Drafting Issues update 1

United Kingdom
1. Introduction

In this paper, I intend to give an update on various subjects affected by recent developments, which have not been covered in the earlier parts of the seminar programme. These are in particular the following issues: ·

  • Contract formation on-line. ·
  • The Consumer Protection (Distance Selling) Regulations 2000. ·
  • Liquidated damages provisions. ·
  • Agency agreements for sale of goods - recent case law on compensation for termination.

2. Contract formation on-line

Three points ought to be considered: ·

  • The point in time at which on-line contracts should be considered to be formed, for example by exchange of e-mails; ·
  • The requirements of contract formation by electronic means other than simple exchange of e-mails; ·
  • Issues arising concerning acceptance of web site offers.

2.1 Contract formation by exchange of e-mails

It is well established that in order to determine when an agreement comes into existence, one must look to see if there has been an “offer” followed by an “acceptance”. This involves the communication of the fact of acceptance. The normal rule is that communication of acceptance takes place when the acceptance is received by the offeror.

However, in the nineteenth century, the “postal rule” was developed to enable a fair solution to problems resulting from a delay or loss in the post where the affected party had no quick or effective means to check whether his communication had been received. The “postal rule” provides that in cases where it is reasonable to communicate by post, a binding contract is created when the acceptor commits his acceptance to the post.

The question arises as to whether, with the advent of virtually instantaneous methods of communication such as fax and e-mail, a similar rule should apply. In Brinkibon v Stahag Stahl GmbH (1993) 2 AC 34 the House of Lords stated that no rule of expediency such as the “postal rule” was required where the means of communication is instantaneous in nature, and that in such cases no universal rule can cover all cases. Rather, such cases “must be resolved by reference to the intentions of the parties, by sound business practice and in some cases by a judgment where the risks should lie”.

Under The Electronic Commerce (EC Directive) Regulations 2002 (SI 2002 No. 2013 which mainly entered into force on 21 August 2002), where a recipient of a service places his order through technicological means, the order and acknowledgment of receipt are deemed to be received (Regulation 13(2)) when the parties to whom they are addressed are able to access them. Although this wording does not directly follow the concepts of offer and acceptance. This rule is closer to requiring receipt than mere sending of the communication in question, but the recipient is deemed to have received the communication when he is able to open it or have access to it. The Regulations do not deal with the question of the place of formation of the contract, although this is likely to be the place of receipt of the acknowledgment or order, when in the circumstances this constitutes the acceptance.

2.2 Contract formation by electronic means other than simple exchange of e-mails:

Under the Electronic Commerce Regulations, the following requirements will apply where contracts are concluded by electronic means (other than by simple exchange of emails): ·

  • Unless parties who are not consumers have agreed otherwise, a service provider must, prior to an order being placed, provide to the recipient of a service a clear indication of (inter alia) the different steps to follow to conclude the contract and the technical means for identifying and correcting input errors prior to placing the order; ·
  • Where terms and conditions applicable to the contract are provided to the recipient of a service, they must be made available to him in a way that allows him to store and reproduce them.

Under the Electronic Commerce Regulations, unless parties who are not consumers have agreed otherwise, where the recipient of the service places his order through technological means (other than by simple exchange of emails), the service provider must: ·

  • Acknowledge receipt of the order without undue delay and by electronic means; and ·
  • Make available to the recipient appropriate, effective and accessible technical means allowing him to identify and correct input errors prior to placing the order.

2.3 Issues concerning acceptance of website promotions

Various cases have arisen in which suppliers of goods or services have advertised their products on their website at an erroneously low price and have then been compelled to complete contracts at that price, due to the website promotion being deemed to be an offer which was then accepted on-line by consumers.

This contrasts with the normal position in a self-service shop, where the placing by a consumer of a product in a shopping trolley is normally treated as an offer which is accepted on payment at the check-out.

It is therefore recommended that internet retailers should include wording in their website terms and conditions to ensure that they are not treated as making offers on their websites. Preferably, the website should also systematically provide for the process for concluding a contract and should reserve the supplier’s right to refuse acceptance. For example, the terms and conditions on a website may state the following: ·

  • An order will be treated only as an offer to purchase; ·
  • The retailer will send an e-mail to acknowledge the order; ·
  • A second e-mail will be sent by the retailer either confirming and accepting the order, at which point a contract is made, or alternatively refusing acceptance.

In this way, the retailer is able to ensure control of the contract formation process, whilst making clear the position and rights of its customers.

