Introduction to contract law

Introduction

Someone enters into a contract if he makes a binding – legally enforceable – promise to someone else. So the ‘law of contract’ tells us in what situations someone will make a binding promise to someone else, and what remedies will be available if that promise is breached. While academics refer to the area of law dealt with in this chapter as ‘contract law’ or the ‘law of contract’, it is more helpful to think of it as ‘contracts law’ or the ‘law of contracts’. This is because there are at least three different ways of making a binding promise to someone else, and therefore at least three different types of contract recognised in English law. They are as follows.

(1) Covenant

Someone enters into a covenant if he makes a promise in a deed. (A deed is a particular kind of legal document. It has to be signed and witnessed to be valid.) Promises made in deeds will automatically be binding, other things being equal. The requirements that have to be satisfied in order to make a deed are laid out in the Law of Property (Miscellaneous Provisions) Act 1989. A document will only amount to a deed if it makes it clear on its face that it is intended to be a deed; if it has been signed by the person making the deed or his representative, and the signature has been witnessed; and the deed has been ‘delivered’ (which simply means that the person making the deed has made clear his intention to be bound by it).

(2) Bilateral contract

A bilateral contract arises if two people enter into an agreement under which they each promise to do something for the other. Under the contract, each party is bound to do what they promised to do for the other under their agreement. For example, if you and I agree that I will mow your lawn next Saturday, and that you will pay me £50 for doing so, we will have entered into a bilateral contract – my promise to mow your lawn next Saturday will be binding on me, and your promise to pay me £50 if I do so will be binding on you. The contract is bilateral in nature because each of us is bound to do something for the other under it.

(3) Unilateral contract

A unilateral contract arises if I make a promise to you with the object of inducing you to act in a particular way. If you do so act, my promise to you will be binding on me. For example, suppose I promise to pay you £100 if you find and return to me my lost dog, Freddy. You immediately start searching for Freddy. As soon as you start searching for Freddy, my promise to pay you £100 if you find and return Freddy will be binding on me. I made that promise with the object of inducing you to search for Freddy, and my promise had the effect of inducing you to search for Freddy. So if you do find Freddy and return him to me, I will have to pay you £100. The contract that arises in this situation is unilateral in nature because only one person is bound to do something under it: me. You don’t have to search for Freddy if you don’t want to. But if you do search for Freddy, then I will have to pay you £100 if you find him and give him back to me.

Estoppel

There is no reason to suppose that the number of types of contract recognised in English law will always be fixed at three. In other words, there is no reason to suppose that there will only ever be three ways of making a binding promise to someone else under English law.

For example, American and Australian law has recognised that a promise might be binding under the law on promissory estoppel. The law on promissory estoppel applies (or at least it does in America and Australia) to make A’s promise to B binding on A if B relies on that promise in such a way that it would be unfair to allow A to break his promise.

For example, suppose that EggheadUniversity is in negotiations to buy a precious manuscript for £1m. Dives has agreed to fund the acquisition, but just before the negotiations are completed, there is a dramatic fall in the stock market and Dives loses a lot of his wealth. As a result, Dives tells Egghead that he can’t help fund the purchase. Egghead asks an old member, Croesus, to help out. Croesus reluctantly tells Egghead that he will stump up the £1m needed if no one else can be found to pay for the manuscript. No one else is willing to help fund the purchase of the manuscript, but Egghead goes ahead and contracts to buy the manuscript for £1m, thinking that Croesus will fund the purchase. Croesus then tells Egghead that he has changed his mind – he won’t be contributing a penny towards the cost of purchasing the manuscript.

Is Croesus’ promise to pay Egghead £1m binding on him? Under English law, it would seem not. The promise was not made in a deed. Croesus’ promise to pay Egghead £1m did not form part of a bilateral contract. His promise was not made as part of an agreement under which Croesus and Egghead undertook to do things for each other. And Croesus’ promise to pay Egghead £1m does not seem to have given rise to a unilateral contract either. Although Egghead relied on Croesus’ promise by contracting to buy the manuscript, Croesus did not make his promise with the object of inducing Egghead to buy the manuscript. Almost certainly, Croesus would have been overjoyed if the negotiations to buy the manuscript had fallen through: he would then have been released from his promise to pay Egghead £1m.

