Corporate Law Update

This week:

• The Supreme Court upholds a clause requiring contractual amendments to be in writing, overturning decades of case law
• A cross-border merger of a holding company into its wholly-owned subsidiary could not make use of the simplified procedure

No oral variation clauses are effective after all

In a landmark case, the Supreme Court has held that a contractual clause prohibiting oral and other unwritten variations is effective.

What happened?

In Rock Advertising Limited v MWB Business Exchange Centres Limited, the parties were in dispute over whether an alleged oral variation to a licence was valid.

MWB Business Exchange Centres (“MWB”) operated serviced offices in central London. In 2011, it granted a contractual licence to Rock Advertising (“Rock”) to occupy office space.

A licence is distinct from a lease. A lease is a specific form of contract that creates an interest in land and must meet certain formal requirements, including (in many cases) registration at the Land Registry. A licence, by contrast, is a simple permission to use facilities or space, usually in return for a fee. It does not create an interest in land and is, as a matter of law, merely a commercial contract.

The licence contained the following clause (our emphasis):

“This Licence sets out all of the terms as agreed between MWB and [Rock]. No other representations or terms shall apply or form part of this Licence. All variations to this Licence must be agreed, set out in writing and signed on behalf of both parties before they take effect.”

The underlined wording is commonly known as an “amendments in writing” clause or a “no oral modification” (“NOM”) clause. NOM clauses are very common. Under English law, a contract (including a variation to a contract) does not need to be in writing (except in specific cases). It is possible to enter into or amend a contract orally or even by conduct. The purpose of a NOM clause is to maintain certainty over the terms of a contract by displacing this flexibility and preventing negotiations, informal discussions or wayward behaviour from resulting in inadvertent variations.

By 2012, Rock was in arrears with its licence fees. Its sole director contacted MWB’s credit controller to discuss a revised payment schedule. In due course, Rock’s director and MWB’s credit controller held a telephone call, in which Rock’s director claimed that MWB’s credit controller had agreed orally to the new payment schedule on behalf of MWB. MWB’s credit controller denied this.

Ultimately, MWB refused to accept the new payment schedule, locked Rock out of the offices and sued for the arrears. Rock counterclaimed damages for being wrongfully shut out of the offices.

What did the courts say initially?

To begin with, the county court decided that MWB had agreed to an oral variation to the payment schedule. However, the variation was ineffective, it said, because the NOM clause in the licence expressly rendered invalid any variation that was not set out in writing.

Rock appealed to the Court of Appeal, which decided that the oral agreement was effective. Drawing on numerous previous cases, the court said that, when MWB and Rock agreed orally to the new payment schedule, they also agreed orally to dispense with the NOM clause.

This decision was not altogether surprising. There is a long line of case law (stretching back to 1919) suggesting that NOM clauses cannot stop parties from agreeing orally to vary their contract. Even as recently as May 2016, the Court of Appeal suggested in Globe Motors v TRW Lucas Varity that NOM clauses are simply ineffective.

What has changed?

MWB appealed to the Supreme Court, which held that the NOM clause was effective. As a result, there was no variation to the payment schedule, and MWB was entitled to recover the arrears.

In giving the majority judgment, Lord Sumption said that NOM clauses serve three important purposes:

• To prevent abuse that could occur if written agreements can be amended by “informal means”
• To avoid disputes and misunderstandings over the precise terms of an oral variation
• To allow corporations to “police internal rules” restricting authority to agree to variations

That NOM clauses commonly feature in commercial contracts was, he noted, evidence that business people find it a “mixed blessing” that a contract under English law can be formed orally or by conduct.

In his view, the English law of contract will try to give effect to the legitimate intentions of business people. The courts will only interfere with this principle for reasons of public policy (so as to prevent mischief). However, the court noted that “there is no mischief in NOM clauses”.

So where are we now?

The Court’s judgment is clear. The law now states that NOM clauses are effective. A NOM clause will preclude any variations to a contract that are not made in writing (including an attempt to remove or disapply the NOM clause itself).

Businesses should welcome the decision, which provides certainty for contracting parties. Many commercial contracts contain not only NOM clauses, but specific “change control” mechanisms for agreeing variations in the services to be performed. These mechanisms are critical for businesses to monitor and control their contractual relationships with third parties.

However, Lord Sumption also recognised that his approach is a strict one that could give rise to risks. For example, two contract parties might carry on with a contract on the mistaken belief that their oral variation is valid, but then later find they are unable to enforce that variation.

His solution to this was that, in these cases, a party that would otherwise be in breach of the contract would be able to defend itself under the principle of “estoppel”. This might be available where one party has relied on the variation and moved its position as a result. However, there are limits to the doctrine of estoppel, and it will not always be available.

