Freedom of Contract

Freedom of Contract

 

 

The long-standing idea has been that individuals and corporate are free to enter into contracts without government restriction. From this doctrine, the parties to a contract are seen to be having the freedom to decide the terms and conditions of their contract without government intervention. As such, the fundamental understanding of contract law is “that the content of a contractual obligation is a matter for the parties, not the law”[1]. In this orthodox understanding, the role of the law is limited to the extent of enforcing the terms agreed by the parties[2]. Nonetheless, judicial interventions and statutory legislation have placed limitations to the freedom of contract. The court relies on several grounds such as implied terms, frustration, undue influence, and unconscionability to adjust or nullify the terms of a contract. Parliament has also enacted legislations such as health and safety laws, anti-discrimination laws, and unfair dismissal to limit the terms of a contract. These interventions have led to the conclusion that “the idea that two capable parties should be free to contract on their own terms is now outdated due to parliamentary and judicial interventions”.

Formation of a contract

In English law, a contract is considered valid if it is established that there was an agreement, the parties had a contractual intention, and when there is a consideration. To determine if there was an agreement, the court has to perform an objective test. This is where the elements of offer and acceptance come in. For a contract to be valid there has to be an expression of willingness that a party is ready to enter into a contract under the given terms. An offer is made with the intention that the party making the offer intends to be bound by the terms of the offer.  When such an offer is accepted by the other party without alteration of the terms, an agreement is considered to have been struck.

An agreement is the basis of a contract, but it is not sufficient to create legal obligations. English courts go further to look into the element of consideration. Consideration is simply the bargain of contract which has to be “something of value” in the eyes of the law[3].  When a contract meets all these elements, the court is reluctant to interfere with its terms or the question of its validity.

In most cases, the court has declared that it is not concerned with the abstract fairness or formalities leading to the formation of a contract. Contracts therefore can be formed informally – whether an agreement is written or communicated orally is still binding. Nonetheless, there are statutory limitations to the freedom of form. The Law of Property Act 1925, for instance, creates exceptions regarding conveyances of land. According to the statute, “all conveyances of land or of any interest therein are void for the purpose of conveying or creating legal estate unless made by deed”[4]. The property law goes ahead to require that most of the contracts made in regard to the sale of land must be in writing[5]. The same applies to contracts of guarantee[6] and other types of contracts as obliged by the statutes of fraud. These are some of the few statutory limitations towards the formation of a contract. In most cases though, the parties have the leeway to adopt any form of contract formation. Most of the contracts can be formed orally. The general principle is that even those contracts that are made informally are enforceable.

In the formation of an agreement, the court has not been concerned with the abstract fairness of agreement. This means that the parties are free to negotiate their own terms. In examining the element of consideration for instance, the court has ruled that consideration must be sufficient but need not be adequate[7]. In other words, the court will not intervene in a contract just because one party made a good or bad bargain. It is therefore not the interest of the court to find out whether the consideration measured to the market value; the only concern is whether something of value was exchanged. In Chappel v Nestle, just as an example, the court found that a chocolate wrapper was enough consideration. Such leeway of the courts gives parties to a contract the freedom to bargain and agree the terms of their contract.

Express and Implied Terms

The freedom of contract notwithstanding, there are several grounds on which the court has justified its intervention. One of these grounds is interpretation of express and implied terms. The terms agreed in a contract can be divided into express terms and implied terms.

Express terms are the terms that are specifically mentioned in the contract by the parties themselves. Ordinarily, terms that are expressly stated in a contract are not expected to raise disputes, but difference in interpretation and whether particular term are part of the contract nonetheless raise disputes. The dispute as to whether a term is part of the contract is common in an oral agreement. This is decided on factual consideration. The importance of the statement[8], timing of the statement[9], and strength of statement[10] and special skill and knowledge of the parties[11]are some of the factors that the court considers before deciding whether a statement is part of the contract in oral agreements. Otherwise, a statement could be regarded as a mere representation. Such a wide range of considerations gives the court a wide range t intervenes in contracts.

