No oral modification clause case will have ‘wide ramifications for all types of contracts’
04 / 07 / 2018
The Supreme Court has unanimously held that licence fee payments under a licence agreement containing a ‘no oral modification’ (NOM) clause could not be varied by oral agreement between representatives of the licensor and the licensee, in Rock Advertising v MWB Business. Lawyers at Bird and Bird, Clifford Chance, Charles Russell Speechlys, Herbert Smith Freehills, Howard Kennedy, Stewarts, and Wedlake Bell discuss the impact of this decision which has been described as giving ‘real meaning and support to NOM clauses within contracts’.
Laura Jenkins, partner at Stewarts, notes that the judgment produces two different reasonings, with Lord Briggs’ test demonstrating the ‘practical realities of business conduct’, and Lord Sumption’s being ‘cleaner’.
The conceptual issue facing the Supreme Court was: How could freely negotiating parties not subsequently agree, in effect, to ignore a NOM clause and vary their agreement by oral agreement only?
Lord Sumption’s answer to this was first to point to the use and function of NOM clauses, which are:
- preventing attempts, including abusive attempts, to undermine written agreements by informal means
- avoiding disputes not just about whether a variation was intended but also about its exact terms
- making it easier for corporations to police their own internal rules restricting the authority to agree variations
Their existence does not contravene public policy and they are widely used in many legal systems. This indicated that there was no conceptual inconsistency between a general rule permitting informally created contracts and a specific rule requiring variation to be agreed in writing.
Sumption cited, by way of analogy, the concept of entire agreement clauses, which nullify prior collateral agreements relating to the same subject matter. Where a party relies on an entire agreement clause to modify what would otherwise be the effect of the agreement which contains it, the courts have no difficulty applying the entire agreement clause according to its terms and so declining to give effect to the collateral agreement.
Lord Briggs did not find the entire agreement clause a useful analogy since those clauses do not purport to bind the parties’ future conduct. Rather he cited analogy with negotiations which are ‘subject to contract’ where the parties may abandon the requirement of a formal written agreement only expressly or by necessary implication. He considered that a NOM clause binds the parties until they expressly, or by necessary implication, agree to do away with it. On the facts of the present case, the oral variation said nothing about the NOM clause, and therefore it had not been ‘done away with’ by necessary implication.
Lord Sumption had also considered that the Court of Appeal’s approach overrode the parties’ intentions to bind themselves as to the manner in which future changes in their legal relations were to be achieved. Where, in many cases, statute prescribes a particular form of agreement; there was no principled reason why contracting parties should not adopt the same prescriptions by agreement.
He further considered that parties who agree an oral variation in spite of a NOM clause, either do so in oversight of the NOM clause or, if aware of it, do so in recognition that their oral variation risks invalidity. Where the NOM clause is subsequently enforced then this may prejudice a party who has acted on the varied contract but now finds themselves unable to enforce it.
Lord Sumption’s answer to this was to plead an estoppel. Matthew Scully, partner at Clifford Chance, highlights that Sumption was ‘keen to stress that there must be limits to the extent that estoppel can undermine the terms of a written agreement’. These limits are:
- some words or conduct unequivocally representing that the variation was valid notwithstanding its informality, and
- for this purpose, something more than the informal promise itself
Emma Humphreys, property litigation partner at Charles Russell Speechlys, adds: ‘There may be concern arising from this judgment for those who agree to vary arrangements in good faith and subsequently find the other party trying to avoid the revised agreement on the basis of a NOM clause.
‘However, the Supreme Court recognised this and emphasised that the principle of estoppel still has a role to play in safeguarding against injustice in such situations.’
Jenkins says: ‘The majority of the Supreme Court reason, through the judgment of Lord Sumption, that an oral variation of a NOM clause is invalid because to give effect to the oral variation would override the parties’ intentions as to future changes in their contractual relations.
‘The reasoning adopted by Lord Briggs, who nonetheless reached the same conclusion on the facts, would permit oral variation of a NOM clause in circumstances where the parties expressly agree to the variation (albeit orally) or by strictly necessary implication.
‘With a view to avoiding litigation, businesses might at face value prefer the reasoning of Lord Sumption who provides a cleaner test. However, Lord Brigg’s alternative reasoning may better reflect the practical realities of business conduct, giving more scope for the particular facts of an orally agreed variation to be considered.’