Does this affect “collateral contracts”?

But this may not be the complete picture. While Lord Sumption’s comments on unwritten variations are clear, he did not explicitly address the concept of substantive collateral contracts.

Variations are normally relatively succinct. They rarely alter the fabric of the underlying contract or embody a substantial departure. Rather, they usually tinker around the edges by changing (for example) pricing, delivery schedules or locations, descriptions of services or goods to be provided.

A collateral contract, however, is different. It might stand alongside the principal contract, or supplement it in a way that is more than a mere amendment of its terms. The judgment could suggest that these kinds of contract will still be effective, notwithstanding the presence of a NOM clause.

In his judgment, Lord Sumption compared NOM clauses to “entire agreement” clauses. (Indeed, the NOM clause in this case was combined with a relatively short entire agreement clause.) In relation to entire agreement clauses, he said: “The true position is that if the collateral agreement is capable of operating as an independent agreement, and is supported by its own consideration, then most standard forms of entire agreement clause will not prevent its enforcement.” If he means this principle to apply to NOM clauses too, then presumably a NOM clause will not be able to prevent a collateral contract made orally or by conduct and not in writing.

In a separate judgment, Lord Briggs said that it was “conceptually impossible” for parties to impose upon themselves a scheme, “but not to be free, by unanimous further agreement, to vary or abandon it by any method, whether writing, spoken words or conduct, permitted by general law”.

In this case, he agreed with Lord Sumption that the NOM clause in the licence was effective, saying that “such an agreed departure will not lightly be inferred, where the parties merely … [discuss] and even [reach] a consensus … purely orally”. However, he went on to say that “where … the orally agreed variation call[s] for immediately different performance from that originally contracted for”, there could be “an agreed departure from the NOM clause.”

Courts are reluctant to permit manifest injustice, and it is possible that, faced with an appropriate set of facts, a court might latch onto these statements to permit a substantive collateral contract to stand even in the face of a NOM clause.

Practical implications

Putting this uncertainty aside, the judgment raises clear practical points for contract parties:

• For important or complex commercial contracts, always consider including a no oral modifications (NOM) clause. This could usefully be coupled with, or stand alongside, an entire agreement clause.
• Think about whether there should be an even more formal change control procedure for particular variations to the contract. This might apply to changes in the pricing structure or the nature or scope of the services to be provided.
• If including a change control procedure, try to set out prescriptively the steps to be taken. This could include using a fixed form of variation request containing specified information, obtaining approvals from identified contract managers, and following a discussion and approval procedure.
• If looking to alter a contract, including (for example) timing for deliveries or payment, always check whether it includes a NOM clause or a specific change control procedure. Before this case, a failure to spot a NOM clause might not have been fatal. Now it is clear that the court will simply assume that contract parties have “overlooked” a NOM clause or (worse) “courted invalidity with [their] eyes open”, and will enforce the NOM clause.

Cross-border merger of parent company must follow full procedure

The High Court has held that, where a holding company merges into its own wholly-owned subsidiary under the cross-border mergers (“CBM”) regime, the companies must follow the full procedure and cannot use the simplified procedure for the merger of a wholly-owned subsidiary.

The CBM regime provides for two types of merger. One of these is a merger by absorption, where one existing company merges into another existing company, then disappears.

This category breaks down into a further sub-category: merger by absorption of a wholly-owned subsidiary, where a wholly-owned (or 100%) subsidiary merges into its holding company. This follows the same process as a regular merger by absorption, but the companies can dispense with certain procedural requirements. Most significantly, there is no need to obtain an independent expert’s report.

Although it is common for a subsidiary to merge into its holding company, a CBM can operate the other way round, with a holding company merging into its own subsidiary. This is often referred to as a reverse cross-border merger but, in reality, is simply a kind of merger by absorption.

In Re GSI Group Holding Ltd, a holding company proposed to do exactly this: to merge into its 100% subsidiary. The holding company claimed that, because it was merging into its own 100% subsidiary, it could use the simplified procedure described above.

The High Court disagreed. It said that the simplified procedure applies only where a 100% subsidiary is being absorbed into the holding company, and not the other way round.

The result is not surprising. The High Court has already ruled previously (in Re GET Business Services Ltd that the simplified procedure does not apply where one 100% subsidiary is proposing to merge into another 100% subsidiary of the same holding company.

In fact, as the recent case of Re Reed Global (UK) Ltd shows, merging a holding company into its own UK subsidiary can be more complicated than a simple merger by absorption. It may be necessary to implement a capital reduction at the same time in order to prevent the subsidiary from unlawfully acquiring its own shares.

This is a reminder to businesses that are considering using the cross-border mergers regime for the purposes of group re-organisations that the court will not lightly or readily dispense with the formal requirements of the regime.