Chapter 2

Contracts — what are they?

Doing deals — the stuff of life

Contracts are the essential heart of any commercial relationship. We all enter literally hundreds of thousands of contracts over our lives, many of which are verbal. They are as important a part of modern business life as walking, talking and breathing.

This book is primarily focused on negotiating commercial contracts. It does not deal with a ‘retail’ contract where you seek to buy food from the supermarket or a movie ticket. In those types of contracts there is little room for negotiation and there is a beautiful simplicity to the relationship between you and the other party — you want what they have and are willing to pay for it (or vice versa). That’s it!

While these essential dynamics are present in larger commercial contracts, the rights and obligations of the parties and the context in which the contract is negotiated is much more sophisticated, subtle, and at times, treacherous.

This section will help you:

• understand what a contract is
• understand the consequences of breaching a contract
• negotiate a contract
• avoid pitfalls in negotiations
• better manage your contractual relationships.

Lawyers can be terrifically presumptuous in seeking to advise clients how to negotiate commercial deals at the business level. This is wrong. No-one knows your industry, and in particular your business, as well as you. You are the one selling or buying the product, good or service. You are the one directly dealing with the representative of a company on the other side. You are in the middle of the fascinating, compelling and sometimes frustrating dynamic of trying to do a deal. You are best positioned to know what is a good deal and what is bad.

I have no ambition to try to tell you how to do that.

This is not least because negotiation styles are as varied as the individuals in the business community. What works for one person does not work for another.

The negotiation soup

A successful negotiation is a mix of:

• leverage
• strategy and tactics
• personal relationships
• concessions — giving in what does not matter to you but does to them
• judgement and reading the play
• timing
• restraint
• presentation
• decisiveness
• theatrics — the spectrum of leaving a negotiation in a huff to poker-faced silent contemplation
• the ‘bottom line’ — the point at which an impasse may be reached and the parties do the deal or not.

Reading your counterparty, understanding their agendas, knowing their strengths and weaknesses and seeking to position them to your advantage is a subtle synthesis of all of these elements.

No matter what anyone says, there are no hard-and-fast rules of the game to apply.

Successful negotiators exist on intuition and wit as much as wisdom and intellect.

I have tried to provide you with some background information from a lawyer’s perspective that, when combined with your intuition, wisdom and intellect, will hopefully enhance your position in any commercial negotiation.

The contract tree

There are three broad stages in entering into a contract:

The contract tree pictured in figure 2.1 (overleaf) figuratively represents the three stages.

There will be no contract without some type of negotiation. The negotiation synthesises elements of:

• the relationship between the parties
• commerciality
• due diligence and analysing your counterparty
• price — what makes this a good deal or otherwise
• reputation — what is the reputation of your counterparty? Will this have an adverse or positive impact on your reputation in the market?
• strategy and tactics — how to get the best out of a negotiation.

The next stages of contractual formation are the trunk represented by:

• offer and acceptance
• consideration
• terms.

It is necessary for each of these elements to be present for a contract to be entered into.

On the formulation of the springboard and the safety net, the audacious and entrepreneurial (although possibly unwise!) contractual counterparty will stop here. They have their eyes on the prize being the good or service or the income they will earn from providing a good or service. They do not anticipate the need for more.

On the other hand the judicious contractual negotiator will move to the third stage of contractual formation which is the negotiation and discussion of precise terms of the agreement. While these terms incorporate a dimension of the springboard, this is where the safety net comes into play.

It is important to give equal attention to each stage before fully and finally entering into the agreement.

What is a contract?

When it is all broken down, a contract is essentially:

an agreement or understanding between two or more parties over an issue or subject matter in which they are to have rights and undertake obligations to the other party.

Types of contracts

There are, in broad terms, two types of contracts: oral contracts and written contracts.

Written contracts

From a lawyer’s perspective, a written contract is the best form of agreement a commercial party can enter into. This is because all the terms and conditions of the contract are clearly set out within it. It makes proving the contract much easier. It is less likely for there to be a dispute as to what the terms and conditions are.

Where a contract is in writing, the courts generally take the view that the contract itself contains all of the rights and obligations of the parties. However, as you will see below, contracts can be a mix of oral, written and implied terms.

Importantly, when a contract is in writing it is generally not relevant how one or both of the parties understood the contract or what they intended it to be. Courts are very literal. They look at the language and construe or interpret the words used; the words ‘speak for themselves’. The court considers it its job alone to understand what those words mean in their plain and ordinary use. This is because courts generally place faith in parties to express contracts to reflect the bargain or the deal they have negotiated.

However, courts are filled with cases in which contracts for the sale of expensive goods and services are by words only.

Oral contracts

An oral contract is when an agreement is made only in spoken words between two parties. It is as enforceable as a written contract. However, there is a significant practical problem. Often the parties have different views of what the contractual terms, rights and obligations are. This is particularly so when Smith is alleging against Jones that Jones’s breach of the contract has caused Smith significant financial damage. Smith wants Jones to pay for the loss caused by Jones’s conduct. In many instances, whether driven by opportunism or a genuinely different understanding of what Jones was to do under the contract, a dispute develops as to what obligations Jones had.

As you will appreciate, oral deals are uncertain. If there is disagreement as to what the deal was, it is necessary for a court to determine on the basis of the evidence presented which party’s version of events is more persuasive or objectively likely. This is a complex and difficult exercise when Jones is saying black and Smith is saying white. The presence of contemporaneous documents reflecting one version of events or evidence of other witnesses may be extremely useful.

Bear in mind it was an oral contract where a representative of Prosperous Mining contacted Industrial Plumbing and simply requested that they attend to fix the problem. There was no discussion of the precise terms of the contract.

Industrial Plumbing feels entitled to the complete amount in its invoice given it did the best thing by Prosperous Mining by replacing the pipe to avoid further problems. And, given prior practice, it considers the premium charge as reasonable.

