2 THE CONSTRUCTION CONTRACT

Defining a contract

While this book deals with those situations arising in construction contracts which give rise to a remedy at law, it is essential that a review of the fundamentals of the law of contracts be completed first. The words “contract” and “agreement” are synonymous and it is in the word “agreement” that the true nature of contracts arises. “Has there been an agreement?” is the essence of all contract disputes because without the parties’ agreeing on what has to be done and for what price (consideration) there can be nothing to enforce, i.e. there can be no remedy at law. Building contracts do not enjoy any special status and the fundamental requirements for contract formation established by the common law apply to all contracts. Thus, any contract is considered as formed if there has been a proper offer, which was validly accepted and the contracting parties have legal capacity to enter into a contract, as well as having the requisite intention to enter into the contract. Once this is established it will be necessary to determine whether the contract is supported by consideration and, in certain limited circumstances, whether the contract is in writing. Finally, the issue arises as to whether the contract is for an illegal or legal purpose.¹

An agreement is reached when an offer, which is capable of “immediate” acceptance, is without qualification accepted. Further, the parties who are “doing the agreeing” must have the necessary capacity to contract and the contract must not be indeterminate, impossible or illegal. All contract law is based on the Latin principle pacta sunt servanda, i.e. that “pacts must be kept”, which is just another way of saying that agreements, once made, must be kept which in turn means that once an agreement (contract) comes into existence any breach is recognised and a remedy is available to the non-breaching party.

Generally, contracts need not be in writing in order to be enforced so long as the goods and/or services, which have been agreed, are legal. An oral agreement between two parties can constitute a binding legal contract. Needless to say, a written agreement is best in terms of showing what the parties agreed; however, most contracts are oral, such as when you buy a cup of coffee or a newspaper and you agree to pay an agreed price. While oral contracts are allowable under certain jurisdictions certain transactions must be in writing such as the purchase of property. But in essence a contract or agreement is nothing more than a way of setting forth the rights and obligations of the parties to the agreement so that what they have agreed upon can be enforced if either party ignores what has been agreed.

The law relating to contracts is not just a common law concept and is equally relevant in civil law and other countries with different rules applying depending upon the jurisdiction, e.g. Sharia law.

Offer and acceptance

Under the common law, the requirements for the creation of a contract are the actual offer and acceptance, which is the reaching of an agreement followed closely by the necessity for adequate consideration. Additionally, the parties must have the requisite intention to create a contract (rather than, say, to make a gift), the necessary legal capacity and finally, depending upon the jurisdiction, the necessary formalities (in writing, a deed, etc.). It should be noted that in civil law countries consideration is not necessarily as critical as it is in the common law jurisdictions.

Whether a contract has been formed was best discussed in the early case of Carlill v Carbolic Smoke Ball Company.² While not a construction case, it is still illustrative of the elements necessary for a valid offer and acceptance to exist, thus forming a contract. In that early case a medical firm advertised that its smoke ball would prevent those who used it, according to the instructions, from catching the flu and if it did not, buyers would receive £100. The Carbolic Smoke Ball Company then also stated that they had deposited £1,000 in the bank to show their good faith. Unfortunately, Mrs Louisa Elizabeth Carlill bought the smoke ball, used it and still caught the flu. Thereafter she promptly commenced proceedings against the company. Carbolic argued the advertisement was not to be taken as a serious, legally binding offer. It was merely an “invitation to treat” and a “mere puff”. The court held, however, that it would appear to a reasonable man that Carbolic had made a serious offer, primarily because of the reference to the £1,000 deposited into the bank. People had given good “consideration” for it by going to the “distinct inconvenience” of using a faulty product. The court further wrote: “Read the advertisement how you will, and twist it about as you will here is a distinct promise expressed in language which is perfectly unmistakable.”

Carbolic used the phrase “invitation to treat” which comes from the Latin phrase invitatio ad offerendum, meaning “inviting an offer”. In effect it is “an expression of willingness to negotiate. A person making an invitation to treat does not intend to be bound as soon as it is accepted by the person to whom the statement is addressed”.³ This should be distinguished from what is referred to as a “binding offer” which, when accepted, becomes a binding contract.

