argument. As the
agreement provided that the defendants
were to take ‘all steps to establish SAV
[understood to mean SPV]’, this required
them to establish a company that would
fulfil the role contemplated by the agreement
but with the defendants afforded discretion
as to its nature. If they did not establish
the SPV, they bore personal liability. Thus
the agreement was not too uncertain to be
workable.
314
June 2009
Butterworths Journal of International Banking and Financial Law

Biog box
Tom Hibbert is a partner and George Hoare is an associate at Reed Smith in London.
Email: thibbert@reedsmith.com and ghoare@reedsmith.com
BEAR STEARNS
Maple Leaf, unsurprisingly, has striking
similarities to the earlier judgment of Smith
J in Bear Stearns.
In this case, from March 2005, Forum and
Bear Stearns negotiated the sale of Forum’s
loan notes issued by two Parmalat companies,
with the main focus of the negotiations being
the price. In a telephone conversation in July
2005, Forum agreed to sell the loan notes to
Bear Stearns for €2.9m.
Both parties agreed that their respective
lawyers would prepare the transactional
documents. They were aiming for a settlement
date by early September, although Bear
Stearns made it clear that it could not commit
to a settlement date.
A dispute arose as to whether the
telephone conversation had created a binding
contract. Forum argued, inter alia, that no
contract was formed because:
the parties had simply made an
‘agreement to agree’; and
the parties did not intend to create legal
relations.
‘Agreement to agree’
Forum submitted that the parties deferred
reaching agreement about the settlement
date, and argued that cases such as May &
Butcher v R [1934] 2 KB demonstrated that
an agreement is not contractually concluded
if it leaves significant matters subject to the
parties’ future agreement.
Based on the evidence of the negotiations,
Smith J did not conclude that the parties
had arranged that there would be further
discussions about the settlement date in order
that they make a binding commitment and so
complete their contract.
The discussions were only relevant to
when the parties might expect settlement
to take place, and the judge held that the
parties intended to enter into a contract
without any express term as to the
settlement date.
Intention to create legal relations
On this point, Smith J also stated that
the relevant principle to apply was how
the reasonable man, versed in the relevant
business, would have understood the
exchanges between the parties.
He noted that in deciding whether
parties evinced the necessary intention to
create contractual relations, it is important to
remember the market in which the parties were
conducting their negotiations. Expert evidence
showed that the distressed debt market almost
always operated on the basis of oral deals.
Explicit words were needed to avoid a binding
contract being made at the point at which the
price was agreed. On the facts, when Forum
accepted Bear Stearns’ firm bid of €2.9m it
showed an intention to conclude the contract.
ANALYSIS AND CONCLUSIONS
A legacy of the credit crunch is a likely
increase in litigation in which contractual
parties seek to avoid or enforce purported
agreements. Such cases will turn on the
factual matrix and the particular market in
which negotiations take place.
However, the English courts take a robust
approach to arguments concerning contract
formation and contractual certainty. Both
Maple Leaf
and Bear Stearns demonstrate this
and the following conclusions can be drawn:
Intention to create legal relations
This is assessed objectively, by a reasonable
man versed in the relevant business, with the
particular market practice being significant.
In both cases, the court took the view that
the parties intended to be bound, in spite of
the fact that further significant terms still
had to be agreed. In the Bear Stearns case, the
parties had only reached an oral agreement
by telephone for the price of the notes.
Although concerned with the distressed debt
market, this principle could well be applied to
other markets where contracts are agreed by
telephone.
Acceptance of an offer
Maple Leaf
is significant for Smith J’s
comments about the ‘proper approach’ to
the question of whether a party entered into
a contract. He states that formation of a
Feature
contract is traditionally analysed in terms
of whether an offer was accepted. However,
‘the law does not require rigorous compliance
with an analysis along these lines’.
The court will, if appropriate, ‘assess a
person’s conduct over a period and decide
whether its cumulative effect is that he has
evinced an intention to make the contract’.
In support of this, the judge referred to The
Zephyr
[1984] 1 Lloyd’s Rep 58 and Trentham.
On the facts of Maple Leaf, a contractual
party was bound by the agreement, even
though it had only agreed to an earlier
version of the contract. The question to apply
was whether what was introduced into the
new version would have been regarded by a
reasonable investor as introducing a new term
into the bargain rather than an acceptance
of the terms already agreed. In Maple Leaf,
"The distressed debt market almost always operated
on the basis of oral deals."
Smith J ruled that there was no such new term
introduced and so held that the party had
entered into the contract.
Uncertainty
The courts remain reluctant to find an
apparently binding agreement unenforceable
due to uncertainty, especially if a party has
taken steps to implement the contract.
Such a position has a long history, with
the House of Lords noting in Hillas & Co
Ltd v Arcos Ltd (1932) 147 L.T. 503 that
businessmen ‘often record the most important
agreements in crude and summary fashion
… [I]t is accordingly the duty of the Court to
construe such documents fairly and broadly
without being too astute or subtle at finding
defects’.
Courts are even more unlikely to deem
an agreement too uncertain if a party has
taken steps towards implementing its side of
the bargain, as the claimants did in Maple
Leaf. As Lord Denning stated in Sykes, when
‘an agreement has been acted upon and the
parties … have been put to great expense in
implementing it, we [the courts] ought to
imply all reasonable terms so as to avoid any
uncertainties.’
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TO CONTRACT OR NOT TO CONTRACT
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Butterworths Journal of International Banking and Financial Law June 2009 315