Lecture notes
LAWS10078 Contract Exam Notes-PRE CONTRACTUAL LIABILITY
- Module
- LAWS10078
- Institution
- The University Of Edinburgh (ED)
LAWS10078 Contract Exam Notes-PRE CONTRACTUAL LIABILITY
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PRE CONTRACTUAL LIABILITYPromises and Contract Law: Comparative Perspective
Wasted pre- contractual expenditure following termination of contract negotiations
Should a party negotiating a contract incur liability for negotiating expenses of the other party if negotiations
for a contract are broken off? When the negotiations break down and a contract is not concluded, a party
could have incurred huge sums of expenses in terms of contracting service like lawyers etc to help with the
negotiations. Where the money expended by one negotiating party has conferred some objective benefit on
the other party there may be a claim in unjustified enrichment, however, the party is unlikely to recover for
wasted expenses.
If we take the strict view to this then we can see the contract relation as two stages: the negotiations stage
and the contract signing i.e. agreement. It is the latter where duties and rights are assumed and there is
consensus in idem. There is no middle ground, i.e. no liability can arise for wasted pre- contractual
expenditure, unless caused by a tortious act, each party assuming his own risks.
However, there are people of the view that the parties should be entitled to recover for pre- contractual
expenditure- this could cause possible problems like posing a risk to the freedom not to contract and could
skew the risk allocation between the parties.
Common Law solution to the problem of pre-contractual expenditure: promissory and proprietary estoppel.
The idea of estoppel can be briefly describes as it would be unconscionable to allow a party in some instances
to adopt a position which is at odds with a position previously adopted by it.
At common law estoppel by representation provides a defence against a party seeking to deny a
representation of fact which it has previously made. Equity recognises estoppel as preventing party which has
made a promise from acting inconsistently with that promise.
The doctrine of promissory estoppel holds that if A has made a clear or unequivocal promise to B, which has
affected B’s position, and it would be inequitable to allow A to go back on his promise, then A will be
prevented from acting inconsistently with that promise. In US thus then B would be given a direct right to
enforce A’s promise by raising a claim against A and thus bypassing consideration requirement. In England, B is
given a defence to any action by A to enforce a position contrary to A’s promise. In England the courts have
restricted the doctrine to cases where the promise relates to a right stemming from a pre-existing legal
relationship existing between the parties. In US, a belief that a legal relation in the future will exist suffices.
This narrow reading by English courts has restricted the recovery of pre-contractual expenditure. In USA
however, where the promise made need not relate to a pre-existing right between the parties, this evidently
opens up the way for promissory estoppel to play a role in relation to liability for pre-contractual expenditure,
as happened in the Hoffman v Red Owl Case.
In England the law is largely governed by the case of Walford v Miles, 1992. In this case the defendants were
the owners of a company a property of a photographic business. Negotiations between them and the plaintiffs
began for the sale of that business. The defendant agreed orally, to terminate negotiations with any other
competing party if the claimant furnished the defendant with a letter of comfort from the claimant’s bank
indicating that they have the necessary finances to purchase the business. This condition was complied with.
They ended negotiations with others, but eventually sold off the business to another third party. The court
held: As to good faith, it is said that there is no principle of English law whereby a party negotiating in
circumstances such as the present owes a duty of good faith. This is not so; if an appropriate agreement has
been concluded there will, in the absence of contrary express provision, be an obligation upon the parties to
,behave reasonably. It is necessary first to ask what legal right has been invaded and then to ascertain what
consequences flow from the invasion of the right. In the present case all that has been lost is the opportunity
to negotiate. This cannot be tangibly assessed. Loss of opportunity to negotiate is not a head of damage known
to the law. While accepting that an agreement to agree is not an enforceable contract, the Court of Appeal
appears to have proceeded on the basis that an agreement to negotiate in good faith is synonymous with an
agreement to use best endeavours and as the latter is enforceable, so is the former. This appears to me, with
respect, to be an unsustainable proposition. The reason why an agreement to negotiate, like an agreement to
agree, is unenforceable, is simply because it lacks the necessary certainty. The same does not apply to an
agreement to use best endeavours. This uncertainty is demonstrated in the instant case by the provision which
it is said has to be implied in the agreement for the determination of the negotiations. How can a court be
expected to decide whether, subjectively , a proper reason existed for the termination of negotiations? The
answer suggested depends upon whether the negotiations have been determined "in good faith." However
the concept of a duty to carry on negotiations in good faith is inherently repugnant to the adverserial position
of the parties when involved in negotiations. Each party to the negotiations is entitled to pursue his (or her)
own interest, so long as he avoids making misrepresentations. To advance that interest he must be entitled, if
he thinks it appropriate, to threaten to withdraw from further negotiations or to withdraw in fact, in the hope
that the opposite party may seek to reopen the negotiations by offering him improved terms. A duty to
negotiate in good faith is as unworkable in practice as it is inherently inconsistent with the position of a
negotiating party. It is here that the uncertainty lies. In my judgment, while negotiations are in existence either
party is entitled to withdraw from those negotiations, at any time and for any reason. There can be thus no
obligation to continue to negotiate until there is a "proper reason" to withdraw
Promissory estoppel: promissory or reliance based principle?
