Oil & Gas / Shipping – Commercial Court Examines Legal Effect of “Subject to Approvals” 

International

In the context of a crude oil voyage charter, the Commercial Court has provided guidance on the legal effect of “subject to” provisions in contracts. 

In doing so, the Commercial Court noted that, generally speaking, there are two alternative effects: (i) the “subject” could be a “pre-condition” to the contract, in which case the contract would be prevented from coming into existence; or (ii) the “subject” could be a “performance condition”, which, if not satisfied, would mean that performance does not need to take place – albeit there was an implied obligation on the relevant party to take steps to attempt to meet the performance condition. The distinction is obviously an important one to those drafting and agreeing contracts in the oil and gas sector.

Facts

This was a dispute about whether a contract was concluded and, if so, what the terms of the contract were. The contract in issue was a voyage charter for the vessel “Leonidas” (the “Vessel”) for the carriage of crude oil from the Caribbean to the Far East (the “Charterparty”).  The Claimant, Nautica, was the registered owner of the Vessel and the Defendant (“Trafigura”) was seeking to charter the Vessel.

The parties negotiated the Charterparty but came into dispute as to whether those negotiations had “crossed the finish line”.  The particular issue for the Commercial Court to decide was the effect of an outstanding “subject” in those negotiations (and one common in the trade): the supplier’s approval of the Vessel.

The terms of an in-principle agreement summarised in an email to both parties stated as follows:

“WE ARE PLEASED TO CONFIRM TERMS AND CONDITIONS OF THE FOLLOWING FIXTURE CONCLUDED JANUARY 8, 2016 FOR ACCOUNT OF TRAFIGURA TRADING LLC OR NOMINEE WITH SUBJECTS TO CHTRS' S/S/R/MGT APPROVAL LATEST 1700 HOURS HOUSTON TIME TUESDAY 12, 2016” (our emphasis).

It was common ground that “S/S/R/MGT” stood for “Stem / Suppliers / Receivers / Management”, and that “Stem” is an acronym for “subject to enough material”, which meant subject to the charterers confirming that they had sufficient cargo to load on the Vessel.  It was also common ground that the Stem, Receivers’ Approval and Management Approval subjects were subsequently lifted.

The decision to be made was:

  1. whether the outstanding supplier’s approval was a “pre-condition” to the contract, in which case the Charterparty would be prevented from coming into existence; or 
  2. whether the supplier’s approval was a “performance condition”, which did not prevent the existence of the Charterparty, but if not satisfied would mean that performance does not need to take place. 

The key distinction between the two arose from a number of previous authorities concerning contracts subject to obtaining an import or export licence, or planning permission, which held the subject to be a performance condition, with an implied term obliging one party to “take all reasonable steps” to obtain the relevant licence or permission.  A failure to take such steps would be a breach of contract.

Decision

The judge, Mr Justice Foxton, reviewed the leading authorities, with which there was little dispute.  These included the following well-known dicta:

“Whether there is a binding contract between the parties and, if so, upon what terms depends upon what they have agreed. It depends not upon their subjective state of mind, but upon a consideration of what was communicated between them by words or conduct, and whether that leads objectively to a conclusion that they intended to create legal relations…” – RTS Flexible Systems v Molkerei Alois Muller [2010] 1 WLR 753, [45] (our emphasis).

“Even if the parties have reached agreement on all the terms of the proposed contract, nevertheless they may intend that the contract shall not become binding until some further condition has been fulfilled. That is the ordinary “subject to contract” case… – Pagnan SpA v Feed Products Ltd [1987] 2 Lloyd's Rep 601, 619 (our emphasis).

Foxton J then distilled the following principles:

