IT law

By Jonathan Cohen, Bird & Bird, London

Pre-contractual negotiations and the formation of a binding contractDMA Financial Solutions v BaaN UK (2000)

'A verbal contract isn't worth the paper it's written on,' according to Sam Goldwyn, the US film producer.

Subscribers to Mr Goldwyn's theory should urgently re-consider that view following Mr Justice Park's decision in DMA Financial Solutions Ltd (DMA) v BaaN UK Limited (BaaN).

He ruled that negotiations for a software training contract resulted in a binding contract before a written agreement could be signed.

The factual backgroundBaaN licensed a software program for financial accounting systems.

It also provided customer training for that program.

However a strategic review in 1998 convinced BaaN to phase out the program from early 2002.

BaaN realised that in the meantime it would not be financially viable to continue its customer training.

In the circumstances BaaN decided to outsource its customer training function.

BaaN approached the IT consultant DMA to negotiate a contract for DMA to train BaaN's customers until 2002.The negotiations progressed well.

By 19 November, 1998 BaaN was able to notify its customers that DMA would provide training for the program from 1999.

After a further meeting on 4 December, BaaN's negotiator sent a note of his understanding of the agreement to his opposite number.

Those terms included a start date of 1 January 1999 for DMA to commence the training.

In a telephone conversation on 16 December the two sides agreed one minor variation to the terms.

Difficulties only emerged once the lawyers became involved.

BaaN sent the terms to its US attorneys to draft a formal agreement.

However none had appeared by the 1 January deadline.

Instead BaaN's lawyers raised objections to the agreed terms and produced a draft contract which failed to reflect those terms.

In the meantime, BaaN had been winding down its training operations and passing its customer lists to DMA.

For its part DMA had started to employ training staff.

The parties could not resolve their differences.

DMA issued proceedings.

It pleaded that a contract for it to train BaaN's customers had been agreed.

BaaN denied that any contract had been concluded.

The judge's analysisMr Justice Park tested the facts against three models which the law applies to assess whether parties to negotiations have actually concluded a binding contract.The first model is the 'subject to contract' negotiation.

On this scenario the negotiations proceed on the basis that even when all terms are agreed they do not bind the parties until they sign a formal document.

On the second model the negotiations proceed on two assumptions.

The first is that there will be a binding contract as soon as the parties have agreed the terms.

The second is that the lawyers will then encapsulate the agreement in a formal document.

The parties often agree changes in the written document from the terms which were previously agreed.

In that case, the parties then sign up to the formal document and are bound by its terms.

The formal document replaces the earlier agreement.

However, if the parties fail to come to an agreement on the new terms of the formal document they are still bound by their earlier agreement.

DMA argued that this applied exactly to its negotiations with BaaN.

On the third model, the parties proceed on the same basis as the second model, that is to say, they will be bound as soon as there is agreement without any necessity for a written document.

However, the parties do not agree on one or more of the essential terms of the agreement, for example, the price.

In those circumstances there is no contract.

Mr Justice Park explained that if the only outstanding point is non-essential then there is still a contract.

He gave the example in the present case of a proper law clause.

BaaN invited the judge to apply this third model and rule that its negotiations with DMA had never reached the stage of a concluded contract.In a forthright judgment Mr Justice Park ruled in favour of BaaN.

The second model applied to the facts of this case.

All the essential elements of the contract had been agreed.

The existence of a binding agreement was confirmed by the parties actions in beginning to transfer the training function from BaaN to DMA.

Implications of the judgment for the negotiation of contractsParties embarking on contractual negotiations should involve their legal advisers from the outset, rather than simply instructing them to write up the contract afterwards.

This might avoid the problem which afflicted BaaN and DMA.In any event the parties should agree the basis on which their negotiations are to proceed.

If that basis is the 'subject to contract' model described above then those words should be inserted prominently on the memorandum of understanding, heads of agreement or term-sheet being negotiated.

That insertion would demonstrate - though not conclusively - that the parties did not intend to be bound by the terms of the document.

An additional clause at the end of the document that its terms were not intended to be legally binding should put the matter beyond doubt if proceedings follow.If the negotiations are not made subject to contract then the executives carrying out the negotiations must be aware that their organisations might be bound without any written agreement.

They should also ensure that no work commences in advance of the terms being confirmed unless the parties agree that the work will be separately remunerated.

In the IT industry in particular it is all too easy for negotiations to be overtaken by events when both sides are under time pressure.

There is also the danger that the start of work might in itself confirm a binding contract, as BaaN found to its cost.In any of these situations the parties should take full and accurate notes of all meetings and telephone calls, and save all e-mails.

Correspondence confirming points agreed can also prove crucial if the worst comes to the worst and litigation commences.

Whatever the significance of Mr Goldwyn's contribution to the film industry, his unhelpful contribution to legal reasoning should be left on the cutting room floor.