Promissory estoppel has been argued to be more of a reliance based principle than a promissory one, in that it
aims to protect the detrimental reliance of one party in whose favour the undertaking is made by the other
party.
The promissory view can be supported by a historical analysis of the development of the ideas of consideration
and promissory estoppel. Promissory estoppel was designed to mitigate the unjust results of the consideration
rule. The promissory view is evident in the famous High Trees House Case, where Denning J stated that the
basis for holding the landlord to his undertaking to accept reduced rent not merely as the landlord being
estopped from denying later contrary statements, but rather because a promise was made which was
intended to create legal relations and to the knowledge of the person making the promise, was going to be
acted on by the person wo whom it was made and which was in fact so acted on. This can be seen as an
attempt to create a free standing form of unilateral promissory liability, ie. Following the American way.
However, conservative interpretations of this case led to the English result.
Court practice also indicates towards the promissory and not reliance based nature of promissory estoppel. If
promissory estoppel were genuinely a species of reliance based liability, one would expect an examination of
whether such reliance was actually present to be a crucial part of the court’s analysis. The fact that this does
not occur tends to suggest that promissory estoppel is at hear an expression of promissory principle. In
addition to this, true reliance based theories, would suggest that the some detriment should be shown by the
party acting in reliance of the undertaking, however, English courts are of the position that the party only
needs to prove that they were affected by the promise, not that it has suffered any loss.
Promissory estoppel and failed contractual negotiations
Hoffman v Red Owl, US case- Hoffman had received various assurances from Red Owl that they’d gran him a
franchise. On the faith of those assurances, Hoffman sold various existing concerns he had, including a bakery.
One of the assurances he was given was in the nature of we are ready to go- get your money together. This
,turned out to be inaccurate, Red Owl claiming that they said if Hoffman could find the additional sum for
promotional purposes then the deal could go through. Negotiations collapsed. Hoffman sued for pre-
contractual wasted expenditure to a sum of $20,000. The court found in favour of Hoffman, stating that he had
reasonably and detrimentally relied on the promises made by Owl.
The Court’s analysis is evidently dependent upon there being some promise upon which to base liability for the
subsequent loss: what then was the relevant promise upon which H relied? The court states that the record
discloses a number of promises and assurances given to Hoffman – like for the sum of $18,000 Red Owl would
establish Hoffman in a store. The court stated that no promise needs to be comprehensive as to meet the
requirements of contractual offer.
Thus promissory estoppel cab be used to recover pre-contractual expenditure if there has been a promise
made by the defendant and that by relying on that promise losses followed. Any loss the party suffers as a
consequence of a decision of the party itself, not influenced by promises of the defendant would not be
recoverable.
In England this approach cannot be adopted due to the need to show that the promise arouse out of a pre-
existing legal relationship.
In Australia, they have developed their own radical approach, allowing promissory estoppel to be used to
recover for losses in the instances of failed negotiations. Walton Stores (Interstate) v Maher, negotiations for a
lease of land reached to a point that the draft terms of the lease were agreed. The solicitors of both parties
claimed that if there were any amendments that were not agreed to they would be intimated to the party.
There was no such intimation and the landlord signed the lese. Acting on reliance of the lease, he began to
demolish a building on the land to construct a new one as per the terms of the lease. The tenant had not
signed the agreement and attempted to renege on the agreement. The Australian court treated the case as
though a contract existed between the parties on the basis of promissory estoppel, noting that the tenant was
estopped in all circumstances from retreating from its implied promise to complete the agreement, and thus
damages are being awarded for the breach of that contract. This can be seen as a mechanism to enforce an
exchange of promises which lack only the legally required form.
