Note for directors and in-house counsel: Where your contracts can go wrong

By Darrell Jardine / 14 December 2016
5 min.
Worthwhile read for: In-house Counsel, Directors, Contracts Managers, Business Owners

In my previous article, “Why a litigation lawyer is good for you”, I provided two examples of how litigation lawyers can help you; both in pre-contractual negotiations, where a critical eye can look at the weaknesses and worst case scenarios before you enter into an agreement; and also after a contract has been performed, to take the stress out of any disputes and allow you to focus on what you are best at.

However, it is at the intersection of these two processes - while your contract is being performed - that you are at your most exposed and at risk of things going wrong.

The purpose of this article is to highlight the things that a good litigation lawyer can see going wrong, so that you can be alive to potential areas of a dispute as they are evolving.  

Everyone thinks that a contract will follow a set path, like this.

But what often happens is that, after everyone has signed the contract and the parties start performing their obligations, there is a change somewhere that causes a variation to the contract, more like this.  

It is during this period of performance that you need to be most alert. It is here that you are at your most exposed for any disputes in the future. 

A standard, black and white contract that has been signed by both parties can always become varied.  A variation can occur in one of three ways, either through:

  • a verbal variation;
  • a written variation; or much more subtle
  • variation by conduct. 

Once a variation has occurred and impliedly accepted by the parties, an argument can subsequently be raised that the strict terms of the contract (that is now sitting safe in your office, gathering dust) no longer apply and the parties are now proceeding potentially on a new set of rights and obligations that may not necessarily have been written down. 

As litigation lawyers we often see parties come into our office waving around their pristine contracts and seeking to rely on the strict interpretation of those contracts when the reality is that the parties, often unknowingly, have performed in a different way and the contract has been varied. 

Some possible scenarios include:

  • A contract requires a civil works contractor to pour concrete in hundreds of trenches that are to be over three metres deep.  However, once the contract has been signed and the workers are on site, the Superintendent apparently gives the indication that the concrete only needs to be poured to two metres deep.  This verbal variation is not recorded and, years later, huge costs are incurred trying to prove that the contract has been varied;
  • An ongoing supply contract requires payments to be made within fourteen days of an invoice being delivered but, over time, payments are made after thirty days and after a series of months this payment cycle becomes entrenched.  No one questions or raises any issues with receiving payments after thirty days.  Eventually, one party tries to terminate the contract because payment has not been made within fourteen days.  However, they are unable to rely on this strict termination right because, by their conduct, they have accepted payments after thirty days and have so waived any right to require payment after fourteen days.  In legal jargon, that party is now estopped from denying that a new term of the contract has been entered into whereby payments may be made after thirty days;
  • Parties enter into and start performing the contract but then emails will pass back and forth between the parties which end up varying the terms of the contract. For instance, say a party is required to deliver one hundred tonnes of steel each month for twelve months but, by email, one party indicates that it will only be able to deliver half the steel this month and will make up for it in the next month.  Strictly speaking, the terms of the contract have been varied in writing, so no longer can the party strictly say there has been a breach of the agreement by failing to deliver the amount of tonnes this month;
  • Parties enter into a contract with strict notice requirements as to variations, which are not complied with.  In those circumstances, a party’s ability to recover may be prejudiced. 

Most companies employ a contracts manager to ensure that there is compliance with the rights and obligations and procedures in any contract and that any variations are formalised so that disputes do not occur. 

For companies that do not employ a contracts manager, it is important for in-house counsel, directors or otherwise to be alive during performance of the contract where the potential for variations either orally, in writing or by conduct, is high and may leave you most exposed to potential disputes later on.

The person responsible for the performance of a contract needs to be aware of each party’s obligations and the terms of the contract.  Any variations or changes should be dealt with strictly in accordance with the process in the contract. 

It is vital to be not only able to recognise a variation, but also to document and record any such variations immediately and, if necessary, formerly make variations to the strict terms of the contract so that the parties understand what the new obligations are. By being alive to the potential exposure during the performance of a contract and not just adopting a business-as-usual policy, you have a much better chance of avoiding lengthy and protracted disputes over what the parties were required to do in the future. 

14 December 2016
Key Contacts
Darrell Jardine
Darrell is a Partner and leads the firm’s Dispute Resolution practice.

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