The distinction between an offer and invitation to treat include newspaper advertisements, giving a price at an auction or, more importantly for the purposes of this book, in construction settings an invitation for tenders.

Another way of analysing this is to understand that when a product is advertised in a newspaper or magazine, while it can be considered an offer, more than likely it will be treated as an invitation to treat. In other words, an invitation to tender offers for acceptance by the advertiser. This concept goes back to Partridge v Crittenden,⁴ where the appellant advertised to sell wild birds but was not in fact offering to sell them. The court held that it did not make “business sense” for advertisements to be offers, as the person making the advertisement may find himself in a situation where he would be contractually obliged to sell more goods than he actually owned. In Carbolic Smoke Ball,⁵ the difference was that a reward was included in the advertisement.

What the courts are looking for is whether the parties really ever had what is referred to as a “meeting of the minds”. To capture the essence of this picture, let us consider two people haggling over the purchase of a donkey. The donkey owner says that he wants £100. The prospective purchaser says he will only pay £50 but will give the seller two chickens in addition to the money. The seller and buyer go back and forth until the prospective purchaser says he will pay £75 plus two chickens and will give the seller his shoes. The seller agrees – a meeting of the minds has occurred. Now take a more familiar situation. A contractor submits its tender offering to build a garage for £10,000. No mention is made of what the materials are to be, how long it will take to build, what the dimensions are to be. The owner rings back and says, “I accept!” Has there been a meeting of the minds? No, and for obvious reasons. Thus an agreement may be incomplete, as here, where the parties have agreed on the building of the garage but have not agreed on the other important points. While there are times the courts can imply the missing terms, if they are essential terms the agreement will fail. Additionally, there will generally be no contract if the parties agree “subject to contract” but never agree on the terms of the contract. A provision that certain terms are to be agreed from time to time, with no fallback as to what is to happen if agreement is not reached, may make an agreement so uncertain as to be unenforceable.

As can be seen from that example, the essential part of any contract is that the one making the offer must give sufficient detail so that once accepted it can be binding on both sides – a meeting of the minds of the parties concerned. Thus, there has to be some evidence that objectively the parties engaged in conduct manifesting their assent and a contract will be formed when the parties have met such a requirement. “Objective” in these situations is that the appearance of making an offer and/or accepting it is what counts, not a subjective view as to whether the parties really intended to enter into a contract.

As discussed in Carlill v Carbolic Smoke Ball Co,⁶ a “unilateral contract” obligation is only imposed upon one party upon acceptance by the performance of a condition and this can be either by actually performing the requested act or by promising to perform the requested act in the future.

Implied agreements

Many agreements arise specifically by an offer being made which is then accepted. This can be expressed either orally or in writing. A great number of agreements arise by what is termed “implication”. This type of contract is referred to as an “implied contract” and is one in which some of the terms are not expressed in words. An implied contract can take two forms. A contract which is implied in fact is one in which the circumstances imply that parties have reached an agreement even though they have not done so expressly. For example, asking a brick mason to build a chimney to a house implies an agreement to pay for the work done at a fair price. So if the chimney is built and the owner refuses to pay he will be held liable for breach of an implied contract to pay for the constructed chimney.

This sort of implied contract is also referred to as a “quasi-contract”, because it is not in fact a contract. Rather it is a legal mechanism of creating a contract that can be the basis for collection of monies due, thus allowing the courts to remedy situations in which one party would be unjustly enriched by not strictly adhering to the law of contracts. For example, a contractor asks for a variation on a project because the amount of concrete actually used on site is 20 per cent higher than shown on the Bill of Quantities and the employer receives the benefit of this mistake. The employer has been enriched unjustly and will be held liable for payment. This sort of claim is also referred to as one for “quantum meruit”.