Even more radical is the case of Sabemo v North Sydney Municipal Council, where the judge talked of imposing
liability for the imputed fault of the defendants, an imposition which he was willing to make irrespective of the
parties common intention. This has an air of tortiousness. The judge stated the following: where two parties
proceed upon the join assumption that a contract will be entered into between them, and one does work
beneficial for the project, and thus in the interest of the two parties, which work he would not be expected, in
other circumstances, to do gratuitously, he will be entitled to compensation or restitution, if the other party
unilaterally decides to abandon the project, not for any reasons associated with bona fide disagreement
concerning the terms of the contract to be entered into, but for reasons which, however valid, pertain only to
his own position and do not relate to any other party. He went on to say while the defendant may have good
reasons for dropping the proposal, these were irrelevant because they had nothing to do with the plaintiff,
which had in good faith worked assiduously towards the conclusion of a contractual relationship. This
harshness can be seen as a grave interference with the freedom of and freedom to contract.
A civilian solution to wasted pre-contractual expenditure: culpa in contrahendo and bad faith termination of
contractual negotiations
The German doctrine of culpa in contrahendo has been described as: once a party enters into negotiations for
the formation of a contract, a relationship of trust and confidence comes into existence irrespective of
whether such negotiations succeed or fail. Thus, protection is afforded against the blameworthy conduct which
, prevents the consummation of contract. A party is liable for negligently creating the expectation that a
contract would be forthcoming although he knows or should know that the expectation cannot be realised.
This shows the doctrine as having wide capabilities, which can destroy the freedom not to contract and might
put parties off negotiating contracts in the first place without having formed a preliminary contract dealing
with the negotiations. This doctrine has been criticised for ignoring the reality that the negotiating party looks
to their own interests, and expecting them to protect the other party’s position may be unrealistic.
In Germany the doctrine has been framed in the following way: the obligation obliging each party to take into
account the rights, legal interests and other interests of the other party comes into existence by the
commencement of contractual negotiations. There is agreement that this version of the doctrine is not
promissory based liability but trust based liability. There is no agreement whether liability in culpa in
contrahendo is best seen as lying in contract or tort, and this is because of the varied circumstances which can
trigger the doctrine as well as from the nature and extent of the recovery available. Despite the varying
nature, there are also versions of strict liability for culpa in contrahendo. In such instances damages protect
the restoration interest, and in some they can amount to compensation for performance- adding further
confusion to where the place liability under this doctrine.
Criticising the doctrine: if we understand the doctrine in way that entering into the negotiations stage will bar
a party from breaking off the negotiations in bad faith, then it would be problematic to assess what may or
may not be a good cause for breaking off negotiations. This would be asking the court to dabble in business
decisions and assumes that the motivating factors of commerce are susceptible to scrutiny by reference to
judicial norms.
The Dutch distinguish 3 stages in the contract negotiations process: at stage one, the stage of preliminary
enquiry, both parties are entirely free to break off their negotiations. At stage two: during the substantive
negotiations, a party may still break off negotiations, but will have to pay the others expenses if it does so. At
stage 3: as negotiations draw to a close, if one party has been reasonably led to believe that a contract will be
concluded between the parties, the parties will no longer be free to break off negotiations and if this occurs,
damages will be due in the performance measure or the other party may be compelled to continue with
negotiations. This clearly hinders the notion of freedom to contract.
A mixed system solution to wasted pre-contractual expenditure: liability from an implied assurance that a
valid contract exists
Liability should arise when an implied but false assurance has been given by one negotiating party to the other
that a contract exists, such assurance leading to detrimental reliance on the part of the other party.
The doctrine is well explained by the case of Dawson International v Coats Paton, where Lord Cullen identified
3 requirements for a claim by A as being that B had given an implied assurance to A that a valid contract has
been entered into by the parties; that this assurance is false and no valid contract exists between them; and
that A has incurred expense as a result of reliance on B’s assurances. In Bank of Scotland v 3i plc, it was held
that because the remedy is equitable in nature, in order to claim, A must have no other remedy available to it
for the recovery of wasted expenditure.
Given that there must have been at least an implied assurance that a contract already exists, it will be obvious
that a mere promise that the other party intends to contract is insufficient, and so is a mere breaking off
negotiations without any promise or assurance of any kind been given.
Khaliq v Londis (holdings) Ltd- here K a business man was looking at joining a franchise. Just like the Red Owl
case, the pre-contractual expenditure proved useless. The inner house claimed that K did not meet the
requirements as asset out in the Walford v Milne case, claiming that the expense incurred was not made in
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