Freedom of contract - or is it?

Many contracts have a clause which requires that all variations of the contract must be in writing and signed by the parties (a No Oral Modification or NOM).  It is not unusual for parties to informally vary a contract without reference to the NOM clause and in recent years there has been uncertainty as to whether the doctrine of freedom of contract should give effect to that agreement.

Welcome clarity has been provided by the Supreme Court in a decision in which it was held that the law gives effect to contractual provisions requiring specified formalities to be observed for a variation to contract to be effective.

Rock Advertising Ltd (Rock) occupied serviced offices managed by MWB Exchange Centres Ltd (MWB) under a written licence agreement which contained a NOM clause.

Rock struggled to make the licence payments so during a telephone conversation between representatives of each party, a new payment plan was agreed which meant that Rock would pay less than the amount originally agreed for the first few months but following that, it would pay more than originally agreed, so that the arrears would be cleared by the end of the year. Rock paid the first instalment of the new payment plan on the same day. MWB subsequently decided that the full amount originally agreed was due, purported to exercise its right to lock Rock out of the premises, gave notice to terminate the agreement and issued a claim for the arrears.

The case turned on whether the oral agreement for the payment plan varied the licence, or whether this was not possible due to the NOM.

The trial judge held that the oral agreement had been entered into and this amounted to a variation of the licence which was supported by consideration that Rock would honour some, and hopefully all, of its obligation and that it could continue to occupy the premises, so it would not be empty. However, the judge held that the variation was not enforceable because it was not in writing nor was it signed by the parties.

The Court of Appeal reversed this decision and held that autonomy of the contracting parties allowed them to mutually override the NOM clause.

This was overturned on appeal to the Supreme Court. The Supreme Court held that the licence was not varied by the oral agreement reached between Rock and MWB, since it did not comply with the terms of the licence.

Lord Sumption noted the commercial reasons for upholding NOM clauses:

“There are at least three reasons for including such clauses. The first is that it prevents attempts to undermine written agreements by informal means, a possibility which is open to abuse, for example in raising defences to summary judgment. Secondly, in circumstances where oral discussions can easily give rise to misunderstandings and crossed purposes, it avoids disputes not just about whether a variation was intended but also about its exact terms. Thirdly, a measure of formality in recording variations makes it easier for corporations to police internal rules restricting the authority to agree them.”

All the Supreme Court judges agreed that a party could be bound by an oral variation if there had been reasonable reliance and estoppel. However the restrictions of a NOM clause cannot totally be avoided by estoppel, as Lord Sumption stated:

“The scope of estoppel cannot be so broad as to destroy the whole advantage of certainty obtained with a NOM clause. At the very least, (i) there would have to be some words or conduct unequivocally representing that the variation was valid notwithstanding its informality; and (ii) something more would be required for this purpose than the informal promise itself.”

This decision should make contractual relations more certain and it should reduce the risk that a party is inadvertently bound to a variation by an informal decision. However, it does take away some of the desirable aspects of an informal variation. If you do want to vary the terms of a contract, it is important to follow the correct procedure even if the other party appears amenable to changing the terms of the contract informally.