Capacity

An additional element to any contract is whether or not the parties have the capacity to contract. This is a key issue and there is an assumption that every individual adult, company, partnership or other legal entity has the right to enter into contracts of their own free will. The issue arises, however, as certain categories of individual are not regarded as having full capacity, such as undischarged bankrupts, minors, i.e. persons under 18 years of age, and persons of unsound mind. Additionally, companies, corporations and unincorporated associations may not, in accordance with their own internal rules, have the capacity to enter into certain contracts. Contracts entered into with individuals and/or entities lacking capacity may be unenforceable. Generally, issues relating to the contractual capacity of parties to building contracts are rare and generally relate to the identity of the contracting parties, e.g. when a subcontractor operates both as a sole trader and as a limited company or where the employer operates through an agent.

Consideration

The other main element of a contract is that, to be effective, it requires the proper intent, which is shown through what is termed “consideration”. This concept developed out of the need to differentiate contracts from gifts. A contract has binding consequences, i.e. damages can result from its breach. Damages do not normally arise from the making of a gift. In effect you have the right to rely upon a promise made in a contractual setting but not necessarily in a gift setting. Thus, consideration is something of benefit to the person who has the obligation or who makes a promise – known as the “promisor” – to do, or forbear from doing something, or do something which is a detriment to the person who has the benefit of the promise or who wants to enforce the promise – known as the “promisee”. As long as some value is given for the promise, the courts will not consider whether “adequate” value is given and, thus, an agreement to transfer something valuable for say £1 is enforceable. However, if the promisee has already done the act that is said to be the consideration, that is usually “past consideration” and is not treated as being good consideration – this is discussed in more detail later. Further, the “consideration” must be given by the party who wants to enforce an obligation in the contract (but need not be provided to, or benefit, the promisor), thus a promise not to sue on a valid claim can be good consideration. The only other way to have an enforceable agreement, in the absence of consideration, is if the contract is made as a deed. A deed is a document under seal which either: (i) transfers an interest, right or property; or (ii) creates an obligation which is binding on someone or some persons; or (iii) confirms an act which transferred an interest, right or property. It should be noted, however, that not all documents under seal are deeds.⁷

Consideration is thus sometimes referred to as “the price of a promise”. While this was essential at early common law, over the years the necessity of actual consideration has become less strict, and some common law and civil law systems⁸ do not require consideration. Its original purpose was to show that both sides to a contract were in fact giving up something of value and usually equal value. Thus, the contractor who offers to build the garage and the employer who agrees to pay £10,000 for it are both willing to part with something of value. The contractor is giving up the materials and labour now for the promise of something of value in the future, i.e. the money. This concept arose in the common law in its current form from early in the nineteenth century where consideration was at the basis for the action of assumpsit, which was the action for breach of a simple contract in England and Wales until 1884, when the old forms of action were abolished. At this time the concept of the parties actually reaching agreement became the essential legal basis of contracts in all legal systems, having been discussed earlier in the eighteenth century by the French writer Pothier in his Traité des Obligations⁹ and was also reflected in the works of John Stuart Mill regarding free will – both together were added by jurists of the day to the traditional common law requirement for consideration as a basis for an action in assumpsit.¹⁰

Under civil law systems, an exchange of promises, or a concurrence of wills alone rather than an exchange of consideration, is the basis for a contract. Thus, if our contractor promised to build the garage and the employer accepted this offer without either promising to pay or giving anything in return, the contractor would have a legal right to the money and could not change his mind about building it as a gift. The way this is dealt with at common law is through the equitable concept of “estoppel” which is used to create obligations during pre-contractual negotiations. It arises in the law when a party gives another an assurance and the other has relied on the assurance to its detriment. Over the years it has been debated whether the concept of consideration should be abandoned altogether, but because of its long history in the common law this is unlikely to happen, and rather it will be looked at with varying degrees of exactitude and on a case-by-case basis.