But it is when it comes to the interpretation of the terms of a contract that the court is seen to be having an undue intervention. In most cases, the court has intervened to give contracts different meanings on the bases of objectivity. Before, the interpretation of contracts was tied to the lateral meaning, but in the 21^st century, the courts are seen to be adopting a more purposive approach. As the court has severally ruled, the terms of a contract are to be interpreted objectively. In so doing, the court attempts to ascertain the intention of the parties on an objective basis. As Lord Hoffmann ruled, it is the duty of the court to look for “the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract”[12]. When Lord Hoffmann was making this ruling, he was by far informed by speeches made by Lord Wilberforce in Penn v Simmonds[13] and Reardon Smith Line Ltd v Yngvar Hansen-Tangen[14] to the effect that a contract has to be interpreted having regard to the background knowledge or what Lord Wilberforce referred to as the “matrix of facts”.

These are some of the rulings that have opened the gate for the court to interfere with the terms of a contract. The modern court favours purposive approach to contractual interpretation more than the historical literal approach. In addition, the modern court also favours more evidence to rebut any literal meaning that can be born out of contractual provision. This is the reason that the court has assigned itself the liberty or the discretion to assign meaning to contractual terms, both in ambiguous and non-ambiguous provisions.

In non-ambiguous provisions, the meaning is clear, but one of the party contest that the outcome is not the commercial intention of the contract. Even in such cases, the court has still reasons to intervene, ostensibly to input “business commonsense”. In the Antaios Compania Neviera SA v Salen Rederierna AB, for instance, Lord Diplock ruled that “if detailed semantic and syntactical analysis of words in a commercial contract is going to lead to a conclusion that flouts business commonsense, it must be made to yield to business commonsense”[15]. This precedence of applying “business common sense” in commercial contracts has been taken a notch higher in modern-day rulings. In Rainy Sky SA v Kookmin Bank, for instance, the doctrine of “common sense” again prevailed in Supreme Court[16]. In such cases, the “common sense” doctrine can viewed as an affront to the traditional doctrine of freedom of contract.

In a recent case, Lord Justice Aikens emphasised that it is the responsibility of the court “to discern the intention of the parties, objectively speaking, from the words used in the commercial document in the relevant context and against the factual background in which the document was created”[17].  However, Aikens LJ was quick to point out that it is only when there are two “possible construction of the document that the court is entitled to prefer the construction that is more consistent with business common sense”[18]. This ruling, therefore, creates a safeguard to the doctrine of freedom of contract. As Aikens LJ explains, business common sense should not be elevated to replace commercial wording. Further, the Lord Justice cautions that the parties should not be subjected to “the individual judge’s own notion of what might be the sensible solution to the parties’ conundrum”. The court was also concerned that if the “common sense” doctrine was allowed to prevail without safeguard, contractual dispute could be decided from what seems like “commercial common sense” in the views of one party to the contract. Such observation from a higher court is indeed a reprieve to those who think that judicial interventions are quickly eroding the freedom of contract.

The other way through which the court has grabbed an opportunity to intervene in contracts is through interpretation of implied terms. Generally, a contract may contain other terms that are not expressly mentioned in the contract. Some of the terms could be implied by fact, by law or by statute, or even by custom or usage. Relying on implied terms, the court has an adequate leeway to interfere with terms of a contract. For those terms that could have been implied by fact, the court has developed two alternative tests: officious bystander and business efficacy.  Officious bystander test argues that there are terms that are too obvious that even if an officious bystander was present and suggested that a particular term should be included into the contract, the parties could have gladly agreed[19]. The alternative test of business efficacy suggests that a term is implied if it is necessary to make the contract workable. These test, are however outdated in modern law where an objective construction of the contract is more preferred[20].