So Croesus’ promise to pay Egghead £1m will not be binding on him under English law. In contrast, the American and Australian courts would probably recognise that Croesus’ promise was binding on him under the law on promissory estoppel. The fact that Egghead foreseeably, reasonably and irretrievably relied on Croesus’ promise makes it unfair for Croesus’ to go back on his word, and as a result he would be bound by his promise to give Egghead £1m. It should be noted that the concept of promissory estoppel is not unknown in English law. If A promises not to enforce a debt owing to him by B, and B relies on that promise in circumstances where it would be unfair for A to go back on his word and enforce the debt, then the law on promissory estoppel may apply to prevent A from going back on his promise not to enforce the debt. Again, if A promises to grant B an interest in land belonging to A, and B relies on that promise in circumstances where it would be unfair for A to go back on his word and refuse to grant B that interest, a different kind of estoppel – what is called a ‘proprietary estoppel’ – will apply to give B a right to go to court to ask the court to compel A to give B the interest that A promised to give B. However, the English courts have yet to take the step of building on these developments and recognising the existence of estoppel contracts in cases such as Croesus’, where there was no promise to waive a debt or grant someone else an interest in land.

Should the English courts take this step? Should the mere fact that a promise has been relied upon in circumstances that make it unfair for the promisor to break his promise suffice to make the promise binding under English law? Obviously, if it would be unfair for the promisor to break his promise then there is a case for the State to intervene and force the promisor to keep his promise. Moreover, as we have seen, English law recognises that some promises – such as promises to grant someone else an interest in land, or promises to waive a debt – will be legally binding under the law on promissory and proprietary estoppel. Given this, it is hard to see why English law does not say that any kind of promise will be binding if it was been relied upon in circumstances that would make it unfair to break it.

On the other hand, if the law held that promises such as Croesus’ were legally binding, the law on when a promise will be binding extremely uncertain. How can we tell with any certainty when the courts would find that it would be ‘unfair’ for someone to break a promise that has been relied upon? On balance, it seems that the unfairness involved in allowing people like Croesus to break their promises is a price worth paying to avoid this uncertainty. The fact that promises such as Croesus’ could be made binding by the simple device of inserting them in a deed means that genuine cases of unfairness created by the English courts’ current refusal to recognise that promises such as Croesus’ are legally binding will be few and far between.

A double-edged sword

There are, of course, immense benefits in having a system of contract law. Without it, it would be very difficult to rely on the promises of anyone but one’s friends and family and therefore very difficult to plan for the future. This is particularly important in the marketplace. It would be impossible for two businesses to make any long-term deals and give effect to them if they were not legally binding.

Suppose, for example, that EggheadUniversity projects that it will need 2,500 computers a year for the next 10 years. Magic Computer plc makes computers of the type needed by EggheadUniversity. In return for getting guaranteed sales of 2,500 computers a year for 10 years, Magic Computer would be willing to sell their computers to Egghead for a special discount price of £300 a computer. There is a deal to be struck here which would benefit both parties – but if it were not legally binding, it would be impossible to make the deal and then put it into effect. Distrust would prevent the parties coming together. Magic Computer would think, ‘We can’t commit ourselves to supply Egghead with 2,500 computers a year. We’d have to take on a lot more workers, and buy a lot more parts, to manufacture the computers – and then after we manufactured the computers, Egghead could make a nonsense of our investment and hard work by refusing to pay for them and buying computers from our rivals.’ Egghead would think, ‘We can’t commit ourselves to buying 2,500 computers a year from Magic Computer. Admittedly, they’re currently available at a bargain price – but after we’d bought the first batch and designed all our systems around them, what would stop Magic Computer from jacking up the price of the next batch of computers?’ Fortunately, the projected deal between Magic Computer and Egghead would be binding – it amounts to a bilateral contract. And it is precisely the bindingness of the deal that allows Magic Computer and Egghead to enter into it and plan their affairs around it – to the benefit of both parties. (It should be clear from the foregoing that the reason why the law enforces bilateral contracts is because doing so allows parties in the marketplace to make and implement long-term deals with each other.)

There is, then, no denying the value of the English law of contract – indeed, modern life would be unimaginable without it. However, the existence of the law of contract does give rise to a range of potential problems. Chief among these is the problem of people trying to use the law of contract to take advantage of other people. For example, suppose that Sandy is driving to Greenville, where she has an important appointment. In order to get to Greenville, she has to go across BlueLake in a ferry. The only available ferry is run by Red Ferry plc. Normally, when travelling on a ferry, Sandy would have a right under the Occupiers’ Liability Act 1957 that the ferry company take reasonable steps to see that the condition of the ferry is such that she will be reasonably safe while travelling on the ferry. Before she is allowed to go onto the ferry, Sandy is presented with a form which says, among other things: ‘I hereby waive any rights I might have that Red Ferry take care for my safety while on the ferry.’ Sandy is told that unless she signs the form she will not be allowed on the ferry. She has no real choice but to sign. Sandy subsequently breaks her leg slipping on a concealed patch of oil on the deck of the ferry. Sandy sues Red Ferry for compensation. In its defence, Red Ferry argues that Sandy is bound by her promise to waive any rights she might otherwise have had that Red Ferry take reasonable steps to ensure that she was reasonably safe on the ferry.

