Entering into a business relationship with another party can be complicated; many issues need to be discussed and agreed to. The parties need to be free to negotiate without commitment until they reach substantial agreement. Once they do, they often engage lawyers to prepare a written contract, which they sign.
What is the position if one of the parties changes its mind before the lawyers agree to the terms of the written contract? Can that party rely on the absence of a signed contract to walk away?
The Ontario Superior Court of Justice considered this issue in a recent decision involving the insurance industry.
The insurance broker concerned changed hands towards the end of the negotiations. The new owner decided not to proceed with the underwriting agency. It argued there was no binding contract with the underwriter because the parties never concluded the negotiations and recorded them in a signed contract.
The underwriter argued the opposite; there was substantial agreement between the parties and a binding contract had come into existence. It didn’t matter that no signed contract existed.
The insurance broker approached a chosen underwriter to enter into an exclusive agreement to develop and market a new home insurance product.
The insurance broker already had an existing relationship with that underwriter, promoting its existing product, along with other underwriters’ competitor products. The insurance broker’s proposal to develop a single relationship with one underwriter was unique to the insurance industry in Canada at the time.
The negotiations progressed smoothly.
The parties agreed that the insurance broker would rollover all of its existing clients with home insurance into the new product with that chosen underwriter. The major financial details were all agreed. The insurance broker advised its employees of the new business arrangement. It also advised the underwriters of the competitor products that their business would be placed with the chosen underwriter at renewal.
Several of those underwriters were unhappy and they exercised their right to terminate their relationship with the insurance broker early. The insurance broker was expecting this and it had made special arrangements with the chosen underwriter to underwrite these policies early before the new business arrangement was due to start. The underwriter took on additional staff to cope with this.
At this point, the insurance broker was sold to new owners. Could the new owners now walk away from the business arrangement with the underwriter?
This turned on a single point of law: was there a contract between them?
The Superior Court reviewed the law about legally binding contracts.
For a legally binding contract to exist, the parties must have agreed on all the essential terms of the proposed contract. An agreement is not final and binding:
• If it is merely an agreement to agree later on essential terms,
• If what has been agreed to is sufficiently uncertain, or
• Where the parties intend that there is no binding agreement until a subsequent formal contract is signed.
The determination of whether the parties intended to contract and whether the essential terms of the contract can be determined with a reasonable degree of certainty is arrived at from the perspective of an objective, reasonable bystander in the light of all the material facts. The subjective intentions and beliefs of the parties are irrelevant.
The nature of the transaction and the context in which the agreement is made establish the essential terms. The parties’ interests also establish them.
In this case, the court established the following essential terms:
• Exclusivity of the agency,
• Development of a tailored home policy for exclusive use,
• The term of the agency,
• How the agency could be terminated by either party,
• The compensation payable between the parties,
• The underwriter agreeing to insure the clients insured with competitor underwriters who cancel their agency with the insurance broker prematurely.
The court then turned to the evidence before it and it found that the parties had agreed to all six of these essential terms.
Therefore, a contract was created between the parties. This meant the insurance broker was not free to walk away from the new relationship without giving the required notice of termination required under it. If it did walk away, it would be in breach of contract, allowing the underwriter to recover its losses from it by way of damages.
A New Zealand court is likely to take a similar approach to the Superior Court.
This case provides a good example of the practical application of the law to a business relationship that goes wrong before the parties sign a formal written contract.
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