Neither party here is morally in the wrong. Industrial Plumbing’s view is formed by prior conduct and a general sense of what is commercially right. On the other hand Prosperous alleges that the contract was a narrow one and did not involve replacement of the pipe or the charging of a premium. Prosperous Mining may contend that if it had known that this was how the job was going to be undertaken and costed by Industrial Plumbing, it may not have engaged it.

It is a dispute about the terms of the contract. Uncertainty prevails. Assumptions and expectations have clouded views about what the contract is and what the parties had to do under it.

Let’s tweak the facts in that example slightly.

Here we have two parties who are likely to have vastly different stories as to the effect of terms of the conversation. The crucial part of the negotiation was when the work was to be done and whether there was a step prior to the work starting. One party says it was made clear. The other party says it was not an issue.

Again, neither party is necessarily lying. There are two views about the implications or meaning of the conversation. Of course there is no sound-recording of the conversation. It is not possible to objectively prove what was said. It is necessary for a court to decide which of the two versions of events is more probable.

Complicating this is the presence of past practice.

It is likely a dispute will develop as to what the terms of the contract were, what was asked for, what was delivered and what it should cost. They have two different views of the same event. The consequences of those views are dramatically different.

Oral contracts are generally to be avoided for this reason. Courts are littered with cases involving alleged breaches of oral contracts. The party against whom the allegation of breach is levied says, ‘I never agreed to that’. There is a significant fight about what the rights and obligations were, let alone whether they were breached. These disputes can be costly and are inherently risky for both sides.

Judges do their best to determine a case on the evidence before them. However, judges are also in a difficult position. They undertake no independent enquiry of their own as to the credibility or honesty of the two parties. They have before them, for all intents and purposes, two honest people with vastly different views of the facts and contract. Often it is difficult for a judge to discern if one is lying or whether the parties merely have different views of events.

Oral contracts are dangerous.

In a commercial context if you are dealing with a counterparty that insists on an oral contract only, your antennae should be raised.

In my experience parties who want to maintain only oral contracts are looking to self-interestedly preserve flexibility in their commercial arrangements. Rarely is a party that wants to maintain this flexibility thinking of you. They are looking to keep their ability to perform the contract flexible and in a way that best suits them, practically or financially. Again, what suits them may not suit you. Beware of the oral contractor!

Are all contracts equal?

There is no legal difference between an oral and written contract. They are equally as binding. However, as you will have seen from the Prosperous Mining example, there is a vastly different level of proof in establishing the terms of the contract between oral, written and implied contracts.

While speaking simplistically, a contract is a contract is a contract — proving it is a vastly different endeavour.

It is on this basis that I display my prejudice for written contracts in every situation where the transaction is of significant size and scope or has any moderate level of complexity to it.

What are the elements of a contract?

The elements of a contract are illustrated in figure 2.2.

Offer

Without an offer there is simply no basis for there to be a contract or agreement. It is the first stage in the process of entering into a contract. However, as silly as it seems, discerning whether an offer is made is not as simple as you may think. The key element is whether the person making the offer will be bound if it is accepted. An offer can be made to one person or a class of persons. An offer can be revoked or withdrawn at any time prior to it being accepted.

This is an offer that can be accepted on its terms. It is simple and complete. Further negotiation is possible, but the deal done will not mean accepting Prosperous Mining’s offer.

Responding to an offer — reject or accept? Do I want a contract?

Acceptance is the second stage of establishing a contract. If there is no acceptance, there can be no contract. There are a number of simple rules in relation to deciding whether an offer has been accepted or not. They are:

Is it an acceptance or a counter offer?

Sometimes the lines can be blurred between what is an acceptance and what is a counter offer. A party may look like it is accepting an offer by adopting 90 per cent of what is offered. However 100 per cent is the mark that needs to be reached. An ‘acceptance’ that adopts part of what is offered and changes a component of it is a counter offer. That reverses the roles. It is up to the original offerer to decide whether to accept the counter offer or not. A counter offer is a rejection of the initial offer.

In the Prosperous Mining–event company example, the offer to do the work by the events company for $30 000 is a counter offer. It may be accepted as a counter offer, however that would shift the positions of offerer and accepter. The event company would become the offerer and Prosperous Mining the potential accepter.

How long does an offer hang out there?

An offer lasts until one or more of the following occurs:

• it is revoked by the offerer
• it lapses on its terms (such as being open for seven days)
• the offering company is wound up or a person making an offer dies
• the accepter does not fulfil all the conditions in relation to the offer
• the party receiving the offer makes a counter offer
• a reasonable time passes from the time of the offer being made.

The most uncertain position in the above scenario is the passing of reasonable time from the offer being made. There is no neat or clear formula of law that allows a party to decide whether an offer is still available on the basis reasonable time has not passed. It very much depends on assessing the nature of the offer, the nature of the acts required for acceptance, the subject matter of the contract, the general commercial circumstances of the parties and any prior dealings between them. It is an issue that is considered in all the circumstances of the commercial relationship.

It is likely in this context that the court would find a reasonable time for accepting the counter offer was not five days before the appointed time for the function. Therefore, the offer had lapsed at a prior time to the purported acceptance by Prosperous Mining.

Intention to be legally bound

It is not enough to have offer and acceptance. It is necessary for the parties to the contract to agree to be legally bound. That means that implicitly one party understands the other may sue it if it breaches the contract.

It is extremely rare for a contract to expressly state that the parties agree to be legally bound. In this context, courts have developed rules of thumb as to interpreting offer and acceptance and whether there is a contract or otherwise.

Parties to agreements in relation to social or domestic matters are assumed not to intend legal enforceability (such as a son telling his mother that he will meet the midnight curfew. There is generally a serious question of integrity in a promise of this kind!).