The concept behind consideration is that both parties to a contract must bring something to the bargain. A party seeking to enforce a contract must show that it conferred some benefit or suffered some detriment that is recognised by law. Consideration, for example, must be “sufficient” but need not be “adequate”, i.e. the consideration need not be a fair and reasonable exchange for the benefit of the promise. For example, as discussed earlier, agreeing to pay £1 for the garage may constitute a binding contract.¹¹

Other rules relating to consideration include that it must not be from the past or “prior consideration” and that consideration must move from the promisee. For instance, it is good consideration for person A to pay person C in return for services rendered by person B. If there are joint promisees, consideration needs only to move from one of the promisees. Also, consideration must not involve something one is already obliged by the general law to do – e.g. to refrain from committing a crime or to give evidence in court. There is another type of situation which arises and that is where person A promises to do something for person B if person B will perform a contractual obligation person B owes to person C. This will be enforceable as person B is “suffering” a legal detriment by making the performance of his contract with person C effectively enforceable by person A as well as by person C.

More importantly, as just mentioned, a promise to do something that one is already obligated contractually to do is not good consideration. For example, in the case of Stilk v Myrick,¹² a ship’s master promised to divide the wages of two deserters among the remaining crew if they would sail home from the Baltic shorthanded. This was held not to be valid consideration as the crew was already contractually obliged to sail the ship. Another example of this arose in Foakes v Beer,¹³ where the “rule in Pinnel’s case”¹⁴ was brought into the law of consideration. The House of Lords held that a smaller sum of money cannot be good consideration for the release of a larger debt, though if the smaller sum is accompanied by something non-monetary in addition, for instance “a horse, a hawk or a robe”, or payment is to be made early or in some special place or way, then there will be good consideration for the promise to discharge the debt. In other words some “new consideration” is needed and not just what had been previously promised. However, in Williams v Roffey Bros & Nicholls (Contractors) Ltd,¹⁵ the Court of Appeal held that a promise by a joiner to complete the contracted work on time, where this was falling behind, was good consideration for the contractor’s promise to pay extra money. The court’s decision was that the strict rule of Stilk v Myrick¹⁶ was no longer necessary, as English law now recognised a doctrine of economic duress to vitiate promises obtained when the promisor was “over a barrel” for financial reasons. Thus a promise to pay something extra could be seen as conferring a practical benefit on the promisor that could be good consideration for a variation of the terms.¹⁷

Intent to be legally bound

Another essential element of any contract is the intent to be legally bound to the terms of the contract, i.e. that the “agreement” was not made frivolously or without contractual intent. Indeed, there is a presumption that in the case of construction agreements, unless the parties expressly state that they do not want to be bound, it will be held that it was the parties’ intention to be legally bound. Indeed, a contract does not have to be set out in writing and can be made orally (or can be partly oral) and following amendments in 2009 to the Construction Act 1996, parties to oral “construction contracts” now have the right to adjudicate any dispute arising under them.

Further on this point is the recent case of MacInnes v Gross¹⁸ where the claimant, Bruce MacInnes, an experienced investment banker employed by Investec, met with the defendant, Hans Thomas Gross, an Austrian national and the principal figure behind the RunningBall group of companies, over dinner at a restaurant in Mayfair, London.

According to Mr MacInnes, it was agreed at that meeting that he would leave his employment with Investec and personally provide services to Mr Gross in relation to various aspects of RunningBall – in particular, growing the business to maximise any return on its sale – and that, in exchange, he would receive remuneration by being paid 15 per cent of the difference between the target price for RunningBall and the actual sale price. After the dinner, on 24 March 2011, Mr MacInnes emailed Mr Gross, outlining what he contended was an agreement between them on “headline terms”.

Mr MacInnes duly gave notice, but continued to work for Investec. In December 2011, when a possible sale of RunningBall began to materialise, he forwarded to Mr Gross a copy of his 24 March 2011 email, commenting that it was important that the parties were “completely aligned”. In reply on 7 December 2011, Mr Gross commented that, when they next saw each other, the parties needed to make “a proper contract”.

