Understanding the risks of contracting on a 'bare-bones' basis

In international trade, it is very common for parties to reach an agreement on the main commercial terms of each transaction (e.g. the specific product, price, quantity and quality, load port etc.) before the detailed terms are worked out and executed in the form of a formal written contract.

In this update, we will briefly explain when such a 'bare-bones' agreement will be considered to be legally binding prior to the execution of the written contract and contrast it with instances where the 'bare-bones' agreement is not legally binding due to (i) the lack of objective intention to create a legally binding contract or (ii) the failure of parties to agree on the essential term(s).

How would the courts determine if parties’ agreement is intended to be legally binding or not?

In summary, a legally enforceable agreement can arise if parties agreed on the main terms if the parties intended the agreement to be legally binding, and if all the essential terms are all agreed upon.

However, there may be times where the parties do not wish to be legally bound until all the details are agreed upon and set out in writing in a formal contractual document.

In such instances, the usual device that is used is to add the words “subject to contract” which indicates that notwithstanding the consensus that parties have reached on the main terms, the intention is that the parties are not to be legally bound until a formal contract is signed and executed by both sides.

However, in the absence of such express intention to postpone the formation of the contract, the general position is that the courts would examine the parties’ correspondence and conduct in light of the relevant background to determine if parties had objectively intended for a legally binding contract to arise the moment an agreement on the main terms is reached.

For instance, in R1 International Pte Ltd v Lonstroff AG [2015] (R1 International), the buyer and seller entered into five transactions for the sale and purchase of rubber.

The transactions were all completed in a similar manner:

  • After negotiations have concluded, the seller would send an e-mail include the industry in which the parties are in, the character of the document which contains the terms in question, as well as the course of dealings between parties.
  • For instance, one of the evidence before the court in R1 International was that it is market practice in the rubber industry for the parties initially to only discuss the commercial terms of each transaction at the time the trade is confirmed. Thereafter, the rest of the terms of the transaction would be followed up by the operations team.
  • After reviewing the evidence, the court in R1 International was satisfied that the parties had intended for the terms of the email confirmation to be legally binding when they were sent. The court was also satisfied that both parties did contemplate that the basic terms contained in the email confirmation would be supplemented by a set of standard terms.
  • The court, however, made it clear that a legally binding contract could arise on the basic terms of the email confirmation because it was in principle possible for the parties to contract on those terms alone. The failure to agree on the detailed terms to supplement the transaction would not have been fatal to the existence of a legally binding agreement based on the shipment; etc. A clear example is if the parties did not reach an agreement on the price in the main terms, the contract would be void for uncertainty.

Is there a legally binding contract if parties leave an essential term “to be mutually agreed” at a later stage?

In Rudhra Minerals Pte Ltd v MRI Trading Pte Ltd [2013] (Rudhra), the parties entered into negotiations for the sale and purchase of coal at a convention in Indonesia. The buyer requested the seller to check with their supplier on whether they would be agreeable to change the load port surveyor, to which the seller agreed to do so.

Shortly after, the seller sent a full corporate offer (FCO) to the buyer, stating that they were “ready willing and able to offer [the coal] for sale in accordance with the terms and conditions set out”. The FCO was “subject to further terms and conditions to be mutually agreed” and for the load port surveyor to be “mutually decided”.

The buyer replied to acknowledge and “confirm purchase” of the coal. When the draft contract was sent to the buyer, asking them to “sign and revert”, it was discovered that the changing of the load port surveyor was not reflected in the draft contract. The buyer, therefore, proceeded to amend and send the draft contract back for the seller to review. After a chaser was sent, the seller replied stated that it was facing quality issues with the supplier and, hence, could not make further shipments. Subsequently, the seller declined to carry out the sale on the grounds that there was no legally binding contract. The buyer sued for damages.

The court in Rudhra explained that the fact that the load port surveyor was “to be mutually agreed” did not detract from the parties’ intention to be legally bound. However, since the parties intended to be bound on the terms of the FCO, which included an unsettled term (i.e. the choice of load port surveyor), the question was whether the parties had subsequently reached an agreement on the said unsettled term. Otherwise, the existing contract may be invalidated if the unsettled term was an essential term, whereby the failure to reach an agreement would render the contract void for uncertainty, unworkability or incompleteness.

The court in Rudhra found that, on the evidence, the parties had not agreed on the choice of load port surveyor which was essential to the performance of the contract. As such, the contract was void for uncertainty, unworkability or incompleteness.

One key difference between R1 International (discussed earlier) and Rudhra is that in the former case a legally binding contract could arise on the basic terms of the email confirmation because it was in principle possible for the parties to contract on those terms alone. In contrast, in Rudhra the failure of the parties to reach an agreement as to the choice of the load port surveyor would mean that there the contract could not be enforced. As such, the contract was void for uncertainty, unworkability or incompleteness.

Key lessons learnt

The courts’ approach towards analysing whether a legally binding contract has been formed is not a novel one and can similarly be observed in the English case of Pagnan SPA v Feed Products Ltd [1987]. There, the court laid down a concise set of principles that parties should bear in mind in determining when a contract has been concluded:

  • To determine whether a contract has been concluded in the course of correspondence, the court would look at the correspondence as a whole.
  • Even if the parties have reached an agreement on all the terms of the proposed contract, they may nevertheless intend that the contract shall not become binding until some further condition has been fulfilled (e.g. by adding “subject to contract”).
  • Alternatively, parties may intend to be bound immediately even if some terms are still to be agreed or some further formalities to be fulfilled. If parties fail to agree on such further terms, the existing contract is not invalidated unless the failure to agree on those further terms renders the contract as a whole void for uncertainty, unworkability or incompleteness.
  • In any case, the essential terms without which the contract cannot be enforced must be agreed otherwise the contract would be void for uncertainty, unworkability or incompleteness.

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