Jonathan Speed, partner at Bird & Bird, agrees there is a distinction between the two reasonings, highlighting that Sumption’s reasoning will ‘encourage strict compliance with NOM clauses’, while Briggs’ hints at ‘a more flexible approach’:
‘If the parties have orally agreed a change to their relationship and expressly, or by necessary implication, agreed that the NOM clause is to be disapplied then that variation should, in Briggs’ view, be effective.
‘This may be of assistance to parties where rigid adherence to the NOM clause may not be practical or necessary. However, the safest option will be to ensure that the variation complies strictly with the terms of the NOM clause.’
Lara Nyman, partner at Howard Kennedy, adds that Briggs’ approach ‘leaves open the possibility that parties can orally contract to avoid a NOM clause, but they must apply themselves to the mechanisms of the contract itself.
Adam Colenso, partner at Wedlake Bell, says that the reasoning of both judges will ‘make it harder for such defences to succeed in preventing summary judgment being entered’:
‘There remains, though, the possibility that in specific circumstances it may be possible to succeed in an argument for an oral modification to the contract if the defendant can prove estoppel or the necessity of an urgent variation followed by performance.’
Rachel Lidgate, partner at Herbert Smith Freehills, adds that although estoppel ‘may come to the rescue’, estoppel arguments are ‘difficult to establish and such arguments may succeed only in a limited number of cases.’
Lidgate continues: ‘Somewhat ironically, the Court of Appeal also saw its decision as promoting party autonomy, by allowing parties to amend their contracts freely even where they had previously agreed to do so only by observing certain formalities.
‘But that’s not how the decision was viewed by the Supreme Court, nor, I suspect, by most commercial parties.’
The consideration issue
The fact that the oral variation would have resulted in a revised payment schedule encompassing deferral and thus worth less to the licensor than the original terms, had given rise to a further issue for determination. Namely, whether the variation of an agreement to pay money, by substituting an obligation to pay either less money or the same money later, is supported by the necessary ‘consideration’. However, given that the oral variation in this case was invalid, for lack of writing and signatures required by the NOM, this ‘consideration issue’ while ‘ripe for re-examination’ did not require determination by the Supreme Court on this occasion.
Jenkins continues: ‘It is a shame that the Supreme Court did not have the opportunity to address the second issue as to whether or not an agreement to vary a contract to pay money by substituting an obligation to pay less money or the same money later is supported by consideration but Lord Sumption’s conclusion that such an important issue should not be considered as an obiter dictum is well understood.’
‘A welcome clarification’ for lawyers and businesses
In a decision which may be welcomed as having avoided the floodgates to uncertainty—but perhaps unnecessarily curtailing contracting parties’ flexibility—the Supreme Court has allowed MWB’s appeal and refused to allow NOM clauses to be ignored.
Lidgate says the decision promotes ‘certainty’: ‘This judgment gives back control to contracting parties to some extent, allowing them to decide how their agreements can, and cannot be amended in future.’
Colenso says: ‘The ruling is likely to be broadly welcomed as it provides positive news for businesses. There will now be greater certainty about being able to rely on original contract terms and improved prospects of success in summary judgment applications. Such development may possibly lead to slightly lower overheads and slightly greater profits for businesses.’
Tanya Wilkie, commercial lawyer at Charles Russell Speechlys, says: ‘Small businesses and consumers in particular should look out for this seemingly innocuous clause, which they might otherwise overlook.
‘Even if the other party appears amenable and cooperative to changing the terms of the contract informally, it is important to double check the procedure set out in the contract as to how it can be varied as it may require the agreed position to be in writing and signed by the parties.’
Scully adds that the decision highlights the importance of following formal procedures when contracting: ‘Those responsible for implementing agreements will need to be extra-careful to ensure that the written terms are complied with, since variations that are tolerated in practice may not be found to be contractually binding when put to the test.
‘If they want to depart from the written terms, they should follow the agreed process for doing so, by having a written variation.’
Jenkins adds: ‘If a business wants to protect itself against the effects of oral misunderstandings or informal attempts to undermine what was previously agreed or if it wants to ensure that those amending contracts can only be those individuals familiar with their terms then it can now rely on the insertion of a NOM clause into its contracts to give effect to that intention.
‘Lawyers will now also be able to give less equivocal advice as to the effect of an agreement where the written contract contains a NOM clause.’
Nyman concludes: ‘No doubt there will be many who seek to use this decision to negate a NOM clause, but with what success is yet to be seen.’
This article was originally posted by LexisNexis. (£)
For further information please contact Adam Colenso.