Contract – the Court of Appeal takes a pragmatic view on the enforceability of side letters and collateral arrangements

In the September 2009 edition of property update we looked at the High Court decision in North Eastern Properties Ltd v Coleman (1) and Quinn (2).

The main focus of the High Court's decision was whether the buyer of 11 flats in the course of construction could serve a notice to complete when construction of the flats was delayed (see our alert What rights does a buyer have in relation to the timing of construction and completion?).

In the High Court the buyer had also argued that the contracts were unenforceable because they did not incorporate one of the terms which had been negotiated between the parties. The High Court rejected this argument.

The decision of the High Court was upheld on appeal. However, in the course of its judgment the Court of Appeal has given some useful guidance on the circumstances in which a "collateral agreement" will be enforceable.

The buyer's argument was based on section 2 of the Law of Property (Miscellaneous Provisions) Act 1989. This provides that a contract for the sale of land must:

• be in writing
• be signed by, or on behalf of both parties
• incorporate all the terms which have been expressly agreed between those parties.

The facts of the case were that the parties had agreed that the buyer would receive a 10% discount on the price, since it was purchasing a large number of flats. However, the buyer requested that a discount of only 8% be shown on the face of each contract. The other 2% would be invoiced separately on exchange of contracts as a "finder's fee". This was because the buyer had the ability to assign the benefit of each contract to a sub-purchaser. Although the 8% discount would be passed on under each contract to the sub-purchaser, the remaining 2% was the buyer's reward for finding purchasers for the flats and so was payable to the original buyer only.

The buyer argued that the written contracts did not incorporate all of the terms agreed between the parties as they did not contain any reference to the finder's fee. On that basis, the buyer argued, the contracts were void because they did not comply with section 2.

The Court of Appeal ruled that the agreement in relation to the finder's fee was part of a composite transaction. However, it also held that performance of the sale contracts was not conditional on performance of the finder's fee agreement. It reached this conclusion on a number of grounds:

• the fee was payable on exchange of contracts, not on completion of the sales
• the fee was payable to the original buyer only, not to a sub-purchaser who might take an assignment of the benefit of a contract
• the finder's fee was payable in relation to the 12 flats which the buyer had originally agreed to buy, even though the buyer had found a sub-purchaser for one of the flats before contracts were exchanged, such that the buyer only entered into agreements to buy the 11 remaining flats
• bearing in mind that most of the contracts were expected to be assigned to sub-purchasers, it would be perverse for any issue about payment of a finder's fee to the original buyer to influence whether or not a particular sale contract should be completed.

The Court of Appeal was also influenced by the fact that each of the contracts contained a clause providing that the contract contained the entire agreement between the parties (an entire agreement clause). This did not mean that the parties had not reached an agreement about the finder's fee (on the contrary, the court had no hesitation in finding that they had). Rather, the presence of the entire agreement clause put beyond doubt that the agreement about the finder's fee did not form part of the contracts for the sale and purchase of the flats.

On that basis, section 2 was not engaged, and the sale agreements were enforceable. The Court of Appeal went further than the High Court and ruled that the agreement in relation to the finder's fee was also enforceable, since it was supported by consideration.

Things to consider

The Court of Appeal was firmly of the view that section 2 was not intended "to make it easier for people who have genuinely contracted to escape their contractual obligations".

The court acknowledged that the case law around section 2 has not always been easy to reconcile. It listed a number of principles which should provide helpful guidance to parties structuring transactions:

• In order to be caught by section 2, the expressly agreed term must be a term of the sale of the land, and form part of one commercial transaction
• Section 2 does not prohibit parties from structuring a composite transaction which includes a land contract in a way such that the land contract is dealt with in a separate document, provided that it is genuinely separate. In other words, performance of the land contract must not be conditional on the performance of another part of the bargain
• For example, a sale of a company's assets may be structured so that the sale of the land is dealt with separately from the sale of other items such as stock and goodwill, unless the sale of the land is conditional on the sale of the other assets
• Parties are free - and should be encouraged - to set out in their documents whether or not the land contract is conditional in this way. An obvious way to do that is by including an entire agreement clause in the land contract
• An entire agreement clause is sometimes said to have the effect that a "collateral warranty" made during negotiations has no legal effect. However, this will only be the case where the main contract is dependent on the collateral agreement. If the collateral agreement is supported by its own consideration and one agreement is not conditional on the other, then the collateral agreement will be enforceable in its own right.

The above analysis was written by Sarah Allen, associate in Wragge & Co's Real Estate group.

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