  1. The legal effect of the phrase “subject to contract” is clear, which is to enable either party to avoid entering into contractual relations by refusing to sign a written contract or reach agreement on any outstanding terms, as the case may be. Similarly, no contract comes into existence when an agreement is reached “subject to board approval” by one or other party, because the effect of those words is to postpone the decision on whether to enter into legal relations to a subsequent stage.
  2. An important factor in determining whether a “subject” is a pre-condition or a performance condition is whether the satisfaction of the “subject” depends upon the decision of a contracting party, or on that of a third party.
  3. When the event on which the entry into contractual relations depends is a decision by one or both parties to undertake a legally binding commitment, there is “no room” for the argument that some form of preliminary agreement comes into existence imposing an obligation on one or both of the parties to seek to complete the bargain. This is both because the purpose of the “subject” is to signal that the parties have not yet reached the stage of any legal commitment and because of the traditional hostility of the common law to “agreements to agree”, given the difficulties of enforcing them.
  4. In contrast, there are cases in which an agreement is said to be “subject” to some event within the control of someone other than one of the parties, and in which it has been held that the “subject” is not a “pre-condition” which prevents a binding contract coming into existence, but instead has the effect that performance does not have to be rendered if the “subject” is not satisfied for reasons other than a breach of contract by one of the parties (“a performance condition”).
  5. While each case will depend on its own individual facts and commercial context, it is clear that a “subject” is more likely to be classified as a pre-condition rather than a performance condition if the fulfilment of the subject involves the exercise of a personal or commercial judgment by one of the putative contracting parties.
  6. Where a “subject” is only resolved by one or both of the parties removing or lifting the subject, rather than occurring automatically on the occurrence of some external event such as the granting of a permission or licence, the “subject” is likely to be a pre-condition rather than a performance condition.
  7. In the specific context of chartering, the negotiating language of shipowners, charterers and brokers referring to agreements as “on subjects”, and “lifting the subjects”, indicates that a subject in the chartering context is more likely to be a pre-condition, as the subject is resolved by one or both parties removing it, rather than being resolved automatically on the occurrence of an external event.
  8. Based on previous authority, the “subject to stem approval” and “subject to management approval” were both pre-conditions and it would be “surprising” if  subjects appearing as a “compendious phrase” were not all intended to have the same effect.

Applying these principles, Foxton J preferred to classify the “subject to supplier’s approval” as a pre-condition.  Furthermore, there was a surprising degree of uncertainty as to what “supplier's approval” meant (e.g. whether the suppliers referred to were only the loading terminals or whether this extended to the charterers’ contractual suppliers).  Any uncertainty as to the meaning of the subject made it less likely that the subject was intended to create any binding contractual obligation. Foxton J held that the phrase encompassed all those approvals which Trafigura commercially wished to obtain on the supply side.

It followed that the “subject to supplier’s approval” was a pre-condition to the existence of the Charterparty, and therefore the putative charterer, Trafigura, was not required to take reasonable steps to obtain its suppliers’ approval.

Comment

The decision is a welcome clarification on the method of interpretation and the effect of an often used contractual device, used not just in charterparties in the industry but also in a broad spectrum of project and procurement contracts, M&A and financing arrangements.

As is often the case when assessing the existence or otherwise of a contractual obligation, the effect of the “subject to” provision depends upon what the document says, the communications between the parties (written and behavioural) and the commercial context.  Clarity is key.

Those negotiating and drafting contracts should remain aware that the words “subject to” are capable of more than one meaning: (i) there is a pre-condition to the existence of a contract; and (ii) the contract comes into immediate existence but its performance is conditional. As this decision explains, the key difference is that were a contract comes into immediate existence but its performance is conditional there may be implied terms to take reasonable steps to ensure performance may take place.

If the aim is to ensure there is a pre-condition to the existence of a contract, such as to ensure no contract is in existence, parties should seek to use terms well recognised as achieving this end. Save in exceptional circumstances, an arrangement made “subject to contract” means that execution or exchange of a formal legal written contract is a condition precedent to legal liability.  Similarly, no contract comes into existence when an agreement is reached “subject to board approval” by one or other party, because the effect of those words is to postpone the decision on whether to enter into legal relations to a subsequent stage. This decision of the court suggests that “subject to management approval” will be given the same meaning.

However, the impact of other “subject to” wording is less clear. For example, it has been suggested in Australia and New Zealand that “subject to finance” results in an agreement coming into existence where the performance is conditional upon obtaining finance. If this were followed in English law, it may also result in an implied term to take reasonable steps to obtain finance. As a result, a refusal to seek finance to make the deal unconditional would be a breach of contract.

As a result, negotiators and drafters should be cautions of using “subject to” wording outside well recognised uses. If in doubt, more detailed drafting should be capable of making the  position on the parties’ respective obligations pending the conditionality clear.

The decision in this case put the “subject to” firmly in the camp of being a pre-condition to the existence of the contract in question.  This meant that the Commercial Court did not have to consider the question of damages for Trafigura’s failure to take reasonable steps to obtain the supplier's approval.  Instead, the Court's decision on damages is obiter although it is worth noting that Foxton J was of the view that because the benefit alleged to have been lost by Nautica (lost profit under an enforceable charterparty) was dependent on the decision of a third party (i.e. the supplier) to approve the Vessel, damages had to be assessed on a “loss of a chance” basis.

Case: Nautica Marine Limited v. Trafigura Trading LLC [2020] EWHC 1986 (Comm).