3. The Consumer Protection (Distance Selling) Regulations 2000

These Regulations (SI 2000 No. 2334) entered into force on 31st October 2000 and apply to all contracts for the supply of goods or services to a consumer, concluded at a distance or by distance communication means (with certain exceptions, e.g. financial services and the provision of accommodation, transport or leisure services). The Regulations require: ·

  • The provision to consumers of specified information prior to conclusion of the contract; and ·
  • A right of cancellation of the consumer during specified periods after delivery of goods or conclusion of a contract for services.

The information to be provided prior to the conclusion of the contract, includes the identity of the supplier; a description of the goods or services; the price including taxes; delivery costs where applicable; arrangements for payment, delivery or performance; the existence of the right of cancellation; the cost of using the means of distance communication where it is calculated other than at the basic rate; the period for which the offer or price remains valid; and where appropriate the minimum duration of the contract (Regulation 7(1)). In addition, either prior to conclusion of the contract, or during performance of a services contract or prior to delivery of goods, the supplier must provide specified information about conditions of exercising the right of cancellation, including the return of goods, the cost of such returns, and after sales services and guarantees (Regulation 8).

The consumer’s cancellation periods are as follows: ·

  • The cancellation period where such information is provided, is 7 working days beginning on the date the consumer receives the goods or, in the case of a services contract, the date the contract is concluded. ·
  • Where such information is only provided after the dates of delivery or of conclusion of a services contract, but within a period of 3 months commencing on such dates respectively, the cancellation period is 7 working days beginning on the date of provision of the information. ·
  • In all other cases, the cancellation period is 3 months and 7 working days after the date of delivery of the goods or of conclusion of a services contract.

The consumer’s rights of cancellation do not apply in certain specified situations (Regulation 13), for example: ·

  • Where the performance of a services contract has begun with the consumer’s agreement and the supplier has, prior to conclusion of the contract, informed the consumer of his loss of rights of cancellation once performance has begun with his agreement; ·
  • Where the price of goods or services is dependent on financial market fluctuations out of the supplier’s control; ·
  • Where goods are made to the consumer’s specifications or are clearly personalised or are liable to deteriorate rapidly; ·
  • Where the supply of audio or video recordings or computer software which have been unsealed by the consumer.

The supplier must perform the contract within a maximum of 30 days of the consumer’s order (unless the parties agree otherwise), or must within such period inform the consumer if the goods or services ordered are not available (and reimburse any sum already paid under the contract). Where the supplier is unable to provide goods or services ordered by the consumer, the supplier may perform the contract by providing substitute goods or services of equivalent quality or price provided that: ·

  • This possibility was provided for in the contract; and ·
  • Prior to the conclusion of the contract, the supplier gave the consumer appropriate relevant information in accordance with Regulation 7.

Any provision which excludes a consumer’s rights under the Regulations or which imposes additional obligations on the consumer to those specified under the Regulations, shall be void (Regulation 25).

4. Liquidated damages provisions

Liquidated damages provisions are valid where they constitute a genuine pre-estimate of loss by a claimant and do not exceed the greatest loss that the claimant would suffer. Such clauses enable the liquidated damages to be claimed without needing to prove either foreseeability of damage or quantification of the loss, and in this way they are enforceable as if they were a debt.

By contrast, penalty provisions will be unenforceable where they are designed to coerce full performance by requiring payment of arbitrarily high sums relative to foreseeable breaches. The following are examples of provisions which have been held to be penalties and therefore unenforceable: ·

  • Provisions for arbitrary and substantial sums to be paid for various breaches differing in kind, some of which might cause only trifling damage: Ford Motor Co v Armstrong (1915) 31 TLR 267. ·
  • A “minimum payment” clause in a hire purchase or hiring agreement which provides for the same total sum to be repayable by the hirer irrespective of how long the agreement has been in force: Lamdon Trust v Hurrell (1955) 1 WLR 391. ·
  • Provisions for payment of a sum which is liable to fluctuation in amounts depending on the events not connected with fulfilment of the contract: Public Works Commissioner v Hills (1906) AC 368. ·
  • Possibly, where the same amount is to be payable upon breach of different obligations of varying importance (see the Dunlop case).

