Freedom of contract and oral variation: freedom to or freedom from?

Publication | June 2018

Introduction

In Rock Advertising Limited v MBW Business Exchange Centres Limited [2018] UKSC 24, the Supreme Court has confirmed that a purported oral variation of a contract is invalid if it is in breach of a no oral variation provision in the agreement. While businesses can perhaps take some comfort from the fact that there is now greater certainty that such clauses will be upheld, it is important to exercise a degree of caution as parties that have relied on purported oral variations may still be able to invoke estoppel in support of the varied agreement.

English law contains few restrictions on freedom of contract. With the relaxation in recent years of the rule against penalties, aside from illegality and contracts contrary to public policy, the common law will generally uphold parties’ agreements.

However, one area that has, in recent years, caused some uncertainty, is clauses prohibiting variation of the underlying agreement other than by a specified method such as in writing. Parties are, of course, free to include such a clause (often described as a ‘no oral modification’ clause) in their agreement and such clauses are common in many commercial and finance contracts.

But what if the parties subsequently reach agreement to vary their contract in terms other than prescribed by the no oral modification clause – should not the doctrine of freedom of contract give effect to their agreement? After all, as set out in the judgment of Cardozo J in the New York Court of Appeals case of Beatty v Guggenheim Exploration Co (1919) 225 NY 380:

“Those who make a contract, may unmake it. The clause which forbids a change, may be changed like any other. The prohibition of oral waiver, may itself be waived. 'Every such agreement is ended by the new one which contradicts it' (Westchester F Ins Co v Earle 33 Mich 143, 153). What is excluded by one act, is restored by another. You may put it out by the door; it is back through the window. Whenever two men contract, no limitation self-imposed can destroy their power to contract again …”.

However, in Rock Advertising Limited v MBW Business Exchange Centres Limited the Supreme Court has now confirmed that a purported variation of a contract is invalid where in breach of a no oral variation provision in the agreement.

The Supreme Court’s decision

On the facts of Rock Advertising, the Respondent occupied office premises managed by the Appellant under a written licence agreement with the Appellant. The agreement contained a clause providing that all variations to the licence must be made in writing. The Respondent argued that the parties had agreed orally to vary the agreement with a revised schedule of payments. The issue before the Court was whether the purported oral variation effective as a matter of law.

The Court of Appeal had earlier held that that the purported oral variation amounted to an agreement to dispense with the no oral modification clause, a decision which accorded with the dicta of Beatson LJ in Globe Motors Inc v TRW LucasVarity Electric Steering Ltd [2016] EWCA Civ 396. However, the Supreme Court reversed this decision and held the purported oral variation to be of no effect.

The leading judgment was given by Lord Sumption, with whom all the other members, save Lord Briggs, agreed. Lord Sumption noted that there are several commercial reasons for upholding no oral modification clauses: (i) it prevents attempts to undermine written agreements by informal means; (ii) it avoids disputes not just about whether a variation was intended but also about its exact terms; and (iii) it makes it easier for corporations to police their own internal rules restricting the authority to agree variations. English contract law does not normally interfere with freedom of contract save for overriding reasons of public policy and such clauses do not frustrate or contravene any policy of the law.

In reaching this conclusion, he also sought to draw an analogy with entire agreement clauses insofar as both are intended to achieve contractual certainty about the terms agreed. However, Lord Briggs considered that a distinction could be drawn between no oral modification clauses and entire agreement clauses on the basis that the latter do not seek to bind parties as to their future conduct. In Lord Briggs’s view, for so long as any party to a contract wishes a no oral modification clause to remain in force, that party may so insist (as they can with any clause), unless and until all parties agree to do away with it – although he went on to conclude that where parties orally agree to vary the substance of their contract, it should not without more be implied that they have also agreed to dispense with a no oral modification clause, unless such an implication is necessary.

Overall, on the majority’s reasoning, what the parties agree by such a clause is that oral variations will be invalid, not that they are forbidden. Accordingly, the natural inference from a failure to observe a such a clause is not that the parties intended to dispense with it, but that they overlooked it. On the other hand, if they had the clause in mind but proceeded in any event, “they were courting invalidity with their eyes open”.

Ultimately, the rationale behind the majority’s reasoning is to seek to give effect to in the intention of the parties – although by giving effect to what the parties agreed at the date of the contract, it avoids giving effect to what they subsequently agreed.

Implications

In view of the Supreme Court’s decision, it is clear that clauses restricting the parties’ ability to vary their agreement now take on greater significance than had been thought previously. To the extent that the objectives behind such clauses include control and certainty, the decision arguably means that contracts are less likely to be varied ‘by accident’: insofar as formalities need to be adhered to, in-house lawyers or senior management may be able to take comfort in knowing that, at least in theory, they should be able to exercise greater oversight over potential variations.

This, however, leads on to the question of what level of formality is desirable. While the case before the Supreme Court concerned a simple clause requiring variations to be in writing and signed by the parties, the principle enunciated by Lord Sumption was of general application: “…the law should and does give effect to a contractual provision requiring specified formalities to be observed for a variation”. Accordingly, the requirement that formalities be observed in order for a variation to take effect means that parties will need to think carefully about the terms of any such clause and what level of formality they will require. For example, if parties want to be able to act quickly to effect a variation, it might be that simple email exchange would suffice and that it would create undue burden to have to satisfy more prescriptive or extensive requirements.

Finally, it is worth noting that the effects of the decision are still to be worked out. The Supreme Court confirmed that the risk that a party may act on the varied contract but then find itself unable to enforce it is mitigated by various doctrines of estoppel, although how that would be applied in practice remains unclear. It is possible to imagine a commercial contract which has been varied orally in breach of a no oral modification clause and the parties have proceeded on the basis of the variation for a number of years. It would seem surprising that their continued, amended relationship could only be explained on the basis of estoppel. More generally, to the extent that the majority’s decision is influenced by questions of policy, such policy should apply irrespective of what legal doctrine is used. In this regard, it seems odd that estoppel could validate a variation which has been declared invalid as a matter of contract law.

Moreover, according to Lord Sumption, the circumstances in which estoppel could arise would be quite limited: “the scope of estoppel cannot be so broad as to destroy the whole advantage of certainty for which stipulated ... ”. It would need to be established that (i) there existed words or conduct unequivocally representing that the variation was valid notwithstanding the informality; and (ii) something more would be required for this purpose than the informal promise itself. On this analysis, in circumstances where parties have simply forgotten about the existence of the no oral modification clause, it would seem that estoppel is unlikely to provide an escape route.

While an alternative analysis might be the termination of the first contract and its replacement by an entirely new (oral) contract, this might not always be possible, for example, due to questions of priority or regulatory considerations.

In summary, the decision confirms that validity of no oral modification clauses and it will be incumbent of commercial parties to ensure that these are now drafted with care. On the other hand, parties should take care before disregarding informal variations of the agreement, even where they do not comply with contractual formalities. Where parties have acted in reliance of the purported variation, courts will likely be willing to give effect to it and it may prove difficult to insist on compliance with such formalities later.


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