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A Project Managers Guide To Contract Law

Paul Naybour Paul Naybour

Published: 17th September 2010

Project Managers Guide to Contract Law From a project manager’s perspective a contract is a mechanism to involve other organisations in the successful delivery of a project. From a lawyer’s perspective the contract defines the legal rights, obligations and consequences of litigation. Often project managers do not fully understand the need for a contract before starting a project because they expect the project to succeed and in most cases the project is completed without reference to the contract. However when things go wrong the contract is vital in defining the responsibilities and liabilities of the different parties. In this note we explain why contract are vital for project managers before starting work and some of the key elements and terms used in contract law.

Establishing a contract

To establish a legally binding contract five elements are required
1)      An offer
2)      An acceptance
3)      A considerations (or payment)
4)      An intent to create a legal relationship
Considering each of these in turn

Offer and Acceptance

The point at which an agreement moves from pre-contract negotiations to contract is when an Offer has been accepted. The offer must be an expression to enter into a legally binding contract, this offer can be verbal, written or in action. For example you can purchase a newspaper without saying a word.  Acceptance must be final and unqualified acceptance of the terms of the offer.
Most day-to-day contracts are executed verbally however for project managers the liabilities and risk associated with projects mean that this would leave too many ambiguities. A formal written contract is the only way to be sure these liabilities have been agreed.

The battle of the forms

Often sellers and buyers will have different standard terms and conditions. The battle of the forms arises when the seller sends a proposal using their standard term and conditions. The buyer responds with a purchase order with their own terms and conditions. The seller may acknowledge the order using their original terms and conditions. Whilst the parties clearly want to trade that have not clearly communicated an acceptance and therefore many not in fact have any contractual relationship.
For project managers to start work in a absence of a legal binding contract exposes then to not only the risk of not being paid but more important undefined liabilities if thing go wrong. Cases exist in which contracts for small fees have resulted in claims for many millions in damages. For this reason project managers should ensure that there is a clear and unqualified acceptance of the offer before starting work. The best way to do this is a contract signed by both parties.

Consideration

To form a legal binging contract the exchange must include a consideration. This must be something of value in the eyes of the law. It is normal a financial payment but can also an exchange of good, services or promises of value.  Because of this need for a consideration then a binding contract is not in place if work is done free of charge. Interestingly if changes as a result of increased scope are incorporated without a consideration (free of charge) then they may not form part of the contract which is why it is important all changes (even those done free of charge) are recorded through the processes agreed for a contract.

Intention to Create a Legal Relationship

Within business the assumption is that two parties negotiating a contract have intent to create a legal relationship, whereas in many social arrangements (sharing lifts, meeting for dinner etc) there is a presumption against the formation of a legal binging contract. Sometimes a letter of intent is used to indicate that one party is serious about entering into a contract with another. Often these do not normally provide unconditional acceptance of an offer required to form a contract and so are not legally binding and so are not sufficient to start work.

Misrepresentation and Agreement Mistake

Once a contract has been established it is normally binding on both parties unless due to special arise which means that one of the parties can have the contract set aside. These include misrepresentation during pre-contract negotiations or mistake by one or both parties which strikes to the root of the contract.

 Misrepresentation during pre-contract negotiations

In general a party must not make any false or misleading statements to the other party which induce them to enter into a contract. If they do this may result in a successful claim for misrepresentation. To set aside a contract as a result of misrepresentation it is necessary to demonstrate that statements of sufficient credibility to relied upon by the other party and they acted as an inducement to the contract. Critical to this is the relative equality of bargaining power in these situations. A misleading statement from an ‘expert’ in the field is much more likely to consider as misrepresentation than an opinion expressed by an unqualified individual.

Agreement Mistake

If two parties have reached an agreement, supported by a consideration, they are bound by it.  However in very limited circumstances a court may set aside an agreement if one or both parties were mistaken about the something which strikes to the heart of the agreement. However in practice this mostly relates to mistaken identity as part of fraudulent deception.

The Impossibility Doctrines

Most agreement proceed to satisfactory completion but some business ventures fail because of circumstances beyond the control of either party such as the outbreak of war in a country supplying components for the project. These events render the contract impossible or possibly unlawful.  However these do not apply if the venture just proves more difficult or expensive to complete. It must be demonstrated that “without default of either party a contractual obligation has become incapable of being performed”. As an alternative most contract include a Force Majeure clause.

Force Majeure

Force Majeure is defined as all circumstances beyond the will or power of the contractors to control such as strikes, lockouts, accidents to machinery and any other contingencies whatever beyond the seller’s control. Such force majeure do not seek to terminate the contract but typical the suspend performance for an agreed period of time after which on of the parties may exercises an option to terminate the contract.