After RunningBall was sold, Mr MacInnes made a formal claim for payment based on the alleged oral agreement of 23 March 2011, demanding €13.5million. Mr Gross rejected Mr MacInnes’ claim, insisting that there was no binding contract between the parties, on the terms alleged or on any terms, and that, rather, the dinner in question was an informal one, at which no agreement was, or could have been, reached.

Mr Justice Coulson, after considering the relevant authorities, was firmly of the view that Mr Gross’ case was to be preferred, and that no binding contract was made between the parties on 23 March 2011 as there was not the requisite intention to create legal relations. First, there was no agreement on the critical issue of the nature of Mr MacInnes’ remuneration. Second, the terms of the alleged contract were both too complex and too uncertain to be enforceable. And, third, there was no binding agreement as to the relevant parties or the relevant workscope.

In delivering his judgment, the Judge addressed directly the location and nature of the meeting of 23 March 2011, which, whilst not “decisive” of the issue, was considered “an important part of the background”. He held:

“The mere fact that the discussion took place over dinner in a smart restaurant does not, of itself, preclude the coming into existence of a binding contract. A contract can be made anywhere, in any circumstances. But I consider that the fact that this alleged agreement was made in a highly informal and relaxed setting means that the court should closely scrutinise the contention that, despite the setting, there was an intention to create legal relations”.

Accordingly, given the informal nature of the setting, and the fact that Mr MacInnes himself was only able to say in his email of 24 March 2011 that there was an agreement on “headline terms”, Mr Justice Coulson found that there was no such intention to create legal relations – as further confirmed by Mr MacInnes’ own failure to reply to, or otherwise correct, Mr Gross’ email of 7 December 2012, in which he indicated that “a proper contract” still needed to be agreed.

Although Mr MacInnes’ claim failed in this case – and it is submitted that, in the circumstances, the Judge’s decision was plainly the correct one – it is nonetheless a reminder that contracts can in fact be concluded orally in an informal, relaxed setting. As Mr Justice Coulson put it, they can be made “anywhere, in any circumstances”. Against that, however, it is clear that the courts will more closely examine purported agreements reached in such an environment, and that there is no substitute, therefore, for the drawing up of a written contract to reflect what has been agreed and to provide security and certainty. Indeed, Mr MacInnes was asked, during cross-examination, why he – an experienced investment banker – did not do so, and his answers in this regard, according to the Judge, were “unpersuasive”.

Privity of contract

The general rule is that only the actual parties to the contract can enforce the contract. This is changing and at times those who are third-party beneficiaries of a contract may be allowed to recover damages for the breach of a contract to which they were not an actual party. Thus, if the contractor in the earlier example contracted to build a garage and the employer agreed to pay £10,000 for it but the garage was going to be for the benefit of a neighbour, i.e. a third party, it would be reasonable to assume that the neighbour could commence proceedings against the contractor for faulty construction. Thus, in such cases third-party beneficiaries have been considered parties of the contract for purposes of enforcing it.

Indeed the Contracts (Rights of Third Parties) Act 1999 (1999 c 31¹⁹) has changed the common law “Doctrine of Privity” with respect to the rights of third-party beneficiaries. The Act allows third parties to enforce the terms of a contract that benefits them in some way, or that the contract itself allows them to enforce. It also grants them access to a range of remedies if the terms are breached. The Act also limits the ways in which a contract can be changed without the permission of an involved third party. At the same time, it provides protection for the promisor and promisee in situations where there is a dispute with the third party and allows parties to a contract to specifically exclude the protection afforded by the Act if they want to limit the involvement of third parties.

Oral contracts

An exchange of promises can be as legally valid as a written contract and accordingly any contract that uses spoken words is a verbal contract. This is in comparison to a “non-verbal, non-oral contract”, also known as “a contract implied by the acts of the parties”, which can be either implied in fact or implied in law.