Here Red Ferry is trying to use the law of contract to escape its legal responsibilities to Sandy. What is the best way for the law to deal with this kind of advantage-taking? Four responses suggest themselves.

(1) Do nothing

This response is not actually as stupid as it sounds. The idea is to leave it up to the free market to eliminate Red Ferry’s advantage-taking. If enough customers become dissatisfied with the way they are being treated by Red Ferry, then another ferry company will see an opportunity to compete with the service that Red Ferry provides across BlueLake. The rival company will start running ferries across Blue Lake, advertising itself as a ‘kinder, gentler’ company than Red Ferry – one which takes care of its customers and isn’t afraid to pay compensation when it gets things wrong. At that point, Red Ferry will be faced with the choice of either smartening up its act, or losing all its customers and going bust. Either way, Red Ferry’s advantage-taking will not last.

However, this response to Red Ferry’s advantage-taking suffers from a couple of problems. First of all, it involves the law’s tolerating Red Ferry’s advantage-taking for as long as it lasts, with the result that any claims made against Red Ferry by injured customers such as Sandy will be dismissed on the ground that their promises to waive their rights are binding on them. Secondly, it is too optimistic to think that Red Ferry’s treatment of its customers will allow a competitor to put it out of business. It may be that the money Red Ferry saves by treating its customers so harshly allows it to offer very cheap deals to cross Blue Lake that could not be matched by a ‘kinder, gentler’ company – and it may well be that faced with the choice, the general public would prefer to get a cheap fare from Red Ferry and take the chance of not being able to sue if they get injured than pay more to cross Blue Lake, safe in the knowledge that they will be protected if they are injured due to the fault of their ferry company.

(2) Review

This response involves examining the promise made by Sandy and declaring it not to be binding if it was ‘unfair’ or ‘unreasonable’. This response to wrongdoing is embodied by the Unfair Terms in Consumer Contracts Regulations 1999, which provides that ‘An unfair term in a contract concluded with a consumer by a [business] seller or supplier shall not be binding on the consumer’ (reg 8(1)) and further provide that ‘A contractual term which has not been individually negotiated shall be regarded as unfair if, contrary to the requirement of good faith, it causes a significant imbalance in the parties’ rights and obligations arising under the contract, to the detriment of the consumer’ (reg 5(1)). So if it is judged that holding Sandy to her promise to waive her rights against Red Ferry would be ‘unfair’, given all the circumstances, then it will not be binding on her and Red Ferry will not be entitled to take advantage of it to escape their responsibilities to Sandy.

The problem with this response to advantage-taking is that it leaves people like Sandy in a state of uncertainty as to what their rights are. Suppose Sandy was consulting a solicitor about whether she could sue Red Ferry. The solicitor tells Sandy, ‘You would have an excellent case – but the problem is that form you signed, waiving your rights against Red Ferry. If that’s binding on you, then your case is doomed to fail.’ Sandy asks, ‘Well – is it binding on me or not?’ The solicitor replies, ‘Well, that depends on whether it would be “unfair” to hold that it is binding on you. If it would be “unfair”, then it’s not binding, and you’ll win your case. If it wouldn’t be “unfair” to hold you to your undertaking to waive your rights, then it will be binding on you, and you’ll lose.’ Losing her patience slightly, Sandy asks, ‘Well – would it be “unfair” or not?’ Sighing, the solicitor replies, ‘Well, that’s hard to tell. The courts’ general approach will be to ask – Did the form, contrary to the requirement of good faith, cause a significant imbalance in the rights and obligations between Sandy and Red Ferry to Sandy’s detriment? And in order to answer that question, they’ll look at all the circumstances of the case.’

It is immediately obvious that Sandy will have a big incentive not to carry on with her case against Red Ferry. She simply won’t have enough confidence that she will win the case to enable her to take the chance of carrying on with it, losing and having to cover Red Ferry’s legal costs (which are likely to be substantial). So whether or not the form in Sandy’s case was actually binding on her or not will be irrelevant. The mere existence of the form – and the law’s saying that the form may, in certain circumstances, be binding on Sandy – will be enough to discourage Sandy from continuing with her claim against Red Ferry. So this second form of response to Red Ferry’s advantage-taking – saying that Sandy’s waiver of rights will not be binding on her if it would be “unfair” to hold her to it – sounds eminently reasonable in theory. However, in practice it provides Sandy with an utterly useless form of protection against Red Ferry’s advantage-taking.

