Notes from the Bar: Common Pitfalls in Contract Formation

Date published

15/02/2017

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In this update, we will touch briefly on some of the common pitfalls that you may encounter when entering into contracts. We also endeavour to impart some good practices that you should bear in mind when entering into contracts.

Pitfall 1 –‘invitation to treat’ or offer?

The first lesson every law student learns in Contract 101 is offer and acceptance. To put it simply, if Party A makes an offer, and that offer is accepted by Party B, a contract is formed.

An offer is made when the offeror (i.e. the person who is making the offer) expresses his willingness to be contractually bound to perform the definite and specific terms of his proposal, if that proposal is accepted by the offeree (i.e. the person who is receiving the offer). 

In contrast, when a person is merely advertising, soliciting for offers or requesting for information, then it is merely an ‘invitation to treat’ which does not amount to an offer.

Consider the following scenario: A sends B an email stating “I have 5,000MT of BA-63 steam coal at US$90 per MT for shipment between 21 and 28 Feb 2017. Other terms & condition as per our standard form attached herewith. Deal?” In this scenario, A’s proposal is likely to be an offer as he is specific about his requirements and has expressed his willingness to be bound by his offer to sell to B once it is accepted.

Now, consider a slightly different scenario: A sends B an email stating “How much BA-63 steam coal do you have for shipment between 21 and 28 Feb 2017? Lowest price?” B replies “5000MT, lowest price U$S90 per MT”. In this scenario, A’s statement is clearly a request for information and not an offer. B’s response is also merely a supply of information which does not amount to an offer.

In the latter case, if A is interested, it would be good practice for A to then offer to buy from B at the price which B quoted. For example, A can reply by saying “we would like to buy 5,000MT of BA-63 steam coal at US$90 per MT for shipment between 21 and 30 Feb 2017. Other terms & conditions as per our standard form attached herewith. Please confirm within the next 24 hours.”

There are no particular words or phrases which a party has to use in making or identifying an offer. What is important here is to remember that an offer requires the offeror to show his willingness to be contractually bound by the specific terms of his proposal.

It is quite common for traders with a cargo to sell to send mass emails to their contacts to solicit offers for their cargo. Imagine a situation where a trader, by wrongly phrasing his email in the form of an offer, and that offer is accepted by more than one party. He would then potentially have entered into more contracts than he has cargo to sell!

Pitfall 2 – do not inadvertently leave the offer open for too long

An offer that is not withdrawn generally remains open for acceptance by the counterparty. Therefore, it is good practice to state the duration of your offer or, alternatively, expressly withdraw your offer once you would no longer like to enter into an agreement.

It is fairly common for traders, ship owners and charterers to negotiate with several parties simultaneously in respect of one parcel of cargo hoping to find the best terms. Therefore, once a contract is formed with one party, it is important to withdraw all other existing offers to avoid the other offers being accepted.

The other alternative is to use phrases like “subject to contract” in your correspondence when negotiating a contract. Those who are familiar with the chartering of vessels will know that the fixture is normally concluded and finalised when the parties “lift all subs”.

Pitfall 3 - when is an offer accepted: silence, counter-offer and ‘subject to contract’?

An acceptance is valid when the offeree, in response to the offer, communicates to the offeror by words or conduct that he unconditionally agrees to the terms of the offer.

Three points to note with regard to acceptance:

  • First, acceptance can be made by way of words or conduct. It cannot be inferred from mere silence save in exceptional circumstances.
  • Second, the acceptance must be an unconditional and unqualified acceptance of the exact terms of the offer. In other words, if the offeree makes a counter-offer (e.g. accept the rest of the terms but tries to bargain for a lower price) or attempts to accept the offer on different terms (e.g. accept the price and all other terms but only wants 4,900MT instead of 5,000MT of coal), he would have essentially rejected the offer and made a new offer on those terms. As a result, the original offer is terminated and no longer available for acceptance.
  • Third, parties can postpone the formation of the contract until the execution of a formal document by adding the words “subject to contract” which indicates that notwithstanding the consensus that parties have reached on the terms, they would not like to be legally bound until a later stage.

Pitfall 4 – is there a valid contract if parties agree on some of the terms but leave the others to be finalised?

It is not uncommon for contracting parties to agree on the major terms of a transaction before working out the details of the rest of the transaction. In this situation, when is the contract formed? Generally, the terms which parties agree upon must be sufficiently certain before there can be a contract. At the minimum, the parties must have agreed to the essential terms of the contract.

What would amount to the essential terms that are necessary for a contract to come into existence is a fact specific question. For instance, in the context of sale of goods, the essential terms may include the following: type of goods; quantity; quality; price; payment terms; shipment terms (e.g. FOB or CIF); and estimated date of shipment.

Pitfall 5 - oral contracts and evidence of the contract

Contrary to popular belief, the formation of a contract in general does not require any particular legal formalities (save for some exceptions, such as contract for sale of land).

However, as conventional wisdom would inform us, oral contracts are hardly used in high value transactions because in the event one party reneges on his contractual obligations, it would be extremely difficult to prove, as a matter of fact, the existence of the contract and the terms therein.

That being said, it does not mean that we ought to forgo a profitable trade just because the offer was made orally. In this regard, it would be good practice to ensure that all oral contracts that have been concluded are contemporaneously evidenced by way of some written record (e.g. an email to the counterparty). It is important to note that when doing so, ambiguous terms like “please confirm” or “subject to contract” which may incorrectly suggest that parties have yet to reach an agreement should be avoided. Instead, the email recap should clearly state that parties have agreed by way of an oral agreement on a particular date and set out a complete account of the agreement reached between the parties.

Key lessons learnt:

  • Differentiate whether the other party is making a request for information or an offer to buy/sell; only an offer can be accepted;
  • When making an offer, remember to state clear the terms and duration of your offer and to withdraw your offer as soon as you do not want to be bound by the terms you have offered;
  • Be wary of any response that is inconsistent with your offer as this usually constitutes a counter-offer which would result in no binding agreement between parties;
  • Be aware that parties must at least agree to the essential terms of the contract before there is an enforceable contract; once that is done, the fact that some details have not been agreed on is not fatal to the contract; and
  • Remember that while oral contracts are generally valid and enforceable, proving their existence often complicates matters in practice; it is therefore good practice to have contemporaneous evidence of the existence and terms of oral contracts.

About the Shipping & International Trade team

The Shipping & International Trade team at Kennedys Legal Solutions provides seamless dispute resolution support for a full spectrum of shipping and international trade matters through the firm’s international network of offices and liaison firms.

Over the years, Joseph Tan and his team have gathered a good following of clients comprising of ship-owners, charterers, cargo interests, offshore oil & gas support operators, and commodity trading houses. He has also been consistently recommended by Legal 500 Asia Pacific as a leading practitioner in shipping and trade related work since 2011.