Are agreements to negotiate enforceable under English law?

The contract - your flexible friend?

One of the primary purposes of the contract in construction projects is to regulate the legal rights and liabilities of the parties in relation to events that may or may not occur. Clauses dealing with extensions of time, variations, termination, and loss and expense are typical examples.

In the case of a long-term contract, such as a facilities management agreement or a PFI/PPP contract, circumstances may change significantly during the contract period. It may not always be possible to agree before the contract is signed what the precise consequences of particular events should be. There may, therefore, be no choice but to provide in the contract that the parties are to agree on what should happen if and when these events occur. The parties may in any event wish to have the flexibility in the contract to work some things out by agreement between themselves as the contract proceeds.

This gives the draftsman of the contract a difficulty. The courts will not enforce "an agreement to agree". The classic example of the application of this principle is the case of , decided in 1975. One party was a builder; the other was a developer. The developer wanted to develop a site but had a problem over the financing of the project. The builder had access to funds. He wrote the developer a letter, which concluded:

The developer accepted the terms of the letter and the builder introduced a source of finance. The developer instructed his quantity surveyor to negotiate with the builder but differences arose about the price and nothing was agreed. The developer then employed other contractors to do the work, which he paid for through the finance source that had been introduced to him by the builder. The builder sued for the profit he had lost as a result of not being engaged to do the work. The Court of Appeal rejected the builder's claim, holding that the agreement between the builder and the developer was only an agreement to negotiate and was unenforceable.

There are nevertheless some circumstances in which the courts will enforce an agreement to agree.

In one case, for example, a provision in a lease gave the tenant the right to purchase the freehold reversion. At the time when the lease was signed, it was obviously not possible to stipulate the price which the tenant should pay if it decided to exercise its option. The lease provided that any such purchase should be

The tenant exercised its option to purchase the freehold but the landlord refused to appoint a valuer, saying that the clause was a mere agreement to agree. The House of Lords held that the machinery for fixing the price of the freehold reversion was a non-essential term of the contract and that if the agreed machinery broke down the court could substitute other machinery to ascertain the price in order to ensure that the agreement was carried out. Since the contract provided that the price was to be determined by valuers, it necessarily followed that the contract was a contract for sale at an objectively fair and reasonable price.

A similar approach was taken in the case of a fifteen-year coal supply contract. The contract contained detailed provisions for the calculation of the price to be paid during the first five years but stated that thereafter the price was to be agreed by the parties. There was a widely drafted arbitration clause providing for "questions, disputes or differences" to be referred to arbitration. The purchaser submitted that after the first five years the contract failed for uncertainty, because there was then nothing more than an agreement to agree the price. The Privy Council rejected this submission. They held that under the contract the parties had undertaken implied obligations to make reasonable endeavours to agree on the terms of supply beyond the initial five-year period and, failing agreement, to do everything reasonably necessary to appoint an arbitrator. It was implicit in the contract that the new pricing structure was to be such as was fair and reasonable between the parties. This was the criterion by which the arbitrator should be guided.

This approach was applied to very different circumstances earlier this year by the Technology and Construction Court. The case arose out of the project to extend the Tyne and Wear Metro. Alstom, as main contractor, entered into a contract with Railtrack for works relating to this project. It was a target cost contract with a pain/gain sharing mechanism for cost overruns and underruns. Alstom wished to sub-contract part of their works to Jarvis. Although there were lengthy negotiations, no sub-contract was ever signed. During the negotiations, Jarvis accepted in principle that they should enter into a pain/gain sharing arrangement with Alstom. However, the parties had radically differing approaches to the manner of calculation of the pain/gain. Alstom wished to link it to Alstom's position under the main contract. Jarvis wished to have a "stand alone" pain/gain sharing mechanism relevant only to its sub-contract.

The court found that, notwithstanding the absence of signed documentation, a binding contract between the parties did exist comprising a draft sub-contract which had been sent by Alstom to Jarvis during the course of the negotiations. This sub-contract contained a clause stating:.

The sub-contract also provided that any party could refer a "dispute or difference" to adjudication under the Housing Grants, Construction and Regeneration Act 1996, and that, subject thereto, any "dispute or difference which arises between the parties" should be referred to the Technology and Construction Court.

Following the line of earlier cases which gave effect to agreements to agree, the court held that the sub-contract contained an unequivocal agreement to participate in pain/gain sharing to an extent and in a manner which had yet to be agreed. The parties' failure to agree it was a "difference" which the court was empowered to determine. The standard by which the court was to be guided was fairness and reasonableness as between the parties. In deciding what was fair and reasonable, the court should be fully informed of the background to and/or the development of the "difference". It should be able to consider the arguments which the parties themselves developed during the course of their negotiations, the reasons why negotiations broke down or were not pursued, the reasons why the arguments were left in abeyance and not brought to a head and any and all potentially relevant further matters raised during the course of the proceedings.

This case extends the circumstances in which the courts will enforce an agreement to agree. It is one thing for an arbitrator or a court, with the assistance of expert evidence, to determine a fair and reasonable amount payable for the freehold reversion of a property, or a reasonable price for the supply and delivery of coal. It is quite another thing for the court to determine what is a fair and reasonable pain/gain sharing mechanism, particularly where, as in this case, the mechanism included a maximum limit on the amount of the pain which one of the parties should be required to bear. These are matters which are fundamentally commercial and cannot be decided by reference to external objective criteria.

Except in the case of fraud or misrepresentation, the courts do not have regard to pre-contract negotiations when determining the rights of the parties under a contract as entered into. However, in the Alstom case the court was prepared to take into account the exchanges between the parties for the purposes of deciding upon a fair and reasonable pain/gain sharing mechanism. This effectively means that the manner in which the parties conducted themselves in negotiations pre-contract could have a bearing on their position post-contract.

The case may indicate a willingness by some courts to adopt a more interventionist role in the contractual relations between the parties. Yet we are still a long way away from saying that the contract can always be given the flexibility that the parties sometimes desire. If an agreement to agree is included in the contract, appropriate supplementary provisions may need to be added to reflect the principles upon which the courts have been willing to enforce such an agreement. This will at least give it a sporting chance of working.

For further detail please contact Peter Long on +44 (0)20 7367 2507 or at [email protected]