Contract law set for a makeover

The Law Commission's Consultation Paper published in August 2002, proposed some interesting amendments to English contract law, which may have a significant effect on the construction industry. The Commission suggested that the current, rather complicated, regime for assessing the acceptability of contract clauses should be overhauled in favour of a new, comprehensive regime whereby almost every contract clause can be individually checked for fairness before it is enforced.

The current position
The existing regime derives from English law's traditional robust starting point of 'freedom of contract', according to which the courts are reluctant to interfere with the bargain made between parties as set out in their contract.

The risk with this approach is that where parties are of unequal bargaining power, the stronger party may impose unfair terms, such as stringent 'limitation of liability' clauses, which prevent the weaker party from gaining adequate compensation if the stronger party fails to perform. To attempt to correct this imbalance, English lawmakers introduced a series of statutes, culminating in the Unfair Contract Terms Act 1977 (UCTA). This applies to both consumer and business-to-business contracts but it only affects exclusion of liability clauses or limitation of liability clauses. Its effect is to make some exclusion or limitation clauses completely ineffective, and others only effective if they are reasonable.

Later on, the European Commission decided it was necessary to give consumers additional protection. As a result, the United Kingdom introduced the Unfair Terms of Consumer Contracts Regulations 1999 (UTCCR). These protect consumers only, in contrast to UCTA which protects everyone. However, the terms to which UTCCR applies are much more diverse – they go beyond limitation of liability and exclusion clauses and apply to almost any kind of contractual term. The only terms UTCCR do not apply to are those defining the main subject matter of the contract (ie the price, the object in question and the time for performance of the contract), or 'individually negotiated' terms. The effect of UTCCR is that if a term is unfair, it doesn't bind the consumer affected.

The new rules
The Law Commission wants to unite the two different regimes by extending the protection offered to businesses, so that it is the same as that offered to consumers.

So what does this mean for business-to-business contracts? The major change is that all terms (apart from the central terms, such as price, or individually negotiated terms) will be subject to a test to decide whether or not they are fair and reasonable.

If the Law Comission’s proposals become law, the effect of contract law on standard form contracts may be more unpredictable over the next few years

Construction contracts may be particularly hard hit by this proposal because there are many standard form contracts, prepared by institutions such as the JCT, ICE, ACE etc. Unless the courts give the definition of individually negotiated something very different to its everyday meaning, none of these standard form contracts will be individually negotiated, and every single term could potentially be subjected to this 'fair and reasonable' test.

Unfair arbitration clause
An illustration of what may be to come, is in the case of Zealander versus Laing Homes. In this case, a house purchaser agreed a contract to build a house with a contractor, which contained an arbitration clause. The arbitration clause was only partially effective. When the homeowner sought to sue the contractor, the contractor sought to rely on the arbitration clause to stymie the elements of the claim which were covered by the arbitration clause. But the court decided that the homeowner was a consumer, UTCCR applied and the arbitration clause was unfair, because it would have forced the homeowner to bring half of his claims in the courts, and half in an arbitration.

It is arguable that this case may be restricted to its own facts, because the effect of the arbitration clause had an unusually harsh effect on a homeowner who would not have been experienced in contract drafting. However, if something as apparently innocent as an arbitration clause can be unfair, it is difficult to be at all confident that any of the standard form clauses will not occasionally be considered unfair.

Even so, the courts may not be quick to interfere with standard terms in business-to-business contracts if they take into account the experience and knowledge base of the parties to the contract. Also, the parties to a contract will often negotiate a schedule of amendments which change the standard terms, and it is difficult to envisage the courts regularly neutralising standard terms when the parties have not taken the opportunity of doing so themselves in the schedule of amendments.

Nevertheless, if the Law Commission's proposals become law, the effect of contract law on standard form contracts may be a little more unpredictable over the next few years.