Understanding the Legal Effect of Pre-Contract Negotiations

and Representations

Introduction

It was said by Lord Wright in 1932 that businessmen often record the most important agreements in
crude and summary fashion.1

Professor A L Corbin wrote in 19632:

It can hardly be insisted on too often or too vigorously that language at its best is always a
defective and uncertain instrument, that words do not define themselves, that terms and
sentences in a contract, a deed, or a will do not apply themselves to external objects and
performances, that the meaning of such terms and sentences consists of the ideas that they
induce in the mind of some individual person who uses or hears or reads them, and that
seldom in a litigated case do the words of a contract convey one identical meaning to the
two contracting parties or to third persons.

In my view although these comments were made in the 20th century they are still apposite. Lawyers
today are still sometimes faced with the task of preparing formal documentation of a contract having
received instructions based on notes scribbled on a piece of A4 and signed by parties, or an email
chain or perhaps simply the recollection of the client.

As we will hear, even where lawyers are used to document a deal, sometimes important terms that
have been discussed between the parties and agreed upon do not make their way into the formal
document.

Common issues that arise before final documentation are as follows:

(a) Have the pre-contractual negotiations and representations been sufficiently recorded?

(b) Are the negotiations and representations to be binding on the party?

(c) Have the parties in fact entered into a binding agreement?

(d) What matters spoken or written down during pre-contractual negotiations and
representations will have significance following execution of a formal contract?

Typical Nature of Pre-Contractual Negotiations and Representations

These can take many forms:

Anything you say. It may not be written down by you but the other side may have written it
down.

Anything you write.

Anything the other side writes.

1
Hillas & Co Ltd v Arcos Ltd (1932) 147 LT 503, Lord Wright.
2
A L Corbin Corbin on Contracts (West Publishing Co, St Paul, rev ed 1960) vol 3 at 536.
 Anything written by both sides eg: an exchange of letters.

Anything you hear and comment on.

Anything you hear and ignore remember estoppel by convention.

Any terms that you and the other side acknowledge but do not record because you and the
other side appear to think the meaning is obvious.

Any reference to industry norms.

Any memoranda of understanding.

Any term sheets.

Any agreements.

Any agreements to agree.

How Should They be Documented

The key issue here is whether the pre-contract terms and negotiations and representations are to be
binding. This is where the lawyer comes in. The lawyer must ask this question. If the
memorandum is not to be binding then it should say so. If some terms in the memorandum are to
be binding eg: process, due diligence, exclusivity of dealing then the memorandum should declare
those terms to be binding with the balance being not binding. A typical clause would be This
agreement does not constitute an offer capable of becoming a contract by acceptance and with the
exception of clauses 1, 2, 3 (which are legally binding) it is not and will not become legally binding
on the seller or the buyer.

Further if it transpires that the parties appear to be agreed on the meaning of a particular term in the
contract the lawyer should be asking what that meaning is, and should provide a definition in the
formal document.

A Real Practical Example

I was recently asked to document the sale of a commercial building to a developer. It was intended
that the building be demolished and replaced by a larger commercial building. One of the terms
agreed between the parties was that accommodation would be provided in the new building and it
was agreed that that accommodation would be a like for like swap.

Both parties were apparently happy with this agreement until I asked what like for like swap meant.
This was for the purpose of ascertaining whether a definition was needed.

It transpired that the developer thought like for like meant as to value. The vendor however
thought like for like was as to size and quality.

Fortunately the potential problem was revealed prior to final documentation with an agreed definition
as to like for like. Had this not happened inevitably there would have been a dispute.
Enforceability and Interpretation Issues

From a lawyers point of view, of particular importance is the issue of the Courts ability (and
willingness) to consider pre-contractual negotiations when disputed contracts come before the
Courts. Supposing that the pre-contractual negotiations are not already binding on the parties, the
issue becomes to what extent the pre-contractual negotiations can be relied upon in the
interpretation of a substantive contract.

This issue has become the topic of much discussion and academic comment of late, following the
Supreme Court decision of Vector Gas Limited v Bay of Plenty Energy Limited. Before discussing
this case, however, it is necessary to briefly touch upon the traditional judicial approach to pre-
contractual negotiations.

The Traditional Approach to Pre-Contractual Negotiations

The traditional view is that pre-contractual negotiations cannot be considered by the Courts when
interpreting contracts (the exclusionary rule).