Parties to agreements concerning commercial matters do infer legal enforceability (such as when an accountant performs services for a client and is not paid, there is an avenue to sue and recover the fees).

Consideration

Another essential element of contracts is consideration. Consideration is an elusive concept. It essentially is an act involving legal detriment or giving something of value in exchange for a promise for a good, service or act. For example, consideration for the purchase of a pair of shoes is the price of the shoes themselves. Without consideration there can be no agreement or contract.

The terms of the contract

The terms of the contract are its contents. Like contracts themselves, there are two types: express terms and implied terms, as illustrated in figure 2.3.

Express terms

Express terms are terms that are overtly agreed between the parties. In a written contract, express terms are the parts of the contract that are openly in writing and to be clearly understood by the parties.

On the other hand, with oral contracts, identifying express terms can be more difficult. They still exist, but because words are ephemeral, so often are the express terms. There will regularly be a difference of opinion as to what was said, and therefore what the express terms of that contract will be. Again, written contracts are vastly preferable.

An express term, as the name suggests, is an express agreement of the two parties as to the terms of their deal.

Implied terms

A contract may also comprise implied terms. An implied term is necessarily ancillary, or secondary, to the express terms.

It is not possible to have a contract without express terms but with all implied terms. There are broadly two types of implied terms. The first is a term implied as a matter of fact. The second is a term implied as a matter of law.

A term implied as a matter of fact is to assist the parties in facilitating their commercial agreement.

Courts will imply terms to contracts so as to allow the parties to honour their obligations and enforce their rights. In this context the court looks at the contract and sees what terms need to be implied to it to make it commercially effective.

There are three main circumstances where courts will imply terms as a matter of fact. They are as follows:

There are certain terms implied by law.

Terms implied by law are, for example, that corporations providing goods and services must provide those goods and services in a way that is fit for the purpose for which they are required. Goods must be of merchantable quality and services must fulfil their requirements.

Similarly, there is a term implied in all commercial contracts of good faith and reasonableness. That is, all parties to the contract must behave reasonably and good faith in relation to their counterparties.

These are legal principles that are implied in every contract. In some circumstances they can be contracted out, but this is quite rare. It is generally considered as a matter of law that implying terms of this type is a good thing in contracts because it assists parties in honouring their obligations and exercising their rights fairly, justly and appropriately.

If a court was invited to determine this dispute, it is possible it would imply a term to the contract that delivery must be within business hours. This is to give business efficacy or effect to the contract. While the parties do not expressly contemplate in their agreement times of a day when a delivery may be made, a court may consider the delivery time being at Carbon Refining’s discretion to be uncommercial. Bear in mind here, the general rule is to give practical business effect to the contract.

It is possible a court may find that alleged termination of the contract by Inky’s, given the technical and inconsequential nature of the breaches fails to meet this obligation of good faith and reasonableness. Inky’s is neither showing good faith or reasonableness in relying on these minor breaches as a basis to attempt to terminate the contract. Again, the court has implied a term to give the contract business efficacy and to give effect the bargain between the parties.

It is the general tenor of the law not to let parties avoid contractual obligations and commitments on the basis of minor and trifling breaches by another party. The purpose of a contract and the impact of the breach on the party are matters that the court may closely consider.

Formalities

Some contracts must be formalised in writing as a matter of law. These contracts tend to be important contracts dealing with significant commercial issues like the sale or purchase of land, agency agreements or certain significant commercial promises.

From blurry to precise — the evolution of contracts

As stated above, a written contract is vastly preferable to an oral contract in almost every regard. In this sense I have broadly identified eight stages of a contract going from uncertainty to certainty. Each of these types of contract is enforceable. Each of them is binding. The emphasis here is on being able to clearly, precisely and categorically identify relevant contractual terms. In general terms the greater clarity the better your position is.

Figure 2.4 represents the evolution of contracts as I see them in the evolution of certainty. Each of these forms of contracts are dealt with throughout this book in greater detail.

The essential message here is that detail is important and valuable.

Using examples to illustrate the movement from uncertainty to clarity, each of these stages is set out in the following pages.

Oral contract

An oral contract is one reached by a conversation and no more.

John will be mired in a puddle of uncertainty. It is likely there will be two substantially different versions of events as to the oral contract. It is possible there will be different views as to what the contract was. John has a significant problem in establishing the terms of the contract, let alone their breach.

Oral contract confirmed in writing

This is when an oral contract is reached and later confirmed in writing.

Jane has wisely sought to record in writing the agreement between the parties. While the contract is oral, and the later email is merely a record of it, it substantially improves her position in the event there is a dispute about the subject matter or the performance of the contract. This is because the electrician conducted the work after he received the email and read it.

A contract with a mix of oral and written terms

This is when some of the terms are in writing whereas others are oral and not recorded anywhere.

This is a situation where there is a mix of oral and written terms of the contract. The initial retainer only sets out or represents part of the ultimate deal done between the parties. There was a variation and expansion of the contract halfway through, which was oral. Again, this is as enforceable as a written variation subject to it being proved by the party seeking to enforce it.

Again, the party seeking to enforce this part of the contract will suffer the same potential difficulties as a party seeking to enforce an oral contract.

Informal contract in writing

Happy’s position is substantially improved by there being terms in writing that were initialled by representatives of both parties even though not in the terms of a formal and fully considered agreement. Hopefully the document will be sufficiently clear to state what the parties are to do even though it may be eccentric in form.

Heads of agreement

An agreement of this kind is a stepping stone to something more complete and generally formal.

In essence, the agreement keeps Big Bank’s options open. It is not obliged to report back to Little Bank at any stage as to the terms of the due diligence or whether it has been successful. The deal is a platform to allow a bigger deal to be done. Within itself, the deal is not for the transfer of any substantial asset but rather to allow further exclusive negotiations to continue.

