Practical Law PLC 6.2.09

Background

Where the parties are intending to execute a formal agreement, the courts will normally infer that the parties do not intend to be bound by that document unless and until both of them sign it. However, that inference will change if the facts change, so that the court can objectively find, on a balance of probabilities, that the parties have changed their minds, and now intend to be contractually bound immediately and not following formal execution of the document (paragraph 2-116, Chitty on Contracts

Facts

The claimant (G) and the defendant (B) each held a 50% shareholding in a company of which they were both directors. Under the terms of a shareholders' agreement between G and B, if either G or B became unable to work for more than six months because of long-term sickness, the affected shareholder would sell the shares to the other. G became ill in March 2006 and was absent from work until late November 2006. On G's return to work, it was agreed that the shareholders' agreement had been triggered, and that B would buy G's shareholding in the company.

A draft agreement for the purchase of G's shares (draft agreement) was drawn up but was never signed by the parties, although, at the time it was drafted, they intended to do so. While the negotiations of the contract were taking place, B began to exclude G from the business of the company. By January 2007, B was running the business to the complete exclusion of G.

On 30 January 2007, B's agent sent G an e-mail (30 January e-mail) confirming that B was willing to proceed with the purchase of the shares on the basis of the terms of the draft agreement, and asking G to confirm whether he accepted these terms. On 2 February 2007, G confirmed by e-mail to B's agent (2 February e-mail) that he was prepared to accept the terms of the draft agreement.

B subsequently claimed that he was not bound to buy G's shares as the draft agreement was never signed. G issued proceedings against B to enforce the sale, arguing that a binding contract had been concluded.

Decision

The judge found that there was a binding contract between B and G.

B had taken control of the company and effectively forced G into resigning as director, which meant that B was effectively taking all the benefit of G's shares without owning the shares themselves. The judge considered that it would defy commercial reality and the objective intention of the parties to say that in the circumstances of the case the parties still intended that they should not be contractually bound unless and until a document in final form that was entirely agreed was executed.

The judge considered the case of G Percy Trentham Limited v Archital Luxfer Limited [1993] 1 Lloyds Law Reports 25, in which Steyn LJ made the following points:

• English law generally adopts an objective theory of contract formation. The governing criterion is the reasonable expectation of honest men.

• The fact that the contract in that case was executed, rather than executory, was an important consideration on a number of levels. In a case where the transaction was fully performed, the argument that there was no evidence on which the judge could find that a contract was proved was implausible. The courts ought to be realistic about the practical application of rules of contract formation: it was important not to lose sight of the commercial transaction.

The judge considered that, applying G Percy Trentham Limited v Archital Luxfer, the yardstick had to be the reasonable expectations of sensible businessmen. He accepted that, up to 30 January 2007, B and G had not intended to be contractually bound unless and until the draft agreement was agreed and executed. However, on the facts, the situation changed when the 30 January e-mail was sent. Objectively analysed, the 30 January e-mail could not be regarded as being conditional on the execution of the draft agreement, but was an offer which G accepted by the 2 February e-mail. There was nothing that still needed to be agreed, and there was no suggestion that the negotiations had at any stage been expressly or implicitly stated to be subject to contract.

Therefore, a binding contract came into force through the offer and acceptance contained in the 30 January and 2 February e-mails for the sale of G's shares to B, on the terms and at the price set out in the draft agreement.

Comment

If the parties do not want to be bound by an agreement unless and until it is executed, they should state expressly that the agreement is "subject to contract". They should also avoid beginning to carry out its terms in anticipation of execution: if the parties are effectively performing the contract, and a party is benefiting from it, the courts are more likely to find a binding contract to ensure a fair result.