The House of Lords case of Chartbrook Limited v Persimmon Homes Limited3 may be cited as an
example of this approach. Chartbrook Limited v Persimmon Homes Limited involved a dispute over
the correct application of a formula contained in a development agreement. The salient issue was
whether the Court was entitled to consider background circumstances in interpreting the disputed
formula. The leading judgment of the Court was given by Lord Hoffmann.

His Honour cited the traditional rule that pre-contractual negotiations are inadmissible when
interpreting a document, set out in Prenn v Simmonds [1971] 1 WLR 1381, subject to limited
exceptions.4 The appellant argued that the exclusionary rule ought to only be applied where pre-
contractual negotiations are actually irrelevant.5 Lord Hoffmann rejected this submission. At
paragraph 41 of his judgment, His Honour explained that while he acknowledged the arguments
made against the exclusionary rule he concluded that, on balance, the arguments favoured keeping
the rule:6

The conclusion I would reach is that there is no clearly established case for departing with
from the exclusionary rule. This rule may well mean, as Lord Nicholls has argued, that the
parties are sometimes held bound by a contract in terms which, upon a full investigation of
the course of negotiations, a reasonable observer would not have taken them to have
intended. But a system which sometimes allows this to happen may be justified in the more
general interest of economy and predictability in obtaining advice and adjudicating disputes.

As further noted by Lord Craighead:7

the very purpose of a formal contract is to put an end to the disputes which would
invariably arise if the matter were left upon what the parties said or wrote to each other
during the period of their negotiations. It is the formal contract that records the bargain,
however different it may be from what they may have stipulated for previously.

3
[2009] UKHL 38.
4
Chartbrook Limited v Persimmon Homes Limited [2009] UKHL 38, at [28] per Lord Hoffmann.
5
At [32] per Lord Hoffmann.
6
At [41] per Lord Hoffmann.
7
At [3] per Lord Craighead.
Criticisms of the Exclusionary Rule

The exclusionary rule has been widely criticised.8 Arguments in favour of allowing consideration of
pre-contractual negotiations include that the evidence of pre-contractual negotiations may shed light
on the actual consensus, which makes such evidence directly relevant to the intentions of the
parties; Among the dirt of aspirations, proposals and counter-proposals there may gleam the gold
of a genuine consensus on some aspect of the transaction9

Perhaps most convincing is the argument that even if it is not considered for the purposes of
interpretation, it is likely that the evidence of pre-contractual negotiations will still be admitted some
other way. In addressing arguments made in support of the rule, Lord Hoffmann in Chartbrook
Limited v Persimmon Homes Limited noted that: 10

evidence of the pre-contractual negotiations is almost always tendered in support of an

alternative claim for rectificationor an argument based on estoppel by convention or some
alleged exception to the exclusionary rule. Even if such an alternative claim does not
succeed, the judge will have read and possibly been influenced by the evidence.

It has been argued that, as a result, there are likely to be few cost savings attributable to the
efficiency of the exclusionary rule.11 Furthermore, given that these alternative causes of action allow
pre-contractual negotiations to be used to change the position of the parties under a contract, it
seems that the exclusionary rule adds little in a practical sense to ensuring certainty as to the
ultimate position of the parties.

Given that the Court will likely see the evidence in issue should a alternative claim such as estoppel
by convention be made, it is arguable that the Judge may then be influenced by the evidence, even
if strictly unable to take it into account when interpreting the contract.12 Indeed, in Chartbrook
Limited v Persimmon Homes Limited, Baroness Hale noted in finding for the appellant as to the
interpretation of the relevant formula: 13

But I confess that I would not have found it so easy to reach this conclusion had we not
been made aware of the agreement which the parties had reached on this aspect of their
bargain during the negotiations which led up to the formal contract. On any objective view,
that made the matter crystal clear. This, to me, increased the attractions of accepting
counsels eloquent invitation to reconsider the rule in Prenn v Simmons

Accordingly, it seems that there would be greater intellectual honesty in rejecting the exclusionary
rule.14

8
See for example McLauchlan, David Deleted Words, Prior Negotiations and Contract Interpretation (2012) 2
VUWLRP 5.
9
Chartbrook Limited v Persimmon Homes Limited, above n 4, at [32] per Lord Hoffmann.
10
At [35] per Lord Hoffmann
11
McLauchlan, David Deleted Words, Prior Negotiations and Contract Interpretation (2012) 2 VUWLRP 5, at 300.
12
Chartbrook Limited v Persimmon Homes Limited, above n 4, at [35] per Lord Hoffmann.
13
At [99] per Baroness Hale.
14
At [35] per Lord Hoffmann.
The position in New Zealand

