Contract negotiating

Commercial relationships between parties in the energy sector are almost always governed by contracts, and a number of different methods and tools are used in documenting negotiations. Bryan Gundersen examines the pros and cons of confidentiality agreements, minutes, letters of intent, letters of comfort, terms sheets, heads of agreement and draft contracts.

Under the law relating to negotiations, statements made during negotiations are covered by the Contractual Remedies Act 1979, which can provide relief when a party makes a misrepresentation, namely, a false statement (either innocently or fraudulently) to the other party which induced them to enter into the contract.

The end contract will usually exclude liability for these misrepresentations, but under this Act the courts have a discretion as to whether the exclusion clause should be enforced. Here, the issue is whether, notwithstanding the existence of the exclusion clause, the other party was induced to enter into the contract by the misrepresentation. Exclusion clauses do not give negotiating parties a licence to make misrepresentations.

The Fair Trading Act 1986 prohibits conduct that is, or is likely to be, misleading or deceptive. This Act applies broadly to those engaged ‘in trade’ (i.e. carrying on commerce). Whether conduct is misleading or deceptive is a question of fact. The issue is not whether the person making the misleading statement in the negotiations intended to mislead, but simply whether it was misleading. Unlike misrepresentation, where the Court has a discretion, this Act overrides clauses that attempt to exclude liability.

Again, exclusion clauses do not provide any licence to mislead and one has to be careful to exercise due diligence on the information to be provided during negotiations to ensure that it is accurate.

A claim of negligence may be invoked where one person is owed a duty of care by another person, and that other person breaches the duty by not exercising a reasonable standard of care. In a negotiation context this can result in a negligent misrepresentation where one party provides information to the other party, knowing that it will be relied upon, but does not take reasonable care to ensure that it is correct.

Parties can generally contract out of liability for negligence. Avoiding this liability is the reason why most contracts provide that neither party will accept liability to the other for statements made during negotiations. However, be aware that they may not avoid liability for misrepresentations and will not avoid liability for misleading statements or deceit.

Law in relation to negotiation documents

Obligations of confidence may be either contractual (agreed) or equitable (implied). An equitable obligation arises if the information is obviously confidential by nature and it was imparted in circumstances where both parties should have known that there was an obligation of confidence.

In negotiating a contract, do not rely on any equitable obligation of confidence. Get a confidentiality agreement signed or even entered into orally at the outset of negotiations before any confidential information is disclosed.

The confidentiality agreement needs to address what aspects of the negotiations are covered and how confidential information is to be identified, who owes the duty of non-disclosure and whether there are any exceptions to confidentiality (for example disclosure to lawyers and other professional advisors), and the return of the confidential information once the negotiations are completed.

Minutes are often used in negotiations to record the position of the parties and any key agreements made during the negotiations. Recording negotiations through the use of minutes is advantageous because they

discourage a party from relitigating matters that have been agreed to date; yet at the same time they encourage parties to speak up early should they wish to relitigate issues. It is rare for a party to leave information that they are uncomfortable with on the record for too long. They also form a record of all issues addressed and how they have been addressed. Minutes form a valuable point of reference and enable the parties to keep negotiations on track.

However, remember that they can be a record of a legally enforceable contract which has been entered into orally. If the commercial intention is not to be legally bound by anything recorded in the negotiations, then this should be recorded as a matter of course in the minutes.

Letters of intent are often used to provide comfort as to a commercial commitment to do the deal. They are common in the construction industry, particularly where one party (A) indicates to another (B) that, in the event of A entering into a contract with party C for the execution of specified work, A will sub-contract some of the work to B.

Letters of intent are useful for creating a climate of confidence for the parties to commit resources to do the deal and preclude the parties making similar commitments to someone else. However, if they are poorly worded such letters may create legal obligations which were not intended to be binding. Letters of intent should be avoided unless there is a real commercial advantage for using them. They should make it clear that while there is an intention to do a deal, the letter is not legally binding.

Letters of comfort are common in certain financing transactions.

Typically, one will be provided by the owners or directors of a company to a financier to induce it to advance funds to the company. Such a letter usually contains certain clear promises (such as an undertaking to inform the financier if the issuer of the letter of comfort sells or otherwise parts with their shareholding in the debtor company) which fall short of a guarantee of the debt of the company. As with letters of intent, letters of comfort should be avoided unless there is a real commercial advantage for using them and they should be absolutely clear as to the extent they are legally binding.

A terms sheet identifies the key commercial terms to indicate the basis on which a party will do a deal or to record the outcome of negotiations. They are often used by banks to set out the terms on which they will lend funds. Once the terms sheet is agreed, the parties can obtain corporate approvals to proceed with the final documentation.

The advantage of terms sheets is that they establish whether there is any scope for agreement between the parties. This means that parties can begin to agree on key commercial terms before investing time and expense on final documentation.

The disadvantage is that the parties can invest too much time and effort introducing detail into the terms sheet. This is best left to the final document. Do not fall into the trap of negotiating the terms sheet as if it were a summary of the final agreement.

Heads of agreement are usually preliminary agreements which record the commercial terms decided between the parties. A memorandum of understanding is often used to record a non-binding understanding between the parties or establishing a framework for undertaking a project.  The advantage of a heads of agreement is that by establishing a preliminary agreement, the parties can proceed with the transaction before the completion of the final contract. However, the number of disadvantages outweighs any benefit of using a heads of agreement. Once a heads of agreement has been completed, the parties are often unwilling to commit time and resources into completing the final contract. Hence, when things go wrong, the heads of agreement fails to address all the issues and common law applies so as to allocate risk, often in a way that the parties did not foresee, leading to conflicts and disputes.

In light of the disadvantages, proceeding directly to a draft contract is the preferred method of documenting the negotiation. A draft contract will contain all the terms which relate to the transaction and will better inform the negotiations and their progress. However, always make it clear on the draft contract that it is not legally binding – you will only want to be legally bound once everyone signs the final contract.

The key message is that the negotiation documents discussed above have one very important thing in common – if the parties do not intend to be legally bound by what is recorded, then the document should state this clearly. 

• Bryan Gundersen LLB (Hons) is a Senior Partner at Kensington Swan, and leader of the firm’s energy workgroup. He acknowledges the assistance of Taryn Tuck, also a solicitor at Kensington Swan, in the preparation of this article.