The Court of Appeal has recently ruled (on 26 March 2002) on the construction of a liquidated damages clause and on the distinction between liquidated damages and penalty clauses, in Cenargo Limited v Empresa Nacional Bazan De Construcciones Naveles Militares SA [2002 EWCA CIV524]. Following this case: ·

  • A liquidated damages provision may be invalid if it could apply to minor or trivial breaches, thus making it advisable to limit the application of a liquidated damages clause accordingly; ·
  • It is advisable to specify different levels of liquidated damages for different types of breach.

The Cenargo Limited case concerned a shipping contract and the clause in question read as follows:

“Article III – Damages

Deficiency in a trailer carrying capacity ....

(a) if the actual trailer carrying capacity of the Vessel is less than 146 units of 13 metres each the Builder shall pay to Buyer as liquidated damages One Hundred and Fifty Thousand United States Dollars ($150,000) for each trailer unit by which the Vessel is deficient but excluding the first one (1) in respect of which deficiency no liquidated damages shall be payable. If the deficiency in trailer carrying capacity is ten (10) or more the Buyer as an alternative to receiving the aforementioned liquidated damages may rescind the contract.”

Lord Justice Longmore gave a useful commentary on construction of liquidated damages clauses. He stated that liquidated damages clauses have a generally useful function in pre-estimating damage likely to result from breaches of contract. However, it is important that such contracts should be construed to avoid the result that breaches of contract resulting in minor losses will be covered by such clauses. There is a danger that, if a liquidated damages clause is held to apply to trifling breaches of contract or breaches of contract which result in a trifling loss, the whole clause might be struck down as a penalty clause. He cited Lord Wolf in Philips Hong Kong Ltd v Attorney General of Hong Kong [1993], in saying:

“So long as the sum payable in the event of non-compliance with a contract is not extravagant, having regard to the range of losses that it could reasonably anticipated it [the relevant clause] would have to cover at the time the contract was made, it can still be a genuine pre-estimate of the loss that would be suffered and so a perfectly valid liquidated damage provision.”

It is therefore important to have in mind the range of losses the parties would anticipate the clause would cover when they made their contract The important point to note here is that it is the contemplation of the parties upon agreeing liquidated damages provisions, which is relevant in construing the liquidated damages clause.

The Court, in order to demonstrate the difference between penalty clauses and liquidated damages clauses, cited Treitel on Contract, 10th Edition (1999):

“A sum may, therefore, be regarded as penal if it might have become due on a trifling breach, even though the breach, which actually occurred was quite a serious one, and one for which the sum could be regarded as a genuine pre-estimate. In this way, the rule can invalidate perfectly fair bargains. The courts will do their best to avoid such results by construing the contract so as to make the sum payable only on major breaches, for which it is a valid pre-estimate.”

Lord Justice Longmore was at pains to emphasise that “major breaches” should cover breaches of contract giving rise to substantial loss of the kind contemplated by the liquidated damages clause. On the facts, as the breach was only minor, the Judge ruled that the true loss of the buyers cannot have been intended to have been covered by a liquidated damages clause, and therefore allowed their appeal.

As a practical matter, a potential claimant under a liquidated damages clause should keep records of calculations underlying any elements of a liquidated damages figure. If it is not possible to make any reliable estimate of the range of amounts of loss that would be suffered, a party should consider relying on the normal common law rights to damages instead of liquidated damages.

In summary, a potential claimant under a liquidated damages clause should ensure that the contract: ·

  • Specifies that the amount of liquidated damages is a genuine pre-estimate of loss and does not exceed the greatest loss that would be suffered by the claimant; ·
  • Specifies different levels of liquidated damages for different types of breach; ·
  • Excludes the application of the liquidated damages clause to minor or trivial breaches; ·
  • Specifies that he may claim an injunction in addition to or as an alternative to enforcing the liquidated damages provision; ·
  • Specifies that the liquidated damages will be recoverable as a debt; ·
  • Specifies that the liquidated damages can be deducted from existing or subsequent sums due from the claimant to the defaulting party.

By contrast, a potential defendant of a liquidated damages claim should ensure that the contract: ·

  • Specifies that the right to liquidated damages is the claimant’s sole right for breach either generally or within specified limits; and ·
  • Specifies that the claimant will only have the right to terminate the contract if the seriousness of the breach goes beyond any such specified limits.