Exchange of letters or assembling documents to compile a contract

In this instance a number of documents are assembled to reflect the contract as a whole.

This is a binding and enforceable contract when the two letters are assembled constituting the offer and acceptance. There were no other terms and conditions to be agreed or unresolved. It was a simple contract in brief terms setting out the deal.

Richard and Lemon had resolved all of their differences on an enforceable and fully concluded agreement.

Written agreement

As the name suggests, the deal is set out in full detail in a document signed or assented to by the all parties.

Deed

This is a different form of written agreement. It will generally look similar to a properly drafted written agreement, however it contains some additional formality. Without going into great detail, its primary difference is that it requires no consideration for it to be enforceable.

Now I am in the contract, when do I have to start performing it?

This will depend very much on the terms of the contract itself. Sensible negotiators will pay close attention to when their obligations under the contract start. This is an issue that can be of huge importance. This is dealt with more fully below.

There are generally three timing sequences as to when your obligations under the contract start:

In the first two categories the parties are immediately bound. In the third category the parties are not bound unless an agreement is entered into or a trigger event occurs.

Your commercial circumstances will dictate which of the three contracts you wish to enter into.

But we didn’t have a deal — I didn’t agree to that!

The boundaries between oral and written contracts can be fluid. A contract can exist that has a mix of written, oral and implied terms. This rarely arises when there is a formal document. Here the parties turn their minds to what all the rights and obligations of the parties are to be. Terms may also be implied, but rarely will oral terms be imported to such an agreement.

Where an agreement is by an exchange of letters or an ‘order and quote’ there is much greater scope for there being ambiguity in what is to be said and done.

You need to decide at the outset whether you wish to have a looser oral arrangement or something more formal. On the other hand you may not want an agreement and therefore no rights or obligations until a document is drawn up clearly, precisely and definitively setting out those rights and obligations. If this is the case, it is fundamentally important that you communicate this to your counterparty at the outset. This should preferably be done in writing. A short letter, fax or email to your negotiating counterparty telling them they should consider no agreement to be entered into until a deed, agreement or other identified form of document is negotiated, resolved and executed. This will avoid any uncertainty as to whether you have entered into a contract during the course of negotiations.

Of course there are two sides to every story. You may enter a negotiation on the assumption that you have no obligation to be bound until a formal deed is signed, sealed and delivered. Your counterparty may not share this assumption. On this basis they may take steps immediately after the negotiation on the assumption an oral contract has been entered into. This can be a cause of great heartache and dispute.

This potential unpleasantness can be avoided by a simple statement at the start advising that at no stage should any contract be considered to be entered into by the parties unless it is set out in writing or the trigger event has occurred.

An oral statement to this effect is as valid as if it is in writing. However, you come across the same problem in relation to oral contracts. It is much easier to prove your position if it is in writing. A conversation can be the subject of dispute and your counterparty may deny you ever said what you did.

There is a risk in any context when talking about contracts where your intention, desire or position is not set out in clear and unambiguous written terms.

That document doesn’t reflect what we agreed — how do I fix it?

There is a basis for having an agreement that does not reflect the bargain struck between the parties fixed. However, it is extremely difficult. This circumstance often arises where there are different levels of sophistication with the contracting parties. If there is a party who regularly enters into detailed written contracts and who understands the ways of contracting in sophisticated terms, and a party on the other side who is less knowledgeable, it may be that the sophisticate is able to get the honest but naïve party to sign an agreement that may not reflect those terms and be more beneficial to the sophisticate.

It may be necessary for the small haulage company to seek rectification of the agreement so the written agreement reflects the deal done between the parties. The deal in the document does not reflect the commercial terms agreed. Either by deceptiveness or a unilateral renegotiation of the contract, the infinitely more experienced waste management company did not incorporate the deal agreed in the document.

Putting aside issues of commercial honesty and ethics, it may be possible for the party in the weaker position to seek to rewrite the terms of the contract so that it reflects the agreement struck.

It is necessary in this context for the party who complains the agreement does not reflect the deal to set out in clear terms what the contract should have said. It will then need to prove that the agreement was in the terms it alleges. This, yet again, is easier said than done. Often the more sophisticated party will simply rely on the contract and say with a shrug of the shoulders, ‘The contract is the contract! It is what we agreed. There is no basis for it to be rectified.’

It is hard to show that a written agreement does not reflect the true bargain struck between the parties. The precise circumstances of the negotiation and, often more importantly, the execution of the agreement will be critical. You will need to gather all the information you can explaining the circumstances under which the contract was negotiated and executed. That explanation will need to be sufficiently credible.

A court will not rectify the contract merely because you do not like the way it is expressed or because it seems to be favouring one party more than the other. If the agreement reflects the deal struck between the parties in general terms, the court will not rectify the agreement.

It is extremely important that you closely scrutinise the terms of the contract prior to entering into it. There is no part of a contract that is unnecessary to closely read. There is no aspect of the agreement that is immaterial or unimportant.

There is no easy way to fix a bad contract that you believe does not represent the deal you struck with the counterparty. Bear this in mind at the front end of the negotiation and, more particularly, when the deal is being documented. This will save you significant heartache, anguish and potentially significant sums of money during the course of the contract (not to mention the benefit of avoiding court proceedings!).

I am not happy — how do I get out?

There are broadly two ways to terminate the contract.

They are for breach by the other party or under a right of termination in the agreement itself.

The law provides that if there is a significantly serious breach by the other party to the contract you have a right to terminate it and sue them for damages you have suffered as a result of their breach. It is important that this right is only conferred in relation to serious breaches. Minor or trifling breaches do not allow you to terminate the contract. You may still have a right to claim damages for those breaches but you cannot terminate your rights and obligations under the agreement.

This applies equally to all parties under a contract.

