The ties that bind: When 'subject to contract' backfires

Tags such as “without prejudice” and “subject to contract” are often added by parties and their advisers to correspondence and contract drafts without any detailed consideration of what they are trying to achieve by doing so. Sometimes the parties fall out about the content of such correspondence and drafts, and the effect of those tags must then be considered by the courts.

One such dispute reached the Court of Appeal recently in Farrar and Another vs Rylatt and Others [2019] EWCA Civ 1864. The facts of that case, which were unclear and hotly disputed, related to two properties in West Yorkshire. The relevant property for this issue was known as The Barns. A surveyor brought in by the purchasers put together a draft heads of terms dealing with the sale to them of The Barns and the development of The Barns by the seller, and including arrangements for the sharing of profit on sale of the development. The heads of terms went through a couple of iterations in late 2013 and were headed “subject to contract and without prejudice”. The heads of terms were never signed.

It is a helpful tool to prevent binding contracts coming into force until all parts of the agreement have been finalised. It is not, however, a panacea 

Work started on site, but it was not until the summer of 2014 that a detailed specification was put together. That was attached to a JCT contract, which was signed by the parties in June 2014. The heads of terms were also annexed to the JCT contract.

The parties fell into dispute and the seller claimed a share of the profits, relying on the heads of terms to do so. The purchasers vigorously disputed the seller’s entitlement, relying on the “subject to contract” tag and pointing out there was no written profit agreement subsequent to the heads of terms despite the seller’s frequent requests for such an agreement to be drawn up.

On appeal, the seller sought to get round the “subject to contract” tag by arguing that it should be ignored because the parties had reached a binding agreement on the profit share and had intended to create legal relations in relation to it. The seller also placed emphasis on the fact that the heads of terms had been annexed to the JCT contract.

There are circumstances where a binding agreement may be found despite the use of this tag

The seller also relied on the case of RTS Flexible Systems Ltd vs Molkerei Alois Muller GmbH and Co KG (UK Production) [2010] UKSC 14. In that case, the draft contract was also headed “subject to contract” and the court had found that the failure to formalise the contract had not prevented the formation of a binding contract. 

However, Judge Coulson pointed out that RTS was an exceptional case. In that case a significant amount of work had been done, and money spent, so it was unrealistic to say there had not been a binding contract. Performance can be a critical factor in demonstrating an intention to create legal relations. There had been significant performance in RTS. However, in this case no element of profit share had been paid, and the seller’s entitlement to a share of the profit had always been disputed, and therefore there had been no performance. 

The judge went through each of the documents to determine whether any of them could constitute a contract to sell the land and build the development. He concluded that there were a number of reasons why the heads of terms could not constitute a binding agreement to sell the land or to construct the development – one of which was that the heads of terms were headed “subject to contract”. There was no basis either in the wording of the heads of terms themselves or in any other evidence to suggest the paragraphs of the heads of terms dealing with the profit share should be treated differently – and therefore the “subject to contract” tag equally applied to them and meant the heads of terms could not be treated as a binding agreement as to a profit share. 

As for the argument that because the heads of terms had been attached to the JCT contract this meant that all relevant matters had been agreed and the subject to contract tag had fallen away, the judge found a number of fundamental problems with that. It was not the basis of the seller’s pleaded case and no evidence had been adduced to support it. As a result, the seller’s appeal was dismissed and he was found not to be entitled to any share of the profits.

Using the “subject to contract” tag in this case thus had the effect that is normally intended – that no binding contract was in place. It is a helpful tool to use to prevent binding contracts coming into force until all parts of the agreement have been finalised. It is not, however, a panacea – there are circumstances (such as in the RTS case) where a binding agreement may be found despite the use of this tag.

The use of the “without prejudice” tag on the heads of terms was not in issue in the appeal. That tag is generally used to mean the subject matter of the document is being discussed in an effort to settle a dispute and should not be adduced in evidence. It appears the judge at first instance quite rightly ignored this tag on the basis that it had been wrongly applied in this instance – a useful reminder that a tag wrongly applied will be ignored by the tribunal in the event of a dispute.

Victoria Peckett is partner in, and co-head of the construction and engineering team at, CMS UK