(3) Automatic strike-out

This is a very powerful response to Red Ferry’s advantage-taking. Under it, Sandy’s waiver of her rights against Red Ferry is automatically declared not to be binding on her. This response to Red Ferry’s advantage-taking is embodied by s 2(1) of the Unfair Contract Terms Act 1977, which provides that, ‘A person cannot by reference to any contract term or to a notice…exclude or restrict his liability for death or personal injury resulting from negligence.’ (Section 1(3) of the same Act makes it clear that it only applies to attempts to exclude or restrict ‘business liability’.)

Unlike the previous response to Red Ferry’s advantage-taking, this response does not leave people like Sandy in a state of uncertainty as to what their rights are. Replay the above conversation between Sandy and her solicitor, this time factoring in the existence of s 2(1) of the Unfair Contract Terms Act 1977. This time round, the solicitor starts the conversation by telling Sandy, ‘You have an excellent case against Red Ferry – that form you signed waiving your rights against Red Ferry is no problem: it’s simply not binding under s 2(1) of the Unfair Contract Terms Act 1977.’ End of conversation.

Despite its virtues, there is one problem with this response to Red Ferry’s advantage-taking. Suppose that Red Ferry was forced into making all its customers sign the form that Sandy signed because it had been swamped by a large number of claims for compensation by people who had slipped on the decks of Red Ferry’s ferries while crossing BlueLake. (Ferries are, after all, very slippery places.) Almost all of these claims had no merit (in Red Ferry’s view), but they were almost always for such small amounts that no individual claim was worth the expense of fighting. But added together, the claims amounted to a substantial expense that Red Ferry could not afford to incur. So they came up with the idea of getting all their customers to sign a form, waiving their rights that Red Ferry take care to see that they were reasonably safe while crossing Blue Lake. So whenever a claim for compensation was made against Red Ferry by a customer who had slipped on their ferry, the claim would be very easy and cheap to fight. Red Ferry could simply produce the customer’s form and his case would be dismissed on the ground that the customer’s waiver of rights was binding on him.

Section 2(1) of the 1977 Act prevents Red Ferry solving its problem with unmeritorious litigation in this way. Their forms will not work to protect them from being sued. As there seems no other way round Red Ferry’s problem, s 2(1) of the 1977 Act might eventually work to drive Red Ferry into insolvency, sunk by a tidal wave of groundless claims which it has been made powerless to resist by s 2(1). So s 2(1) may in the long run work to the detriment of all the customers who need Red Ferry’s services to cross BlueLake.

(4) Prior restraint

The fourth response to Red Ferry’s advantage-taking is to allow the government to order Red Ferry to stop making its customers waive their rights against Red Ferry if Red Ferry’s doing so is ‘unfair’ or ‘unreasonable’. This response to advantage-taking can be found in the Unfair Terms in Consumer Contracts Regulations 1999, which empowers the Director General of Fair Trading to order a business to remove a term from its contracts if he or she judges it to be ‘unfair’ under the Regulations. (If the Director General makes a mistake in applying the Regulations, the affected business can apply to the courts and ask them to set aside the Director General’s order.)

This is a superior response to advantage-taking than any we have yet considered. If Red Ferry is acting unfairly or unreasonably in requiring its customers to waive their rights, then it will be made to stop, and any customer who is injured while on one of Red Ferry’s ferries will not be in any uncertainty as to what his or her rights are because he or she will never have been made to waive them in the first place. At the same time, Red Ferry retains the liberty to require its customers to waive their rights when it would be ‘fair’ or ‘reasonable’ to do so – which it may well be if Red Ferry is forced into taking such a step in order to avoid being swamped with groundless claims for compensation that threaten to tip the company into insolvency.

However, there are grounds for concern about this response to advantage-taking. It involves granting the government unprecedented powers to meddle in the running of businesses, dictating the terms on which they will be allowed to trade. This cure may well turn out to produce effects far worse than the disease it was intended to treat.

The bindingness of contracts

It is a common error to think that a promise has to be written down to be legally binding. Perhaps Sam Goldwyn, the film producer, made this mistake when he joked that, ‘A verbal contract isn’t worth the paper it’s written on.’ In fact, very few promises have to be made in writing in order to be legally binding. The most notable example is a promise to convey land to someone else. This must be put down in writing (Law of Property (Miscellaneous Provisions) Act 1989) and inserted in a deed (Law of Property Act 1925, s 52(1)) to be binding.

