30 Sep 2005

Did you know there's a difference between an "agreement" and a "contract"?

by Audine Bartlett

This is a very basic "contract law basics", but it doesn't hurt to be reminded. This month's edition follows on from our previous Did You Know where we looked at the issue of your potential liability under "non-binding"documents, particularly in the context of a memorandum of understanding or letter of intent.

The question as to whether or not the document is binding revolves around whether there is an intention to be legally bound. A "contract" is legally binding and an "agreement" is not. To create a contract there must be a common intention of the parties to enter into legal relations, mutually communicated either expressly or impliedly (Rose and Frank Co v JR Crompton & Bros Ltd [1923] 2 KB 261). In most instances there will be no doubt that a legal relationship was intended, or equally clear that it was not, but there are many cases where the matter remains in doubt.

The intention to create legal relations can be implied from the circumstances. Relevant to assessing intention is the circumstances in which the agreement was reached. There are certain presumptions that arise depending on the circumstances surrounding the formation.

The social or domestic context

If you enter into an agreement in the context of a social or domestic situation, there is a presumption that you did not intend the agreement to have any legal consequences. On the other hand, if you enter into the agreement in a business/commercial setting than there is a presumption that the necessary legal intent was present. Ultimately, a court would ask: "would a reasonable person regard the agreement as binding?"

To work out whether the presumption applies in the domestic or social context, the nature of the relationship of the parties who enter into the agreement is relevant. For example, the relationship of husband and wife, or a de facto relationship is a strong indicator of lack of intention. The presumption may also extend to agreements entered into between parent and child or between friends.

However, the presumption can quite easily be rebutted if, for example, the words used indicate an intention to contract. In Merritt v Merritt [1970] 1 WLR 1211, a married couple separated, but before they divorced they mutually agreed that if the wife paid off the mortgage, the husband would then transfer his interest in the home to her. He signed a document to this effect but later refused to transfer his interest after she had paid out the mortgage. The court held the requisite legal intention was established, and the presumption rebutted.

In Wakeling v Ripley (1951) 51 SR (NSW) 183, a wealthy old man invited his sister and her husband (both lived in the UK) to move to Australia to care for him on the basis that he would provide them with an income, and also his property upon his death. The couple agreed, the husband giving up a stable job in the UK in order to relocate. A dispute arose, and the couple sued for breach of contact. They succeeded on the basis that the agreement was 'more than a mere family or social agreement'.

Some factors relevant to determining whether the presumption can be rebutted are:

  • the seriousness of the conduct involved (eg. relocating interstate/overseas, transfer of a property interest);
  • whether the subject matter of the agreement is business/commercial;
  • whether there is a degree of hostility in the relationship;
  • the degree of closeness of the family ties; and
  • the expense involved.

The business/commercial context

If you enter into negotiations and reach agreement in such a setting, it is automatically presumed you intended to create a legally binding contract. The presumption is difficult to rebut. However, as we have discussed in previous Did You Know articles, examples of where the presumption may be rebutted are letters of comfort, "subject to the preparation of a formal contract" clauses, and letters of intent.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.