Unfairness and Coercion

In limited circumstances a contract may be judged by a court to be unfair if they have not been entering into in a free and voluntary way. This includes
1)      Agreements reached under duress either as a result of the threat of physical violence or excessive economic pressure.
2)      Undue influence as a result of a relationship of trust between two individuals such as a parent and child, solicitor and client or bank and client

Contract Terms

Contracts are made up of express terms and implied terms. Express terms are those stated in the contract and implied terms are as a result of legislation or accepted business practice.

Terms Implied by Law

Terms of contract implied by law do not depend on the common intention of parties. They can we side ranging from remedies for late payment, to requirements for building contractors to provide proper materials.

Terms Implied by Trade Usage

The courts are willing to accept terms which reflect common business practice. This demonstrates the point that it is unwise to rely regard the express terms in isolation. More often express terms which have become custom and practice between two organisations are implied when an oral contract is placed (over the telephone for example).
It is important for project managers to realise that at the heart of contract law is a need to act in a reasonable way and not abuse positions of power.

Standard Forms of Contract

Many organisations adopt standard forms of contract for the purchasing and supply of goods and services. If widely used in a business sector, like the JCT form for building contract, they are assumed by the courts to be fair and reasonable because of their roughly equal bargaining positions. However where a standard form of contract is use in a situation of unequal power then there is no presumption that the terms are fair and reasonable because the terms can be weighted in favour of the more powerful party.  Most commonly used standard forms of contract in construction are:

JTC (Joint Contracts Tribunal)

Issued by the Royal Institute of British Architects and National Federation of Building Trades Employers this form of contract has become a widely accepted form of contract. Most of the power to take fair and reasonable decision rests with the Architect for the project.

Engineering Forms of Contract

In comparison to construction contracts, those used for engineering plants (utilities, transportation systems etc) are high complex and bespoke to the parties in the project. The complexity in such contract means that the parties must be clear who is responsible for the risk in each case. Often these contracts include clauses to indemnify the client against claims by third parties often covering health and safety issues.
Many terms are used in language which has different meaning to common English. Some of these are set out below:

Contract language

Time is of the Essence

Time is of the essence is a term in contract law which indicates that the parties to the agreement must perform by the time to which the parties have agreed if a delay will cause material harm, Contrast this with reasonable time, where a delay in performing may be justified if it is reasonably required, based upon subjective circumstances such as unexpected weather.

Best Endeavours

Best endeavours meant essentially exhausting ALL possibilities no matter how unpalatable. This could mean “the sacrificing” of a commercial interest in effect and so best endeavours should only be agreed as a last resort when all the consequences have been understood and thought through. On the other hand “reasonable endeavours” means “one reasonable course not all of them”

Fit for Purpose

An implied warranty of fitness for a particular purpose is a warranty implied by law that if a seller knows or has reason to know of a particular purpose for which some item is being purchased by the buyer, the seller is guaranteeing that the item is fit for that particular purpose. This is a requirement of the sales and goods act for consumer products but it very onerous in an engineering project.

Intellectual property Rights (IPR)

IRP refers to the ownership of the design. The owner of the design has right to licence, distribute, sell and amend the design. If a client has ownership of the design they can use it as they wish even sell it to other parties.

Target Price Contracts

A target price contract is where the pain of any overspend or gain associated with any under spend is shared between the client and the contractor.   Often there is a maximum price above which all the over spend is born by the contractor. The challenge with target price contracts is agreeing a basis to set the target.

Liquidated Damages

Liquidated Damages are an amount of money agreed upon by both parties to a contract which one will pay to the other upon breaching the agreement based on a genuine pre-estimate of the actual loss likely to be suffered by the injured party.
These notes are for information and guidance only they in no way represent a full and detailed coverage of English contract law. The best advice is to seek the views of a professional contracts specialist or lawyer.

  1. Gerry says:

    Excellent post … thanks Paul!
    Having been almost caught out by the “time is of the essence” statement in my early days (back when I had a ‘real’ job), I can only vouch for the need to get professional lawyers involved in contractual agreements.
    The idiosyncrasies of contract law are difficult enough for lawyers to understand, far less PMs who have typically come from an engineering background.

  2. Mike says:

    Excellent summary Paul and John.
    One area which needs some clarity is consideration.
    Consideration is an exchange of promises, which creates a benefit to the promisor, or disbenefit to the promisee. You are right that it must have an economic value, but it does not need to be adequate, but must be sufficient, e.g. “pepper-corn rents”.
    I agree with Gerry, that contract and agency law is tough enough for lawyers; the real challenge for PMs is having sufficent knowledge to manage the contract, but knowing when their capability ends and legal advice should be sought, without it prejudicing any future legal actions and their stakeholder management.

  3. Umakant Govind Parab says:

    Great Contents displayed on this site , I would also like to know more about contract Legal Important documentations & Law with referenrences no: with penalties / punishment.

  4. paul naybour says:

    Do you have anything in particular that you require?

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