The position as to the exclusionary rule in New Zealand was rather confusingly set out in the
Supreme Court judgment of Vector Gas Limited v Bay of Plenty Energy Limited [2010] NZSC 5. By
way of a very brief summary, the facts of this case related to an interim deal between the parties for
the supply of gas. The critical issue was whether the agreed price, being $6.50 per GJ was
inclusive or exclusive of the cost of transmission. All of the judges grappled with the issue of
whether the pre-contractual negotiations could be considered and resolved the matter by
unanimously allowing the appeal, albeit in different ways.

Blanchard J noted that the traditional approach (the exclusionary rule) is not without exceptions.15
One such exception is the subject matter exception, which his honour believed could be used in
the circumstances to throw upon the objective commercial purpose and ascertain whether the
contract related to gas only, or gas and transmission.16 His Honour said that the extent to which the
subject matter exception can be applied can be left for another day17 and, for completeness,
noted that the conclusion he had already reached as to interpretation of the contract was merely
reinforced if reference is made to the negotiations between the parties.18

Tipping J approached the matter by focusing on business common sense19. His Honour noted
that finding the appropriate contextual meaning to achieve this will involve consideration of facts
and circumstances not apparent solely from the written document.20 His Honour noted that
ambiguity was not needed to consider extrinsic evidence.21 While not supporting the admissibility of
subjective evidence of pre-contractual negotiations,22 Tipping J noted that evidence of pre-
contractual negotiations can properly inform an objective approach to meaning 23 and is admissible
where the evidence demonstrates objectively what meaning both or all parties intended their words
to bear.24

McGrath J started by pointing out that the boundaries of the exclusionary rule are unclear.25 His
Honour was in agreement with Tipping J that an ambiguity is not needed to consider the factual
matrix.26 His Honour noted the criticisms of the rule27 however he effectively reaffirmed the judgment
of Lord Hoffmann in Chartbrook Limited v Persimmon Homes Limited. While recognising the
operation of the exclusionary rule, His Honour stated that this rule does not, however, exclude use
for the purpose of establishing facts relevant as background which were known to the parties. Nor
does it preclude such evidence from supporting a claim for rectification or estoppel.28 In applying
his statements of the law to the facts at hand, His Honour rejected the admission of evidence
relating to the pre-contractual negotiations for the purposes of interpreting the contract, on the basis
that they did not fit within the subject matter exception to the rule as the subject matter was the

15
Vector Gas Limited v Bay of Plenty Energy Limited [2010] NZSC 5, at [13] per Blanchard J.
16
At [14] per Blanchard J.
17
At [14] per Blanchard J.
18
At [13] per Blanchard J.
19
At [22] per Tipping J.
20
At [22] per Tipping J.
21
At [23] per Tipping J.
22
At [28] per Tipping J.
23
At [28] per Tipping J.
24
At [31] per Tipping J.
25
At [63] per McGrath J.
26
At [64] per McGrath J.
27
At [72] per McGrath J.
28
At [67] per McGrath J.
supply of gas which does not need more precise identification.29 His Honour did however find that
the pre-contractual negotiations were admissible in respect to a claim of estoppel.30 Although
estoppel was not actually pleaded by the appellants, His Honour allowed the appeal on that basis.

Wilson J provided the strongest statement of the Court against the exclusionary rule. As to
evidence of prior negotiations, His Honour stated that the time has come to remove in this country
the barrier imposed by Prenn v Simmonds.31 Contrary to Tipping and McGrath JJ, Wilson J
considered that an ambiguity was needed in order to consider alternative interpretations of a
contract (which may be based on extrinsic evidence).32 But that the ambiguity need not be an
objective ambiguity in the words of the contract itself:33

It is irrelevant whether the contract language is ambiguous in the abstract. What matters is
whether it is ambiguous as between the (usually two) meanings advanced by the parties

On the facts of the case, Wilson J considered there to be no ambiguity in the words used requiring
the consideration of extrinsic evidence. His Honour instead resolved the matter by reference to the
rule that the Court can go beyond the words of the contract for the purpose of addressing matters
of commercial sense and estoppel. Wilson J allowed the appeal on the basis that the agreement
as contended by the respondents did not make commercial sense34 and that the respondent was
estopped from relying on the (in His Honours view) clear terms of the agreement as such a
meaning would be contrary to the understanding of the parties during negotiations.35

Gault J wrote a short judgment, essentially agreeing with Blanchard J but providing no detailed
reasoning. His Honour noted that, in his view, the letter setting out the alleged agreement between
the parties could only be read in light of pre-contractual negotiations as it refers to a previous
agreement.

