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Legal know-how for business: “subject to contract”

The phrase “subject to contract” is (or should be) used when you are negotiating but do not want any legal consequences – typically the formation of a binding contract – to result from your communications.  For example, when negotiating a letter of intent or heads of terms, it is a useful way of making it clear that, although the key terms of the transaction are being put in writing, neither party intends to be legally bound unless and until those terms are then confirmed in a more formal, detailed agreement.  And anyone who has bought or sold a house in the UK will be familiar with offers being “subject to contract” (or “STC”), making it clear that, although an offer to purchase a property may have been accepted by the seller, there is no commitment to proceed with the transaction until the parties exchange contracts.

So far, so straightforward.  But it should be borne in mind that using the “subject to contract” phrase is not conclusive, but creates a presumption that the parties do not intend to create legal relations (ie enter into a binding contract), and that the behaviour of the parties may result in the protection offered by the “subject to contract” to be lost.   So, for example, in the case of RTS Flexible Systems Ltd v Molkerei Alois Müller1, Müller had sent a letter of intent to RTS, together with a draft contract which included a clause limiting RTS’s liability in the case of certain disputes.  The draft contract also included a clause stating that the contract would not be binding unless it was signed and executed by the parties, ie that it was subject to contract.  The contract was never signed, but RTS proceeded with its supply obligations with the consent of Müller.  A dispute arose which included a claim by Müller against RTS for failing to supply equipment of the correct specification.  Müller argued that the draft contract (with the clause limiting RTS’s liability) did not apply since the draft included the clause confirming that it was not binding unless signed and executed.  The Supreme Court disagreed, and decided that the parties had proceeded with the project as if the draft contract did apply, and they had therefore, by their conduct, waived the clause in the contract that stated it would not take effect unless signed.

So to summarise:

  • If you want to avoid the risk of finding that a binding contract has been formed during negotiations, make it clear at the outset that the discussions are subject to a formal, detailed agreement being signed, label your emails and any draft documentation with “subject to contract”, and confirm the “subject to contract” nature of the discussions prior to the start of any meetings or phone calls.
  • And if you decide to start work before the formal contract is signed, then you need to make it crystal clear that the contract negotiations remain “subject to contract”, so as to avoid a court inferring that the subject to contract understanding had been waived by agreement as a result of the parties’ conduct and communications.

 

Note 1: RTS Flexible Systems Ltd v Molkerei Alois Muller Gmbh & Company KG (UK Production) [2010] UKSC