But Goldwyn was not wholly wrong. There are cases where a promise that is supposedly binding under English law will not be worth the paper, if any, it is written on. Suppose, for example, that Liam agreed to buy a particular car on Paula’s secondhand car lot for £5,000. A couple of problems with the car needed attending to: Paula promised that she would have those fixed and that she would then deliver the car to Liam’s house. Liam promised Paula that he would give her the money for the car when she delivered it. Paula then rang Liam up a few days later to tell him she was going to sell the car to someone else, who had offered £6,000 for it. What remedies will Liam be entitled to in this situation?

Could he get the courts to order Paula to hand over the car to him, through the award of what is called an order of specific performance? This is unlikely. If the courts judge that getting Paula to pay Liam damages will adequately compensate him for the losses suffered by him as a result of Paula’s breach of contract, then they will not make an order for specific performance against Paula. If the car in question is unique or of great sentimental value, thus making it hard to put a financial value on the loss that Liam will suffer as a result of not getting the car, then damages might not be an adequate remedy and then an order of specific performance might well be available. But let’s assume the car in question is an ordinary, run-of-the-mill car and there is as a result no question of Liam being awarded an order of specific performance in this case.

So Liam can’t get specific performance, but he can sue for damages to compensate him for the losses suffered by him as a result of Paula’s breach. So how much will he be able to sue Paula for? Well, let’s assume that Liam can buy a virtually identical secondhand car for £4,500 to replace the one that Paula has failed to deliver to him. So – can we say that Liam has lost £4,500 as a result of Paula’s breach? No, we can’t. We’re overlooking the fact that Liam agreed to pay £5,000 for the car Paula was going to deliver him, and that Paula’s breach means that he no longer has to pay her that sum. So Liam has actually saved £500 as a result of Paula’s breach (the difference between the £5,000 that Liam would have had to lay out had Paula performed, and the £4,500 that Liam is now going to have to shell out to buy a car to replace the one that Paula failed to deliver to him). So Liam has suffered no loss as a result of Paula’s breach. Does that mean that Liam cannot sue Paula for anything by way of damages in this situation? Not quite. The courts will award Liam nominal damages of £5 as acknowledgment that he has been the victim of a breach of contract.

So in this situation Paula has committed an obvious and deliberate breach of contract and all she has to pay Liam as a result is £5. It is hard to avoid the impression that Paula’s binding promise to deliver the secondhand car to Liam wasn’t worth the paper, if any, it was written on. Some would see this as a good result. Liam hasn’t suffered any loss as a result of Paula’s conduct, so why should he be able to sue her? Indeed, from one point of view, it would be positively regrettable if the law did anything to encourage Paula to keep her promise to Liam. The second buyer – the one who offered Paula £6,000 for the car – obviously valued the car much more than Liam, who was only willing to pay £5,000 for it. If you take the view that resources should go to those who value them most – where you are counted as valuing a resource more than anyone else if you are ready and willing to pay more for it than anyone else – then you will take the view that it was a good thing that Paula broke her promise to Liam and gave the car to the second buyer.

Others are more disturbed at the prospect of someone’s being allowed to flout their legal obligations without any kind of effective sanction. (In any case, the view that resources should go to those who are ready and willing to pay the most for them is extremely questionable. If you had a bowl of rice and had a choice between giving it to a starving child who had no money to pay for it, and a rich man who was willing to pay a pound for it because had been suddenly seized with a desire for some Chinese food, it simply cannot be true that you should give the bowl of rice to the rich man and not the starving child.) Some effective sanction would be provided for Paula’s breach if Liam were allowed to sue her for what might be called restitutionary damages – that is, damages designed to strip Paula of some or all of the gains she made by breaching her contract with Liam. This would allow Liam to sue Paula for some or all of the £1,000 profit that she made by selling the secondhand car to the second buyer, as opposed to Liam. The courts have recently started allowing claims for restitutionary damages to be made in breach of contract cases. However, they have made it clear that such damages will not be available in cases such as Liam’s, where someone has contracted to buy goods from a seller, and then the seller has sold to someone else because he has received a better offer. (Evidently the courts also believe this sort of behaviour is to be applauded and not discouraged.)

A very effective sanction for Paula’s breach would be provided if Liam were allowed to sue her for punitive damages (otherwise known as exemplary damages) – that is, damages designed to punish Paula for cynically and deliberately breaking her contract with Liam. However, while punitive damages may be awarded against people who commit torts, the courts have always set their face against such damages being awarded against people who commit breaches of contract. It is hard to see why this is so: some breaches of contract (such as an unjustified failure to pay up on an insurance contract protecting one in the event of ill health or unemployment or losing one’s house) can be far more devastating than some torts for which punitive damages may be awarded. However, there is no prospect of the current position being reversed.