Contract Law Updates
Two common areas of dispute in contract law continue to be “what is reasonable?” and “what is the difference between an indemnity and a guarantee?” Two recent cases may shed some additional light ...
“What is reasonable?”
R serviced office accommodation and E had rented space in R’s building at Heathrow. When this was closed down, E moved to another building a few miles away and complained of (a) relocation expenses and (b) the inadequacy of the air-conditioning system, especially in the summer. E withheld fees due to R and counterclaimed when R sued for them.
R’s liability was capped at the greater of 125% of the fees or £50,000. R’s standard terms provided that it “will not in any circumstances have any liability for loss of business, loss of profits, loss of anticipated savings, loss of damage to data, third party claims or any consequential loss”.
In arriving at its conclusion the Court of Appeal stated that: (i) the obvious and primary measure of loss for R’s breach was diminution in the value of the services promised. That kind of loss was not excluded; nor, indeed, were fraud, or wilful, reckless or malicious damage; (ii) it rejected E’s argument that “in any circumstances” covered deliberate infliction of loss by R such as failure to repair the air-conditioning. Such failure was deliberate only in the narrow sense that it depended on unwillingness to spend money but was not a deliberate attempt to cause damage to R’s customers. It was negligent and nothing more; (iii) there was no inequality in bargaining power and E had rejected R’s advice to its customers to take out business loss insurance; and (iv) the capping provision was severable and was in any case reasonable when considered as a limitation clause, not an exemption clause.
With this in mind the Court of Appeal held that this exclusion clause was not unreasonable and it did not amount to a total exclusion of any remedy at all.
“What is the difference between a guarantee and an indemnity?”
P were employees and minority shareholders in a company of which J was the managing director and majority shareholder. J wanted to sell his shares and told P they would need to raise £500,000 to exercise their rights of pre-emption. He also said he had found a corporate purchaser who was willing to buy their shares at the same price though in instalments. P were willing to waive their pre-emptive rights but were worried that they would have no security, and their options would be worthless if the purchaser became insolvent before buying their shares. To persuade them to sign the option agreements, J orally undertook that if the named buyer did not pay for their shares he would. On legal advice he declined to put this in writing. The option agreements were duly signed and the waiver of pre-emption rights was approved at an EGM, along with a loan by the company to the buyer. The sale of J’s shares went through but the buyer became insolvent and P received nothing.
The issue was whether J’s oral undertaking was a guarantee or a contractual indemnity. If the latter, it was enforceable; if the former, it fell foul of the Statute of Frauds 1677 S.4
In arriving at its conclusion the Court of Appeal reiterated that a guarantee was a special type of contractual indemnity whereby one person promises to answer for the debt or default of another. Generally speaking, this applies to promises which are separate and distinct from a primary contractual obligation. The usual test was whether the defendant had an interest in the transaction or was totally unconnected with it. Later authorities looked rather at the object of the contract seen as a whole and whether the promise could be said to be incidental to that central object. If so, it was an indemnity. They stressed that liability under an indemnity is independent of the question whether a third party makes default or not, whereas the Statute of Frauds applies only to promises made to the person to whom another is already or is to become answerable.
With this in mind the Court of Appeal stated that the oral undertaking was in the nature of a guarantee. Accordingly J’s undertaking to P was not part and parcel of the transaction whereby he sold his own shares with the company’s approval and financial backing. He had involved himself in the transaction with P only as a means of persuading them to co-operate in the main transaction. The only connecting thread was thus motive, not contractual object. There was no larger transaction which subsumed all these steps and events. The oral promise was therefore unenforceable.
If you require further information on these issues or indeed have any queries regarding possible contractual issues in your commercial dealings please do contact James Lamont in our Commercial Group.
