Beware the Subsequent Contract

A contractor is hired to renovate a bathroom, enters into a written contract, completes the work and is paid.  A month later, the client calls back and asks for some minor work in a second bathroom.  An engineer enters into a written contract to design a mechanical system but excludes field reviews from her scope of work.  Three months later, she is called back by the client and asked to carry out field reviews.  The contractor and the engineer both entered into written contracts when they were initially retained.  Those contracts may have contained important limitations – for example, a clause limiting the time within which any claims could be made, a clause limiting any claims to the value of the services provided or to the amount of insurance, or a clause excluding claims for indirect losses.   By undertaking new work, or by expanding the scope of the originally planned work, the contractor and engineer may be held to have entered into separate subsequent contracts which do not afford the parties the same protections originally agreed upon.

A contract is legally enforceable when there is an offer, acceptance of the offer, and consideration for the offer.  The parties to the contract must agree on the essential terms of the contract and must indicate an intention to be bound by the terms of the contract.  Contracts, however, need not be in writing and the courts will enforce verbal and unexecuted contracts, even in commercially complex matters.  In the first scenario described above, the contractor is asked to carry out unrelated work to the first bathroom renovation (the offer).  A new price is negotiated for the work and is accepted (the acceptance and the consideration).  In the second scenario, the owner asks the engineer to carry out field reviews (the offer), the engineer agrees to carry out the field reviews for a specified hourly rate (the acceptance and the consideration).  In both of these situations, unless the parties specifically discussed and agreed that the terms of the first agreements would apply to their new arrangement, new contracts with new terms have been created.

All work performed under the subsequent contract will only be governed by the terms of that contract.  The general rule is that specifically negotiated protections in the first contract, such as limitation of liability clauses, will not extend to any work carried out under the second verbal contract.  However, there are two limited situations in which a court could extend the terms of the first written contract into the second contract.

First, where there is a custom, or “course of dealings”, between the parties such that historically this omitted term was included in the agreements between the parties.  In other words, the court could conclude that the parties must have intended the same custom to continue into the new contract.  However, only one previous contract is likely insufficient to imply a term into a subsequent contract.  For example, in Hollier v. Rambler Motors (A.M.C.) Ltd.,[1] the plaintiff’s vehicle was damaged by fire while at the defendant’s repair shop. Over the course of five years prior, the plaintiff and defendant had established a working relationship. On three or four previous occasions, the plaintiff had always signed a form which stated “The Company is not responsible for damage caused by fire to customer’s cars on the premises”. But, when the plaintiff’s car was damaged, the plaintiff had not signed this form. Despite the fact the plaintiff and defendant had made three of four agreements over five years, the Court held that the defendant was liable because the defendant had not established a course of dealings. The Court held that in order to establish that a term has been implied into a contract by course of dealings, it is essential to show that the party charged had actual, and not merely constructive, knowledge of the term and with such actual knowledge had in fact agreed to it.

A court could also imply a term into a contract using the “business efficacy” test.  Here, the court would have to conclude that it was the actual intention of the parties to include the implied term into the second contract, because the term was needed to further the parties contractual intentions.  The courts are loath to imply new terms into contracts and the presumption is that, even in a verbal contract, the parties had expressed all of the material terms that they intended would govern the contract.   Thus, any term implied must be necessary to ensure that the contract operates as the parties actually intended it to.  A limitation of liability clause is unlikely to fall into this category of the types of terms that could be implied into a subsequent contract, simply because the parties had previously agreed upon one.

When agreeing to perform work, or to engage services under a subsequent contract, it is thus important to take the time to ensure that either the previously agreed upon terms apply to the subsequent contract – through the specific agreement of both parties, or to enter into a new contract in writing which specifically applies to the new work or expansive of work.  It is not safe to assume that the terms of the first contract will carry over into the second agreement and making that assumption will jeopardize any limitations previously agreed to, so far as any claims arise from the work carried out under the second contract.

[1] (1971), [1972] 1 All E.R. 399 (Eng. Q.B.)