When negotiating a contract, it is important to distinguish between statements that are ‘pre-contractual’ and made as part of negotiations, and those that are intended to be contractual terms. There are significant consequences for parties who make false or misleading pre-contractual statements, however the remedies that are available to the aggrieved party are not as strong as those applicable for a breach of contract.
If a party has been convinced to enter a contract by a pre-contractual statement made by the other party, and that statement turns out to be inaccurate, they may be entitled to rescind the contract and to claim damages for any loss suffered.
In the case of a term of a contract breach, remedies include rescission and damages but also extend to specific implement, interdict, and ‘self-help’ remedies such as performance retention and suspension.
This is why it is important to draw a distinction between these terms, and for parties to be aware of the nature of the statements made and the effect that they have.
Identifying pre-contractual statements
It can be difficult to identify which statements are pre-contractual and which are contractual, particularly in the absence of a well-drafted agreement or where an agreement has a retrospective effect. There are three main categories of pre-contractual statements:
- Invitations to treat;
- Pre-contract documents; and
- Representations.
If a statement falls into any of these categories, it cannot also be a term of the contract.
One: Invitations to treat
An invitation to treat is an expression of willingness to contract as opposed to an offer to contract. Unlike an offer, it should display no intention to be bound at that particular point in time. Advertisements, catalogues, and requests for tenders are all invitations to treat. These differ from offers which must be specific, complete, and capable of acceptance.
An offer must contain the material terms needed to form a contract and intend to evoke acceptance, whereas an invitation to treat is simply a negotiation tool.
Two: Pre-contract documents
Pre-contract documents such as heads of agreement and terms sheets are tools that can advance pre-contract negotiations. They demonstrate how close the parties are to a deal and provide a framework for further negotiation. Usually, these documents are not binding, however, as the High Court held in New Media Holding Company LLC v Ivan Kuznetsov [2016] EWHC 360 (QB), a term sheet can constitute a legally binding contract in certain circumstances.
In this case, the term sheet was drafted by lawyers, circulated to the relevant parties, and subsequently amended to contain a ‘workable agreement’. Crucially, it was then signed by the parties. In light of these facts, the term sheet was found to be a contractually binding and legally enforceable agreement. Simply using the title ‘heads of terms’ or ‘term sheet’ is not enough to preclude a document from becoming a binding agreement.
Where pre-contract documents are used, careful drafting and cautious use of signatures must be exercised to ensure that they do not trigger contractual obligations.
Three: Representations
Representations are statements made during negotiations that lead parties to enter into a contract. A representation becomes important if it is untrue, thereby making it a misrepresentation. Where a misrepresentation is made and that misrepresentation has induced a party to enter into a contract, that party may be entitled to a remedy.
A misrepresentation will be deemed to have induced a party to enter into a contract if it would affect the judgement of a reasonable person in deciding whether or not to enter into that contract. For example, in Patterson v Landsberg & Son [1905] 13 S.L.T. 62, a statement that items of jewellery were antiques when they were in fact of modern manufacture was held to be a misrepresentation that induced the purchaser to enter into the contract for sale. Similarly, inaccurate statements on the profitability of a business that induced a party to enter into a partnership agreement would also amount to a misrepresentation, such as in Ferguson v Wilson [1903] 11 S.L.T. 561.
In the University Court of the University of St Andrews v Headon Holdings Ltd [2017] CSIH 61, one of the parties had only partially disclosed the true nature of their interest in the land that was the subject of the transaction. While the statement that they made was technically true, it was argued that this was only half of the truth due to the information that was left unsaid. In this instance, the court held that the silence and failure to disclose the full truth could amount to a misrepresentation.
However, there are limits on the types of statements that can amount to a misrepresentation. This includes statements made in advertisements, also known as ‘sales puffs’ or ‘puffery’, that a reasonable person would know is not a statement of fact. For example, a reasonable person would know that if they drink a can of Red Bull, they will not grow wings. Likewise, statements of opinion, future intention, and silence will not amount to misrepresentations.
Misrepresentations can either be innocent, negligent, or fraudulent. Innocent misrepresentations are made without any fault on the part of the person making the statement. The maker must have believed that the statement was true and made it in good faith. In this case, the available remedy is reduction of the contract. This is intended to put the parties back in the position that they were in before the contract was made.
The remedies that are available for negligent and fraudulent misrepresentations are more severe.
Negligent and fraudulent misrepresentations may also result in reduction of the contract, however the court may decide to make an award of damages instead of or in addition to reducing the contract. Negligent misrepresentations occur where the maker of the statement does not know that the statement is untrue, but ought to have realised that the statement was untrue, had they exercised ordinary care. Whereas the maker of a fraudulent representation knows that the statement they are making is false or is reckless in regard to the truth of the statement.
Mitigating the risk of confusion
Parties can take proactive steps to mitigate the risk that the nature of a statement is misconstrued, and to avoid falling into the trap whereby a statement, or document, which was intended to be purely pre-contractual becomes a contractual term. Entire agreement clauses can be used to achieve this goal and to provide clarity on the extent of a contract and its terms. An entire agreement clause limits the express terms of the agreement to those that are included within the relevant written document and intends to prevent parties from raising claims that are founded on pre-contractual statements.
However, as the courts held in the case of Anwar v Britton 2018 SAC (Civ) 27, a basic entire agreement clause will not exclude claims for misrepresentation. In Anwar v Britton, missives of sale included a clause that stated that the missives would constitute the entire agreement between the purchaser and the seller.
The purchaser raised an action for reduction of the missives on account of an allegedly negligent misrepresentation that was made by the seller. The seller argued that the purchaser was not entitled to rely on the misrepresentation because of the inclusion of the entire agreement clause in the missives.
However, the court held that while an entire agreement clause denies the contractual force of a pre-contractual statement, it does not affect its status as a misrepresentation. If parties want to exclude liability for misrepresentations, then they need to include clear wording to that effect. It should be noted that it is not possible to exclude liability for fraudulent misrepresentations.
Another tool that can be used to distinguish pre-contractual statements from contractual terms is the expression ‘subject to contract’. This phrase rebuts the presumption of contractual intent and highlights that parties are still in the negotiation phase. The inclusion of this wording on relevant correspondence or documents, such as terms sheets, demonstrates that the parties do not intend for the material to be part of the binding agreement, therefore mitigating the risk of confusion over its nature and potential disputes.
If you would like to find out more about commercial contracts and the common issues our clients face, visit our Commercial Contracts video and article series.