Other terms that interfere with the freedom of contract are implied by the law. Parliament has enacted legislation that implies certain contents to contracts irrespective of the wishes of the contracting parties. In tenancy agreement for instance, it is implied that the landlord has to take reasonable care to maintain common parts of the property[21]. In employment contracts, the court ruled that the term of mutual trust and confidence is implied as it is incidental to employment relations[22]. When it comes to legislation, parliament has enacted statutes that imply terms. For example, the Sale of Goods Act 1979. Sections 12 to 15 of the act list implied terms that relate to the sale of goods.

How the courts imply terms may be seen as undue interference to the freedom of contract. A term may be implied to the advantage or disadvantage of either party. More importantly, the uncertainty surrounding which rules to apply on the implication of terms has led to fears that judges may take the opportunity to curtail the freedom of contract. In Attorney General of Belize v Belize Telecom, Lord Hoffman ruled that the relevant question in implying a term was whether a “reasonable reader of the contract, with the relevant background knowledge, would understand it to be implied.” This was interpreted to mean that reasonableness was enough ground to imply a term. In a recent ruling, however, the Supreme Court has indicated that it is still reluctant to imply terms to a contract[23]. Thus, the strict conditions set out in BP Refinery[24] still apply. In addition, the Supreme Court has cautioned that “it is not the function of a court when interpreting an agreement to relieve a party from the consequences of his imprudence or poor advice”[25].

Apart from interpreting the content of a contract, there are other grounds that the court can rely on to intervene in a contract. Such doctrine as frustration, undue influence, unfair terms, and unconscionability could be used to interfere with the freedom of parties to negotiate their own contract terms.  English law holds that a contract may be discharged by frustration. The Unfair Contracts Terms Act 1977 also places some statutory limitations to the freedom of contract. In some cases, the court has the discretion to strike down exclusion clauses in commercial contracts. Nonetheless, like it was ruled in Cavendish the court is still reluctant to strike down such clauses, especially where such clauses were subject of through negotiation by parties of comparable bargaining power[26].

As it can be seen from all these cases, judicial and parliamentary interventions have not necessarily eroded the freedom of contract. Even where there is leeway to intervene, the court has exercised restraint. Parliament has also enacted legislation to limit freedom of contract, but this still does not significantly erode the freedom of parties to negotiate their own contract terms. In most cases, the freedom of contract prevails.

 

 

 

Bibliography

Books

Poole, Jill ‘Casebook on Contract Law’, (Oxford University Press, 2016), at 265

Smith, Stephen “Contract Theory”, (Oxford University Press, 2004)

Williston, Samuel ‘Freedom of Contract’, [1921] 6 Cornell L.Q, 365

Statutes

Law of Property (Miscellaneous Provisions) Act 1989

Law of Property Act 1925

Sale of Goods Act 1979

Unfair Contracts Terms Act 1977

Cases

Attorney General of Belize v Belize telecom ltd {2009] UKPC 10

Bannerman v White (1861) CBNS 844

BMA Special Opportunity Hub Fund Ltd and others v African Minerals Finance Ltd EWCA Civ 416

BP Refinery (Westernport) Pty Ltd v President, Councillors and Ratepayors of the Shire of Hastings [1977] 52 ALJR 20

Cavendish Square Holdings BV & Another v Makdessi [2012] EHWC 3582

Dick Bentley productions Ltd v Harold Smith (Motros) ltd [1965] 1 WLR 623

Investors Compensation Scheme Ltd v West Bromwich Building Society [1997] UKHL 28

Liverpool City Council v Irwin [1977] AC 239

Malik and Mahmud v bank of Credit and Commerce international SA [1997] UKHL 23

Prenn v Simmonds [1971] 1 WLR 1381

Rainy Sky SA v Kookmin Bank [2011] 1 WLR 2900

Reardon Smith Line Ltd v Yngvar Hansen-Tangen [1976] 1 WLR 989

Routledge v McKay [1954] 1 WLR 615

Schawel v Reade [1913] 2 IR 81

Shirlaw v Southern Foundries [1926] 2 KB 206

The Antaios Compania Neviera SA v Salen Rederierna AB [1985] 1 AC 191

Thomas v Thomas (1842) 2 QB 851