Conclusion as to the use of pre-contractual negotiations in interpretation

Rather than clearing up the question of the relevance of pre-contractual negotiations, the Supreme
Court took five different approaches to the question of their admissibility, despite reaching the same
substantive result. The question now becomes what conclusions we can draw as to the place of
pre-contractual negotiations when the a contract comes before the court. It seems the following
conclusions can be made:

(a) The general exclusionary rule remains the law in New Zealand. That is, Courts are not able
to consider pre-contractual negotiations when interpreting a contract.

(b) Despite this, it is fair to say the rule appears to have been weakened, in particular:

(i) The subject matter exception cited by Blanchard J, where pre-contractual

negotiations can be considered to ascertain the subject matter of the contract;

29
At [83] per McGrath J. Compare with the approach of Blanchard J at [14].
30
At [84] per McGrath J.
31
At [122] per Wilson J.
32
At [120] per Wilson J.
33
Burton, Steve Elements of Contract Interpretation (Oxford University Press, New York, 2009), pp138-139 cited in
Vector Gas Limited v Bay of Plenty Energy Limited [2010] NZSC 5, [120] Wilson J.
34
Vector Gas Limited v Bay of Plenty Energy Limited, above n 15, at [139] per Wilson J.
35
At [144] per Wilson J.
 (ii) Tipping J went further and allowed pre-contractual negotiations to be admitted as
objective proof of not just the subject matter, but what the parties intended their
words to mean.

(iii) Wilson J questioned whether the barrier of the exclusionary rule still had a place in
New Zealand.

(iv) Tipping and McGrath JJ considered that no ambiguity was needed for the
consideration of extrinsic evidence.

(c) Even where evidence is excluded for the purposes of interpretation, it seems clear that it will
still have a role to play as it is admissible for the purposes of the inevitable accompanying
arguments of estoppel or rectification.

Other Matters to Consider

Pre-Contractual Representations

It may be that pre-contractual negotiations cross the line from being simply negotiations, to be
binding on the parties, despite no formal document having been executed. That is, the negotiations
do not simply shed light on the substantive agreement, but constitute agreement in themselves. It is
important for negotiating parties to keep in mind that pre-contractual agreements may result in a
provisional or partial agreement which is binding on the parties. Whether or not there is already a
binding agreement becomes relevant in two situations:

(a) where a party wishes to pull out of negotiations and the other claims that they are already
bound; and

(b) where the formal contract does not fully reflect the negotiations as between the parties, at
which stage it may be argued that there is a collateral contract.

The question as to whether pre-contractual negotiations are binding on the parties requires
consideration as to whether the negotiations constitute a complete agreement. A concluded
contract requires all matters to be settled, and nothing left for later agreement.36

However, despite this general rule, Courts will strive to find a binding agreement where the parties
intended to be bound from the outset, with the intention of the parties to be assessed objectively.
Courts are willing to hold that there was a binding agreement where:

(a) the parties intended a term not settled initially to be resolved at a later date by some
objective or market basis, not by further negotiation. In this case the Courts will usually
have no difficulty in finding a binding agreement, and determining the matter in issue
itself by inserting an implied term;37 or

(b) the parties the parties have agreed on all material terms but contemplate that a formal
document will be subsequently executed. The Courts will look at the intentions of the
parties as to whether they intended to be immediately bound. While the presumption is

36
May and Butcher Limited v The King [1934] 2 KB 17.
37
Money v Ven-Lu-Ree [1988] 2 NZLR 414, 423.
 that parties do not intended to be immediately bound where they anticipate entering into
a formal document, this presumption can be rebutted.38

On the other hand, Courts have shown reluctance to find an agreement to negotiate binding on the
parties. This issue crops up where the negotiations have broken down and a party seeks to claim
that the other party was bound to continue negotiations and reach a binding contract. Where the
agreement is simply to negotiate and there are no certain objective standards that must be followed
in the negotiation, Courts will not find an enforceable agreement.39 However, where there is an
agreement to follow a particular negotiation process, this may be binding on the parties.