5. Agency agreements for sale of goods: recent case law on compensation for termination

The Commercial Agents (Council Directive) Regulations 1993 (SI 1993 No. 3053 as amended by SI 1993 No. 3173), implementing EC Directive 86/653, provides that, on termination of an agency agreement for the sale of goods, the agent must be: ·

  • Compensated for the damage he has suffered as a result of termination (Article 17(6); or ·
  • Entitled to an indemnity to the extent that he has brought the principal new customers or significantly increased the volume of business, and the payment of the indemnity is equitable in all the circumstances (Article 17(3)).

Where express provision is not made for an indemnity, the agent must be compensated rather than indemnified (Article 17(1) and (2)). The compensation or indemnity is payable in all termination situations except where: ·

  • The principal has terminated the agency because of a breach by the agent justifying immediate termination, or ·
  • The commercial agent has himself terminated the agency agreement other than due to the principal’s default (or, in the case of an individual, other than on grounds of age, infirmity or illness of the agent), ·
  • The agreement is terminated through novation (assignment with the principal’s agreement) to a new agent (Article 18).

Until relatively recently, due to the wording of the UK Regulations, it was unclear whether the Regulations were intended to confer any additional rights of compensation on the agent over and above the basic common law rights of compensation on termination, whereby the agent was considered not to suffer any damage and therefore not to have any right to compensation where the agency agreement expired or was properly terminated, taking into account applicable notice provisions, by the principal. Under English common law, an agent would only be considered to suffer damage and therefore to compensation where the agreement is terminated on the grounds of the principal’s breach of contract. This could include premature termination or repudiation of the agreement by the principal of a fixed term agreement, or termination on insufficient notice by the principal. In each case, the agent’s right to termination would be the amount of profit that he would have made from the agreement during the unexpired portion of the agreement or the period of notice that should have been but was not given. By contrast, EC Directive 86/653 on which the UK Regulations were based, was intended to give a general right of compensation or indemnity to the agent even where the agreement had simply expired or had been property terminated.

This was changed by a Scottish case decided on 12 May 2000, in King v Tunnock Limited (The Times Law Reports, 12 May 2000). Being decided by a Scottish court (the Inner House of the Court of Session), the case has only persuasive value in England, but the principle upheld by the Scottish court has subsequently been developed by the English High Court. In King v Tunnock, the Court adopted the French approach to the award of compensation on termination. This takes into account the agent’s damage by reference to the amount for which the agency could have been sold prior to termination, or in the absence of a notional sale, the time it would take for the agent to reconstitute the client base lost by reason of termination. The general starting point in French law is that the agent should receive compensation valued as the gross commission earned by the agent in the last two years of the normal performance of the agency relationship, without deduction for any mitigation of damage.

In a subsequent English case, Barrett McKenzie v Escada (UK) Limited (The Times Law Reports, 15 May 2001), a Deputy High Court Judge in England took a modified approach, holding that in quantifying a compensation payment, the Court should value the goodwill which the agent developed for the principal. This approach gave greater scope to the principal to negotiate a reduced level of compensation where an agent has not been performing well. However, this approach is generally considered flawed and in a subsequent High Court case, Ingmar GB Limited v Eaton Leanard Inc (2001) All ER(D)448; the Court stated that even under French law, the two years’ gross commission rule is only a benchmark, and this approach should be reduced by the English courts if it results in a “windfall” to the agent. In the Ingmar GB case, the compensation to the agent was based on a three-year period, but not on gross commission, rather on three years’ total remuneration to the agent’s sales director, including his salary, pension contributions and a management charge. This was less than two years’ gross commission.

In any event, most commentators now believe that the scope for reducing the level of compensation to the agent for termination below a figure based on two years’ gross commission, will be limited, at least where such a valuation does not produce an excessive windfall to the agent.

As a result of these developments, when drafting or negotiating agency agreements, principals should consider including express provision for an indemnity to the agent on termination, thereby excluding the compensation rights under the Commercial Agents Regulations. The advantages of the indemnity approach are as follows: ·

  • The indemnity is based on only one year’s remuneration, as an average of the preceding five years (Article 17(4)); ·
  • The indemnity is only payable insofar as the agent can show (Article 17(3)) that: o
    • He has brought new customers or significantly increased the volume of business with existing customers and the principal continues to derive potential benefits from such business; and o
    • The payment of this indemnity is equitable in all the circumstances, including commission lost by the agent.

    Therefore, an indemnity to the agent (for which express provision must be made) has advantages to the principal over compensation on termination, in that it will generally be less straightforward for the agent to show entitlement to an indemnity than compensation, and there will arguably be greater certainty of calculation and in many cases a lower valuation in the case of an indemnity.