The alternate course is where there is a right under the agreement for parties to terminate. These rights are generally in one of two circumstances. The first is a right to terminate for no cause at all on a reasonable period of notice (generally identified in the agreement as being 30, 60 or 90 days). There is no magic to this time frame. It is a matter to be agreed between the parties.

The other type of a termination clause is termination for material or substantial breach. This largely conforms to the right conferred at law generally to allow a party to terminate a contract for breach of its terms.

The contract is terminated — what does this mean?

The termination of a contract is effectively the death of it. It means your rights and obligations under it dissolve.

There are some contracts with terms that have a survivorship after the contract is terminated. However, these terms are generally in the nature of preservation of business records or passive obligations. It is extremely rare for a contract to be terminated and there to remain active obligations after it has ended.

However, it is important that any legal rights for damages or other claims that have accrued by one party against the other survive termination.

Often parties see it as commercially necessary to terminate the agreement and then sue for breach. It is an unsatisfactory position to be caught in litigation with your counterparty yet the parties still have subsisting contractual rights and obligations. Human nature seems to stop people on one hand remaining amicable and friendly in a contract while on the other hand being locked in mortal combat in court proceedings.

I know it’s not a fair contract but they agreed to it!

Generally speaking parties can agree any terms of the contract they like. This is subject to the contract being ‘legal’ as set out below.

It is a fact of capitalist commercial life that there is often a disparity of leverage or negotiating power when entering into a contract.

There is nothing wrong at law with a contract of this kind.

There is nothing legally obliging you to be nice to your counterparty in the negotiations.

A key factor the court looks to when assessing contracts like this is whether they are at ‘arm’s length’. This means there is no duress or unconscionable conduct in entering into the contract. If the weaker party elects, on the basis of all relevant information, to not enter into the contract the court will be generally loath to set it aside.

This is because it is an exercise of free will. It may not be a desirable contract in terms, but it was open to the weaker contracting party to reject it.

In various statutes in the states of Australia there are laws that moderate the operation of this general principle. They give the court power to set aside or actually rewrite ‘unfair’ contracts.

However, this aspect of the law is rarely used successfully in relation to commercial contracts.

Take the rubber farmer example. The fact that the rubber farmer could have refused the contract (albeit subject to substantial commercial pain) would be a significant factor weighing against a court rewriting a contract between it and the manufacturing company.

On the other hand if a mortgage was entered into by a lender with two elderly people who spoke English as a second language and who did not obtain any legal advice, a court may set aside or rewrite the mortgage on the basis that there was unfair bargaining power and therefore, in broad terms, the contract is unfair.

While there is no law compelling a party to be nice to their other party in negotiating a contract, this is not quite as clear when the contract is entered into.

As a matter of law there is an obligation of good faith and reasonableness implied in all contracts. While not expressly stated as a ‘be nice’ clause, it may have this effect. It imposes a general obligation on a party to show good faith and be reasonable in performing the contract. That could mean letting go minor or technical breaches. Importantly this clause will effect a party’s right to terminate this contract for breach. Also it may limit rights to damages a party may have for relatively minor breaches by the counterparties.

A court will most likely find the implied term has been breached.

This legal principle moderates the otherwise harsh cold commercial world of contracts where there is no obligation to help counterparties. This principle of law is in line with a broader and more contemporary theory of contracts. That is, both parties are working to a common end. A more traditional theory was that contracts were adversarial and that everyone was out to benefit themselves. You still have no obligation at law at all to assist your counterparty. While, as stated above, the law is not clearly stated in these terms, it may be considered the practical effect of good faith and reasonableness.

However, it is important to note that courts are unlikely to compel you to waive large breaches of a contract or failures by the other party to perform their obligations properly. The compulsion to be ‘reasonable’ will arise in instances of relatively minor breaches or issues under the contract. It means a party cannot opportunistically seize upon minor breaches or infringements for its own advantage.

What are illegal contracts?

An illegal contract is an agreement that obliges one or both of the parties to breach the law. On the other hand, the contract itself may infringe. The illegality of a contract does not necessarily refer to its precise terms and conditions. It generally goes to the subject matter of the contract. A contract to commit a crime is an illegal contract and not enforceable. It is important to analyse the subject matter of your contract and consider whether it is in breach of any statutes or law. If it is, there is real risk the contract will be unenforceable.

This conduct is anti-competitive under the Trade Practices Act. It would not be possible for We Dump to go to court to seek to enforce this agreement because the agreement itself is illegal. It is not legal or proper at law to use market power to exclude a competitor in this way by ganging up on them.

While We Dump may be extremely unhappy their plan has been foiled, they have no legal remedy. A court will not enforce a contract that is illegal.

In fact, it may be much worse than this. If they were sufficiently unwise and badly advised to commence proceedings, it is likely the case would be summarily thrown out and that they would be referred to the Australian Competition and Consumer Commission (ACCC) for prosecution for breach of the Trade Practices Act.

This can have serious consequences for you and your organisation if you unwittingly enter into an illegal contract and lose under it. It may be that you have no rights under that contract and no right of redress or remedy against the breaching party. This is because the court will consider the agreement itself to have been illegal and either void from the outset (in effect not existing at any time at all) or, secondly, to be unenforceable.

This is made all the more disadvantageous if you entered the agreement without knowledge that the subject matter of the contract was illegal and lost a lot of money as a result of its breach.

Horses for courses — types of contracts

There are a vast number of commercial contracts that parties enter into. These include:

• Lease — a lease is an agreement where a landowner confers on another person or entity a right to sole and exclusive possession of land. While the landowner remains the owner of the land, it does not have a right to possession of that land during the course of the lease. The lease generally sets out the terms and conditions upon which the tenant can occupy the land. Depending on the nature of the land and the general circumstances, these terms and conditions may be more or less onerous.
• Licences — a licence is a right to use a particular piece of property, including land. It may be a license to use intellectual property such as a trademark or a work that is copyrighted. A licence sets out the terms and conditions upon which the right is conferred. Obviously the key elements are the fee for the licence, the duration of it, and the uses that the licensee (or the person getting the licence) will be restricted to using the property for. Licences can be granted in general terms in relation to any form of property.
• Guarantees — a guarantee is an agreement by a person to stand behind or support another person or entity.