Most jurisdictions have rules of law or statutes which may render otherwise valid oral contracts unenforceable. This is especially true regarding oral contracts involving large amounts of money or real estate. For example, generally in the United States a contract is unenforceable if it violates the common law statute of frauds or equivalent state statutes, which require certain contracts to be in writing. An example of the above is an oral contract for the sale of a motorcycle for US$5,000 in a jurisdiction that requires a contract for the sale of goods over US$500 to be in writing to be enforceable. The point of a Statute of Frauds is to prevent false allegations of the existence of contracts that were never made, by requiring formal (i.e. written) evidence of the contract. However, a common remark is that more frauds have been committed through the application of the Statute of Frauds than have ever been prevented. Contracts that do not meet the requirements of the common law or statutory Statutes of Frauds are unenforceable, but are not necessarily thereby void and, thus, a party unjustly enriched by an unenforceable contract may be required to provide restitution for unjust enrichment. Statutes of Frauds are typically codified in state statutes covering specific types of contract, such as contracts for the sale of real estate.

In most of the countries that use the English common law and which provide for rules similar to the Statute of Frauds there is no requirement for the entire contract to be in writing.²⁰ In the UK certain kinds of contract must be in writing or they are void, for instance for the sale of land under section 52, Law of Property Act 1925.

With an oral contract the critical issue becomes: what exactly are the terms to be included? Normally, the terms of an oral contract are factual questions for the courts to determine based upon the evidence presented. Exceptions arise where any terms not expressly stated by the parties may be incorporated into the “oral” contract.

The first of these arises from a prior course of dealing between the parties. In this situation the parties have dealt with each other over time and the agreements reached were always in reference to certain external contractual terms. Thus, in McCutcheon v MacBrayne,²¹ the court was of the mind that any new dealing between the parties should incorporate the terms formerly used between the parties into the new agreement between the parties even though they were not expressly mentioned. The decision was based on the fact that the parties must have intended the terms to be incorporated from their previous course of dealing.²²

The second situation arises from the common understanding between the parties (which can be readily ascertained) and, thus, in British Crane Hire Corpn v Ipswich Plant Hire Ltd,²³ Ipswich hired a crane from British Crane Hire based upon an oral contract. Later printed conditions were sent to Ipswich for them to sign and one of these conditions made the hirer liable to indemnify British Crane against all expense in connection with the use of the crane. Needless to say, just before the conditions were signed the crane was sunk in boggy ground, without negligence on Ipswich’s part, and accordingly, they claimed that they were not liable for the cost of retrieving the crane, because the conditions were not incorporated in the oral contract. The court found there was no course of dealing, nor any implied term that the conditions would apply, but nevertheless held the conditions incorporated in the contract, on the basis that both parties were of equal bargaining power and, since both parties were in the plant-hire business, they must have known that such conditions were normally imposed on the hiring of plant equipment.

Although much discussion has arisen as to whether this was a fair decision, as it was assumed that the parties were on equal footing, the question remains open as to whether the same outcome would occur if the crane had been hired by a builder instead of a plant-hire company. The key is that a common understanding of such standard conditions, which are normally used in a specific industry, will be a factor tending to establish that those conditions were incorporated in the contract.²⁴

Letters of intent

These are difficult areas to determine and the question whether or not a contract has been formed by issue of a letter of intent is usually resolved by analysis of several factors such as prior dealings of the parties, the extent that the letter is definite and certain, consideration, etc. Thus, if a letter of intent states only that the employer will at some future point in time award the contractor a contract for works not yet fully specified, this, in and of itself, is rarely interpreted as a binding contract owing to both a lack of consideration and lack of certainty. However, letters of intent issued in connection with building contracts are usually more substantial. Thus, letters of intent issued to contractors are usually based upon the need to get the initial stages of the Works underway while contractual negotiations continue and, as such, the initial works required and the amount to be paid for these works will normally be set out in some detail in the letter of intent or in appended or referenced documents. If the letter of intent contains sufficient detail of the Works, the price to be paid and a start date, it can result in a binding contract and a contract will be formed if the terms offered in the letter are accepted by the contractor.