Pre-contractual representations

It is noted that even where the pre-contractual negotiations do not themselves constitute a binding
agreement, parties are obliged to refrain from making misrepresentations (including innocent
misrepresentations) that induce the other party (or parties) to enter into a binding agreement. The
source of this rule is common law as well as statutory provisions:

(a) Section 6 of the Contractual Remedies Act 1979 provides that where a party has been
induced to enter into a contract on the basis of a misrepresentation (whether innocent or
fraudulent), the misrepresentation will be treated as if it is a term of the contract which has
been broken.

(b) Section 9 of the Fair Trading Act 1986 sets out the general rule that where the party is acting
in trade (which is given a wide description), they must not engage in conduct that is
misleading or deceptive or is likely to mislead or deceive.

The use of entire agreement clauses

It is common for a formal contract to contain a provision which seeks to exclude the consideration of
previous negotiations for the purposes of interpretation, and also for the purposes of excluding a
claim of misrepresentation. Exclusion clauses take many forms, but their purpose is to purport to
limit the rights of the parties to those contained in the contract. This may have an impact on pre-
contractual negotiations where the formal contract document does not reflect the preliminary
agreement between the parties.

It is important to note that these types of clauses are regulated by a number of statues, for example:

(a) in terms of consumer contracts such clauses will be subject to, amongst other provisions,
the Consumer Guarantees Act 1993, which contains statutory guarantees as to quality and
fitness for purpose;40

(b) as a matter of law, Courts have found that parties cannot contract out of the Fair Trading Act
198641.

38
France v Hight [1990] 1 NZLR 345.
39
Wellington City Council v Body Corporate 51702 [2002] 3 NZLR 486.
40
Consumer Guarantees Act 1993 s 6, 8, 29.
41
PJ Berry Estates Pty Ltd v Mangalore Homestead Pty Ltd (1984) APTR 45, 626.
Of particular relevance to the issue of pre-contractual negotiations is section 4 of the Contractual
Remedies Act 1979. This clause deals with provisions in contracts which purport to exclude a court
from enquiring into the pre-contractual negotiations of the parties for the purposes of considering
whether an actionable representation was made. The court is not prevented from doing so unless it
is considered fair and reasonable in the circumstances. Factors that will influence the court in
deciding whether it is fair and reasonable include:

(a) the commercial context, including whether the parties are commercial parties and the
subject matter and value of the transaction;42and

(b) the bargaining strength of the parties, including which party had inserted the clause and the
opportunity of the other party to remove it, whether it had been brought to the parties
attention, and whether it was a pro-forma standard clause.43

Practical Tips for Contracting Processes and Drafting

At this point I would remind you of the famous words of Professor Corbin. Paraphrased language is
at its best a defective and uncertain instrument, words do not define themselves and seldom in
litigation do the words of a contract convey one identical meaning to the parties or to third persons.
Remember also the five different Supreme Court judgments in the Vector Gas case. What practical
tips therefore are available when entering into this legal mine field. Apart from reminding lawyers to
check that they have adequate PI insurance the following may assist:

(a) lawyer and client should sit down at the earliest possible opportunity to discuss the proposed
deal and the necessary documentation. The lawyer must understand what it is that the
client wishes to achieve in entering into the contract;

(b) check whether there have been pre-contractual representations and negotiations. Have
these been documented, if not, should they be;

(c) when preparing preliminary documentation clarify which clauses/matters should be binding
on the parties and say so. Specify as we have discussed what overall further negotiations
are necessary before a binding agreement is entered into;

(d) use clear concise language wherever possible. If technical terms are used insert a
definition;

(e) question every term. Are the parties using a private dictionary meaning for that term and if
so, seek clarification from the client and the other side as to the meaning. Remember, like
for like swap;

(f) if there are important matters left to negotiate/settle question whether it is worthwhile to
prepare a preliminary document or whether it is better to thrash out all remaining details and
produce a final document;

(g) after the document has been drafted the draftsman, whether lawyer or other, must
immediately consider the important question what can go wrong?;

42
See, for example, Brownlie v Shotover Mining Ltd CA 187/87 21 February 1992.
43
PAE (New Zealand) Ltd v Brosnahan (2009) 10 TCLR 626.
(h) if something can go wrong, and something can always go wrong, put in a mechanism for
resolving disputes.