  Example

  Lots of Land Pty Ltd owns a commercial building in the city. Soft Hands Physiotherapy Pty Ltd wants to lease space from Lots of Land. Lots of Land looks at the accounts of Soft Hands Physiotherapy and it forms doubts about the solvency of that company going ahead. It seems as though it does not have any substantial assets and is incurring debts in the conduct of its business. Lots of Land is concerned that Soft Hands will not be able to pay the rent at some stage during the course of the lease. Lots of Land requires that the directors, shareholders or related people of Soft Hands give personal guarantees that, if Soft Hands cannot pay the rent, they will do so. That will mean they will be putting their personal assets at risk so as to ensure Lots of Land suffers no loss if Soft Hands cannot meet its obligations to pay rent under the lease.

• Indemnity — an indemnity is like a guarantee in that it provides a safety net. If a party indemnifies another it means that the indemnifying party will cover any losses or damage that the indemnified party suffers.

  Example

  Happy Insurance Pty Ltd confers a policy on John Smith in relation to motor accident damage. John Smith has a car crash. It was his fault and he claims on his insurance policy. The policy is an indemnity to cover him for any loss he suffers as a result of his conduct in driving his car. The insurance company pays out on the indemnity. That means it makes good all damage he has suffered and the damage to the other car. The policy has indemnified him or covered him for the loss.

• Mortgages — a mortgage is a document that protects a lender of money by giving them a potential right over land owned by the borrower. A mortgage means that the lender has an interest in the land. It generally gives the lender a right to sell if the borrower does not repay part or all of the loan funds.

  Example

  Jim wants to borrow $100 000 from Big Bank and offers his house as collateral. Jim owns the house with no money owed on it and Big Bank accepts the house as security for the loan. Jim signs a mortgage that is relevantly registered against his ownership of the land. The mortgage provides that if Jim does not repay part or all of the money loaned, the bank may take possession of the house and sell it to recover the loan amount, any interest and its costs associated with the sale process. This is a mortgage document. Jim is called the mortgager and the bank is called the mortgagee.

  Using the same Big Bank example, if Jim had an expensive car or a valuable piece of plant or equipment, he may confer a charge on Big Bank as security for the loan in similar terms. While there are significant legal differences between mortgages and charges, given that the security in either instance is different (land as against some other property), the general concept is the same.

• Charges — charges are similar to mortgages but are in relation to property more generally. While charges can be over land, they are generally over other items of property like plant and equipment, companies or intellectual property rights.
• Agreements for services — these are agreements for providing professional and other services by a company, person or entity. They have common elements such as identifying the nature of the services to be provided, the price of those services, when the service is to be provided, who is to provide it and a termination date of the agreement if that is appropriate.
• Agreements for goods — like an agreement for service, an agreement for goods generally stipulates what the goods are (the subject matter of the agreement), when they are to be provided, the price, the quality or nature of the goods and any warranties or indemnities in relation to providing the goods.
• Shareholders’ agreements — a shareholders’ agreement is an agreement between shareholders and a company. A company is a separate legal entity from its shareholders. A shareholder owns part of the company (in the form of shares). Sometimes shareholders enter into agreements with companies setting out the terms and conditions of their relationship. It is not absolutely necessary for shareholders’ agreements to be entered into. However, in a range of commercial circumstances, and with larger companies, shareholders’ agreements can be an extremely valuable and a clear way in which the company can obtain certainty as to the conduct of its shareholders and the shareholders obtain express and clear benefits.
• Directors’ and officers’ agreements — again, these agreements generally relate to the conduct of a company’s business affairs. Directors and officers are the controlling mind of the company. They often enter into agreements with companies in express and clear terms setting out such matters as their remuneration and their duties. An important part of directors’ and officers’ agreements can also be indemnities from the company covering those directors or officers for any loss caused by their conduct in the absence of fraud or reckless disregard of their duties.
• Joint venture agreements — a joint venture agreement is a deal done between two or more parties that consigns them to the undertaking of a commercial endeavour with a common purpose. It is not a company, partnership or other legal entity. It is a statement of a number of parties coming together to undertake some commercial deal. Regularly, joint ventures are undertaken in relation to land development. The agreement sets out the rights, liabilities and entitlements of the parties and generally sets out their respective contributions. Joint venture agreements should contain more rather than less detail. The more clearly the rights, liabilities and entitlements of the joint ventures are set out, the less the chance for a dispute and the more efficient their ability to resolve any disputes that arise.
• Partnerships — a partnership is a form of legal entity where a number of people come together to conduct a business or undertaking. It is a particular term at law and partnerships have large body of law that regulates the way in which they can conduct business.
• Contracts for sale of land — this is a contract that deals solely with the transfer of ownership in land from one person or entity to another. Again, there is a complex and detailed body of law regulating the manner in which contracts for sale of land take place.
• Contracts for sale of business — these are contracts by which ownership of businesses changes hands. While there are legal requirements in relation to the sales of business, they are less mandatory than in the context of land. There is much more commercial flexibility in negotiating contracts for sales of businesses between the parties to the transaction.
• Contracts for sale of personal property — again, there is much greater flexibility in parties negotiating a contract for the sale of a piece of personal property. By personal property I mean anything that is not land or a business. It may be the sale of a large piece of plant or equipment or a valuable gem. The subject matter of contracts in these terms is limited solely by the range and nature of property people can own.
• Employment contracts — this is a contract setting out a relationship between an employer and an employee. Again, there is a long, detailed and complex body of law in relation to contracts in employment. They closely regulate the relationship between the employer and the employee. There are a number of legal terms implied in a contract of employment. On this basis, contracts of employment can be in fairly short form and look informal in that they are by way of letter. However, a contract of employment is like an iceberg. What is not in the contract but implied in it is a matter of law is as important as what the words say themselves.
• Management agreements — these agreements regulate the management of a company, business or thing. There has been a growth in management agreements in the past 20 years, by the growth in outsourcing. Companies and businesses are now seeking to have administrative parts of their business conducted by other specialist companies or entities and a management agreement sets out the terms and conditions of that work being undertaken.
• Restraints — a restraint is a contractual obligation imposed on a person not to do a certain thing. Restraints must set out with absolute clarity what the restraint is, that is, what the person will not do, the duration for which they are restrained from any conduct and whether they are to be compensated for the restraint. Restraints may be standalone documents or incorporated in other agreements.

