The dangers of “sharp practice” negotiation


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A clear contract term was recently reversed to give effect to ambiguous heads of terms due to the “sharp practice” of a negotiator, leaving the losing party with a £2.4 million liability.

This case concerned a contract between Daventry District Council (Council) and Daventry & District Housing Limited (DDH). The Council wished to transfer its stock of council housing, and its housing department staff and their pension scheme. This scheme was underfunded by £2.4 million and there was a fundamental misunderstanding over who would bear this cost.

Negotiations

The Council’s negotiator prepared a proposal intended to make DDH liable for the deficit. DDH’s negotiator (R) understood this but spotted the wording was ambiguous. At a meeting of DDH’s board of directors and their advisers he deliberately misrepresented the proposal as meaning that the Council accepted liability.

In short, the Council thought DDH would pay and DDH thought the Council would pay. The only person aware of the misunderstanding was R, who did not correct the Council’s mistaken belief.

A formal agreement in principle containing the ambiguous wording was signed by both parties on 11 October 2007 (Agreement). This was not intended to be legally binding.

DDH’s solicitors were drafting the contract based on R’s interpretation of the deal. The contract contained a clause that clearly made the Council responsible for the payment. This was agreed by the Council’s solicitors and their negotiator, who did not appear to realise it made them responsible for the deficit.

The contract was completed on 5 November 2007. Shortly after, the Council realised its mistake and took legal action to rectify the contract.

The Court of Appeal

Mutual rectification requires both parties to intend one thing and the contract to say another. If there has been a continuing common intention and the contract does not reflect this, the court will order rectification.

The court found that on a proper reading of the Agreement the common intention at that time was that DDH would pay. Therefore the key issue was whether DDH had changed this position before entering into the contract.

The majority found that an observer would not believe the insertion of the new clause changed this intention. He would not have known DDH expected the Council to pay, as they did not make this clear in the commercial negotiations. The role of the solicitors was not commercial negotiation but drafting of the agreed commercial terms. An observer would not have concluded that DDH was changing its position, but that it was making a mistake.

On that basis, rectification was ordered.

Conclusions

It seems a clear contractual provision may not offer the certainty it once did. A previous House of Lords case ruled that a court would only look at pre-contractual negotiations if there was a clear mistake on the face on the document. This was not the case here as the contract correctly stated what DDH thought were the terms of the deal. Despite this, the court was willing to look beyond the clearly drafted words of the contract to the conduct of the parties. The result now is confusion as to what a court will consider and in what circumstances.

It will be interesting to see how parties respond to the implications of this ruling. Had DDH outwardly changed its position, rectification would not have been ordered. In future, parties may want to consider formally stating that their position has changed and that the agreed contract reflects their intent. Parties may also consider inserting a clause in the contract to similar effect.

Third parties should also consider the implications. It would be clear to any third party reading the contract that the Council was responsible for the deficit. The court reversed this clear position. This could have serious implications for a buyer or funder who would have no knowledge of these negotiations but could face a rectified contract.

Finally, parties may wish to consider their conduct during negotiations. The court clearly took a dim view of R’s “sharp practice”, even though it did not amount to dishonesty. It is unclear whether parties are now under a duty to draw attention to possible mistakes. Parties hoping to exploit a misunderstanding should certainly tread with caution.

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