Everyone involved in the negotiation of charterparties and sale and purchase agreements would be familiar with the use of the word “subject” when parties are in the process of negotiation.
Very often, negotiating parties would insert the word “subject” to indicate that the intention is not to be legally bound until the occurrence of the event referred to, or if that subject is lifted. If party A says in its negotiation that the contract is subject to the occurrence of a certain event, is there a legal obligation on party A to take steps to ensure that event occurs?
In the recent English High Court case of The Leonidas  2 Lloyd’s Law Rep 165, the English High Court examined the authorities on the issue and discussed the difference between a “subject” that is a pre-condition to the formation of a contract and a “subject” that is a performance condition.
Facts of the case
The claimant was Nautica who was the registered owner of the Leonidas. Between 8 and 13 January 2016, the claimant was negotiating with Trafigura, the defendant, on chartering of the vessel for a voyage charter. The negotiations were conducted through a firm of brokers.
On 8 January 2016, the parties reached an in-principle agreement which was stated to be “on subjects”. In the preliminary email recap, it was stated as:-
“SUBJECTS TO CHTRS’ S/S/R/MGT APPROVAL LATEST 1700 HOURS HOUSTON TIME TUESDAY 12, 2016…”
It was common ground that the term “S/S/R/MGT” meant “Stem/Suppliers/Receivers/ Management” and that the recap was subject to these four items which were to be lifted by 1700 hours Houston time on 12 January 2016.
The parties continued to discuss the details of the fixture through the brokers and the evidence was that the broker spoke with Nautica’s representative on the phone and offered to lift all the subjects except for “subject to suppliers’ approval” in exchange for an agreement for reduction in the demurrage rates. Nautica agreed to the offer.
Nautica contends that the charterparty was concluded at this point in time, albeit it would cease to be binding if it was not possible for Trafigura to lift the “subject to suppliers’ approval” despite taking reasonable steps to do so.
That telephone conversation was followed by emails from Nautica confirming that all subjects were lifted except for the “subject to suppliers’ approval”. Thereafter, Trafigura decided that they do not wish to proceed with the charterparty and sent an email to Nautica saying that they were unable to lift all subjects on the Vessel.
The evidence adduced showed that after sending the email on not lifting all subjects, Trafigura’s representative tried to obtain documents to show that the terminal would have rejected the Vessel. Notwithstanding the fact that the intended cargo was crude oil to be loaded at the SPM, Trafigura’s representative sent a request to the terminal to load fuel oil which would have been loaded at a berth which he knows that the Vessel could not access in a bid to try to obtain some form of documentary evidence showing the rejection of the Vessel by the terminal.
Nautica did not accept Trafigura’s rejection of the Vessel and demanded that Trafigura either lift the “subject to suppliers’ approval” or provide a genuine rejection. When Trafigura did not respond, Nautica wrote and accepted Trafigura’s repudiatory breach of contract as bringing the charterparty to an end.
The issue before the Court was whether a legally binding contract was formed when Trafigura lifted all subjects except for the “subject to suppliers’ approval”. Nautica argued that Trafigura had the obligation to take all reasonable steps to obtain the supplier’s approval. Instead, what Trafigura did was to take steps to ensure that the suppliers would not grant its approval of the Vessel.
The English High Court considered and adopted the legal principles set out in the cases of RTS Flexible Systems Ltd v. Molkerei Alois Muller GmbH & Company KG, as well as Pagnan SpA v. Feed Products Ltd on ascertaining whether the parties intended to form a legally binding contract. The legal principles in these two cases were also adopted by the Singapore Court of Appeal in the case of China Coal Solutions (Singapore) Pte Ltd v. Avra Commodities Pte Ltd.
The Court noted that for some well known phrases like “subject to contract” or “subject to details”, it is clear that the parties’ intention is that they are not entering into a legally binding relationship until the contract is signed, or when the details are agreed upon. For cases where such phrases were used by the parties, the contract does not come into existence until the subject is satisfied. This was referred to by the Court as a pre-condition.
There are other cases which held that a “subject” is not a pre-condition to the formation of a legally binding contract. For example, where the contract for international sale is made subject to the obtaining of an export licence, it was held in previous cases that it does not prevent the formation of a legally binding contract. Instead the effect of such a subject is that the performance of the contract does not have to be rendered if the “subject” is not satisfied for reasons other than a breach of contract by one of the parties. This was referred to by the Court as a performance condition.
The significance of the difference between the two different types of “subjects” is that for a performance condition, the contract is formed and parties are legally bound once all the elements for the formation of a contract are present. If the “subject” is not satisfied, it might amount to a breach of contract if the failure to satisfy the “subject” was caused by a breach by one of the parties.
In determining what amounts to a pre-condition and what amounts to a performance condition, the Court considered several past lines of authorities and concluded that a “subject” was more likely to be classified as a pre-condition rather than a performance condition if the fulfilment of the subject involves the exercise of a personal or commercial judgment by one of the parties to the putative contract.
For example, if the contract is “subject to contract”, it means that the parties have expressly reserved it to themselves to consider if they wish to sign the contract and become legally bound. They are fully entitled to decide not to proceed with the contract if they so wish. The law does not support the proposition that there is an agreement to agree.
Whereas if the contract was subject to an action by a third party, for example the granting of an export licence, then the contract is already formed but the parties are excused from any non-performance if the non-performance is due to the failure to obtain the export licence. The most significant difference is that in such a case, the parties would be obliged to take reasonable steps to ensure that the export licence is obtained, or at least, not take steps to prevent it from being granted.
On the facts of this case, the Court found that the “subject to suppliers’ approval” fell within the definition of a pre-condition. The Court held that it was for the charterer to determine who its contractual supplier will be and it could potentially be in discussion with more than one supplier at the same time, or it may have a choice between loading a cargo it already owns or buying a new cargo. It was commercially unrealistic to suggest that there could only be one supplier from whom the charterer may obtain the cargo from.
As the “subject” was held to be a pre-condition, Trafigura was not liable to Nautica since the contract was not legally binding yet.
The Court also considered the position assuming that it was not a pre-condition. On the facts of the case, if the “subject to suppliers’ approval” was a performance condition, then Trafigura would be in breach as they had an implied obligation to take reasonable steps to obtain that approval which Trafigura failed to do so.
When negotiating a contract, it is of crucial importance to determine whether it is your intention to be legally bound once the main terms are agreed. The use of the word “subject” may sometimes defer the formation of a legally binding contract if used correctly. If the “subject” is a pre-condition as described above, there is no obligation to take reasonable steps to ensure that the “subject” is satisfied.
If the “subject” is dependent on an act or approval by a third party, which may fall within the category of a performance condition, but if your intention is not to be legally bound until that “subject” is satisfied, it may be possible to achieve this by wording your communications properly and setting out in clear unambiguous terms that you do not intend to be legally bound until that “subject” is satisfied, although we think that the best way to achieve this and avoid any dispute is to simple include the phrase “subject to contract” in your negotiations.
However, if the “subject” is found to be a performance condition, then the party who does not want to perform would have to show that it took reasonable steps to ensure that the subject is satisfied. If thought is not properly given, you risk ending up being subject to certain legal obligations that you might not otherwise be subject to.
Disclaimer: This article is for general information only and not intended to constitute legal advice. We shall not be liable for any errors or omissions, nor shall we be liable for reliance on the contents of this article.