  Example

  Richard enters into an employment agreement with New Era Electronics to develop LCD televisions. In the contract of employment Richard agrees that upon termination of the contract by him or the employer he will not work in the LCD television industry for six months from the date of termination. As a result of this, New Era Electronics agrees to pay him six months’ salary at the rate of pay he is receiving at the time of termination so as to cover his exclusion from the market. The restraint only restricts Richard from working in the LCD development industry. He could work as an IT professional or in any other capacity other than in research and development with LCD televisions. The benefit for the employer is to take Richard out of the market so his skills and attributes are not immediately accessible by a competitor. The employer is willing to pay for this benefit. This is a restraint. It is seeking to restrain Richard from competing with it.

  There is a significant body of law in relation to restraints and enforceability of them. There is no ‘perfect’ restraint. The circumstances in which the party entered into the agreement, the relative bargaining positions they had, the subject matter of the restraint, whether compensation has been paid and the intended conduct of the party bound by the restraint are all material matters relevant to whether the restraint will be enforced or not.

• Share sale agreements — this is an agreement whereby shares in a company are sold from one person or entity to another. This corresponds to a sale of business agreement, however shares in a company are property that can be bought and sold. They are equity or part ownership in that company. Share sale agreements bear many of the hallmarks and contents of other agreements for the sale of goods and services.

This is a mere sample of the vast range of commercial agreements and instruments parties can enter. There is an almost endless range of contracts in the commercial world that parties can do deals in. It is important to bear in mind that labels given to contracts are often merely descriptive. They implicitly set out the subject matter of the contract and its terms. For example, a guarantee will have certain standard terms and conditions. This is different from a mortgage that will in turn will be different to a partnership agreement that will be yet in turn different from restraint.

There is no set limit of categories of contracts at law. These labels have grown by evolution as descriptions merely of the nature and type of contract a party or parties enter into.

The majesty of master agreements

An agreement that is regularly used — and can be of great assistance in business — is a master agreement. A master agreement is a set of terms and conditions setting out the rules of the game as to the commercial relationship between two parties. It does not oblige one party to buy a good or service from another. It merely says that if an order is placed, this is the way the commercial relationship will be regulated.

Master agreements are of great value when you regularly use the good or service of a supplier or service provider and the good or service is sought at short notice.

It means you do not need to negotiate a new agreement on each occasion. A master agreement will usually set out:

• the standard of quality of the good or service to be provided
• how long after an order the good or service is to be provided
• how the good or service is to be delivered
• terms of invoicing and bulk discounts
• what happens in the event of a dispute.

This will enable you to make a quick, prompt and efficient order for the good or service without there being a residual fear that any of these issues have not been resolved.

It has been traditionally thought that a master agreement is more favourable for the provider of a good or service. This is because master agreements are not usually issued by purchasers of goods and services and have often not been given great scrutiny by purchasers.

A master agreement can work as effectively for a purchaser of goods or services on the basis that they negotiate it properly at the outset of the relationship.

Master agreements are usually prepared by providers of goods or services and presented to purchasers as a done deal. Against their personal interest, the user of the good or service merely accepts the terms of the master agreement on the basis they are ‘standard’ terms and conditions. There is no such thing as standard terms and conditions.

With contracts, subject to statutory or legal obligations, everything is at play. All terms and conditions can be negotiated. It is important as a user of goods or services that you closely consider the terms of the master agreement and assess its commercial implications. You are always able to negotiate these terms and conditions with the provider of the good or service. The extent to which they are willing to negotiate should regulate your eagerness to contract with them!

This is a bad deal — how do I save myself?

Sometimes the best of intentions just aren’t enough.

Regrettably there are instances where a party simply cannot perform their obligations under the contract. Try as they might and using absolute goodwill, circumstances are beyond their control. This is a lamentable situation for both parties to the contract. Neither obtain the benefit of it. There are certain legal avenues available to a party in order to alter or transfer rights and obligations so as to minimise the pain, inconvenience and commercial damage they suffer.

Variation of the contract

The parties to a contract have absolute power and ability to vary the terms of their bargain. It is a matter addressed in further negotiations.

Variation of contracts is a regular feature in the commercial world. With changing circumstances for both buyers and sellers of goods and services, the respective demands change and with that, their contractual needs.

The key element is goodwill on both sides. It takes a degree of maturity and a good relationship in the contract to understand that your counterparty is experiencing difficulties and agree to a variation.

This is an excellent way to avoid a potential breach. The steps in resolving a dispute by variation of a contract are as follows:

Variations to agreements can be oral or in writing. However, I again expose my prejudice for written agreements. An oral agreement is no less enforceable. There are similar problems to proving oral variations as apply to establishing the primary agreement. Parties may have two different opinions about what was said and as a consequence what impact that had on the parties’ rights and obligations. In order to avoid any uncertainty in these terms it is always better to have the agreement put into writing so the terms and conditions are clear. Both parties get a chance to consider what is put down on the page as being the variation.

Oral variations are difficult to prove. Generally speaking a party seeking a variation of a contract is the one benefited by it. Their version of events always helps them. That arouses suspicions in a court’s mind as to whether the party is being truly frank and honest on the variation of the contract. Regularly courts seem to ask themselves if this is so important to that person, why did they not put it in writing so that it was beyond doubt? The absence of writing on an important variation of contract may work strongly against the party who is seeking to rely on the variation in the context of a subsequent dispute.

Transfer and novation

The law allows contractual rights and obligations to be transferred. This is a novation. However, a novation of contract requires agreement of everyone. All parties to the contract agree for one party to step in the shoes of another.

A novation can be in favour of a buyer or seller of goods or services. That is the buyer may want to novate or transfer their rights to a related party in their companies or to some other entities. Subject to the seller of the goods or services being satisfied as to the commercial circumstances of the incoming party, it may agree to the novation. It is generally done by way of a deed or detailed written agreement.

A novation can be an excellent way to avoid the consequences of a breach of a contract that cannot be honoured by one party when there is another who can step into their shoes to make sure no-one suffers any loss. It can be an excellent technique to be used by a party who, for good reason or bad, no longer wishes to be bound by the contract. However, the circumstances in which a novation is sought are important. A party novating a contract (or removing obligations and rights under it) must be sure that all of their obligations pass, any rights they still want are preserved and they get an indemnity and a release. The indemnity is from the incoming party agreeing to cover you for any liability you suffer as a result of the novation. The release is from the other contracting party (your former counterparty) from any claims or other allegations they assert against you in relation to prior breaches of the contract.

As a term of the novation, John Smith may seek an indemnity from Silky that any loss he suffers arising from the unsatisfactory or defective performance of the contract by Three Men and a Modem will be covered by it. If Silky is confident that Three Men and a Modem can do the job and therefore there will be no sustainable or credible claim by John Smith Accounting, it may give this indemnity. It is confident it will never have to pay out under it. This indemnity may oil the wheels of the deal on the novation by giving John Smith the safety net he wants so as to ensure that he is no worse off.

Part of the point of a novation of contract is to obtain a clean break. You are removed from the contractual relationship. To the best extent possible you need to take every step you can to ensure there are no lingering obligations or rights that sit with you or your counterparty.

This may not always be possible to secure. There is no entitlement either commercially or at law to do it.

If you are seeking a novation of the contract on the basis you cannot perform your obligations and it is a ‘get out of jail’, you may have relatively little leverage to require an indemnity and release and waiver. This will mean the incoming party will not indemnify you for any loss that it suffers. On the other hand, the old counterparty to the contractual relationship you are leaving may say it will not give you a release and waiver. This heightens your commercial risk. However, on balance and in circumstances where a ‘get out of jail’ is necessary, this is risk a party may have to take.

This is not a hard-and-fast rule. It is necessary for you to consider closely what prospective liabilities exist against you as at the time of the novation. The more sizeable the liability the less emphasis you should place on novation and the more you should look at other solutions to your commercial difficulties.

But they are just standard terms!

There are no standard terms in an agreement. There is nothing the other side can say to you that is ‘an industry standard’ and is therefore legally required.

Terms that are legally required in contracts are generally implied as a matter of law. That means they do not need to be stated in the contract. They are in there no matter what. The law says so.

All contractual terms are open to negotiation. If your counterparty is telling you that the law requires terms that are favourable to them and onerous to you, this is generally a negotiating tactic. It will require a close analysis of the term itself and the relevant legal principles. However, as a general rule, they are seeking to coerce you into a position where you do a deal that is better for them and worse for you by alleging that the way the clause has been drafted is out of their hands — it is a legal requirement.

More often than not this is a bluff. Closely review these clauses. Seek legal advice if you have to.

The hot tips

• A contract has many elements — they are all part of both the springboard and the safety net and you need all parts combining in the right balance in the commercial circumstances to make a successful whole.
• Beware of oral contracts — they have a danger within them. Do you want to be in an I say/you say fight where you can’t control the outcome?
• All contracts are equal — don’t treat an oral contract as being any less important.
• Offer and acceptance — you need a perfect match.
• Keep it in writing with as much detail as possible — ‘less is more’ is not a theory of contract writing or negotiation!
• Pay attention to the terms — does the written contract match the deal you’ve done? Fixing up a contract that is wrong is easier said than done. You need to convince a court of what the deal was and how it should be expressed — these are two big hurdles to jump.
• Terminating a contract is not like your first boyfriend or girlfriend — the ‘it’s not you, it’s me’ line does not work. You can’t exit when you want to. You’ve done a deal and are bound subject to how well you’ve negotiated the termination provisions.
• Maximise your flexibility to get out — do your best to ensure termination provisions are as flexible as possible for you yet as inflexible as possible for your counterparty.
• Think closely about termination — a rocky period does not necessarily mean the contract is all bad. Does terminating suit your grand plan?
• Make sure you have a replacement to fulfil the job being done by your soon-to-be-severed counterparty — a contract can be varied but requires the agreement of all parties. You can’t unilaterally change the terms to suit your new commercial circumstances or improve your deal.
• Beware of terms implied by law — what is implied at law depends on the nature of the contract. Get advice on this issue. There are unseen dangers in terms implied by law that non-lawyers understandably do not know. Don’t fall victim to this trap.
• You can transfer or novate the contract but you need agreement of everyone — this may be a fix for a bad deal or unpleasant circumstances but only when everyone agrees.
• There are no ‘standard’ terms that are mandatory — except terms implied by law, everything is up for negotiation. Whether you can shake someone from the ‘standard terms’ mantra depends on your leverage and commercial position. Think about this in detail if you are met with the ‘these are our standard terms’ line.