Danger: unexploded MOU

This blog has previously commented on the dangers of signing those short, preliminary documents that have a variety of names: Memoranda of Understanding (MOUs), term sheets, heads of terms, heads of agreement and letters of intent.  Usually the danger is that people sign them without realising that they may be legally binding (particularly in some international transactions); sometimes, as this post discusses, the danger is that people decide they want them to be legally binding and yet the terms are inadequate to cover the transactions in which they are being used.  IP Draughts’ practical suggestions for dealing with these issues, including suggested wording for a term sheet, are discussed in the articles linked above.

IP Draughts was reminded of these articles by a recent article on the China Law Blog, about the dangers of signing MOUs with Chinese parties.  It seems that the Chinese party will often consider that the MOU is the final agreement, whereas the overseas (eg US) party thinks it is merely a prelude to negotiating a more detailed agreement.  The China Law Blog article comments that this difference in perspective can be viewed as a difference between the civil law approach  and the common law approach.

A central feature of civil law systems is the codification of different areas of law in a document known as a civil code.  The civil code originated in Napoleonic France, and was later re-booted in Germany in the late nineteenth century.  Most countries in continental Europe have a civil code that is based on either the French model (eg Spain) or the German model (eg the Netherlands).  Several countries in Asia have a civil code, which IP Draughts understands to be usually based on the German model.  These countries include China and Japan.  This is not to say that the laws in these various countries are the same or even close to the same, but they do have certain core principles in common, which in some areas are different to the core principles of common law systems, including those of England, most US states, and many Commonwealth countries.

One of the civil law principles has a Latin name, culpa in contrahendo.  Depending on how this principle is interpreted in an individual jurisdiction, it may lead to some or all of the following conclusions:

1. A party should not pull out of negotiations once he has declared an intention to enter into an agreement with another party.  Signing an MOU could be treated as evidence of such a declared intention.
2. A party should not negotiate with other parties once he has declared an intention to enter into an agreement with one party.

If the parties sign an MOU but fail to sign a subsequent agreement, under the civil law system the terms of the MOU may be enforced as a binding agreement and the court may be prepared to “fill in the gaps” as to the parties’ rights and obligations in areas not covered by the MOU.

In IP Draughts’ view, this last point does not mean that contracts are unnecessary and that all a party needs is an MOU.  Rather, it is a last resort if the parties have failed to enter into a more detailed agreement.  The China Law Blog article mentioned above may give the impression that Chinese practice in this area (ie of relying solely on an MOU to govern contractual relations) is entirely based on its civil code system of law; if so, IP Draughts doubts whether this is completely correct.  Perhaps it would be more appropriate to say that some Chinese parties prefer to avoid very lengthy US-style contracts and know that a detailed MOU could be enforced in the Chinese courts.  Thus, Chinese practice reflects cultural preferences, combined with the legal safety-net of a civil law approach to interpreting MOUs.

In IP Draughts’ experience, the parties in international negotiations often have different expectations as to how their agreement will be negotiated, executed and administered once signed.  These differences sometimes only emerge at a late stage of negotiations, or even after their agreement is signed.  The answer, in IP Draughts’ view, is to have a discussion about process at the outset and as discussions continue.

Sometimes, commercial parties are reluctant to discuss what may appear to be side issues, preferring to focus on building up a good interpersonal relationship and on finding agreement on core commercial terms.  This preference is understandable but short-sighted, in IP Draughts’ view.  By taking nothing for granted, by talking around the core commercial issues, and by taking the time to get to know the other party and how they operate, parties can build up a much better mutual understanding.  Or at least reduce the risk of being caught out by unexpected moves.  The parties’ lawyers may be well placed to have this kind of discussion if the commercial representatives are reluctant to do so.

Crowd-sourcing legal advice can work. Thank you.

Regular readers may recall the problem that Mrs Smith had, earlier this year, when she terminated a telephone line supply agreement with TryOnLine (not their real names) on its first anniversary.  She believed she was entitled to do so.  TryOnLine claimed that she had agreed to a 5 year contract, and sought to recover from her the revenue that they would have generated over the remaining 4 years.

To recap on the basic facts:

• Mrs Smith is a lady in her seventies, who was cold-called at home by TryOnLine and persuaded to switch her telephone account.
• She did not sign any written contract.  She paid £99 by direct debit as an upfront, annual charge and believed that she was effectively committed for a one-year period.
• At the end of the year, she decided that she didn’t like the approach of TryOnLine (eg their actions in making deductions from her account without telling her, causing her to go into the red at her bank), and switched back to the market leader, British Telecom (BT).
• TryOnLine then called her to try to persuade her to return to them, and at this stage mentioned a 5-year term for the contract, with penalties of several thousand pounds if she cancelled the contract.  The amount claimed changed over time, adding to the suspicion that they were making it up as they went along.  The phone call was followed up with a letter claiming £3,623.92, and later by an invoice for £2,469.85.  The basis for these various figures was never explained.
• Terms and conditions were printed on the back of TryOnLine’s stationery, including a 5-year term and a provision stating that the remainder of the anticipated, 5-year revenue would be payable if the contract were terminated early.  Mrs Smith was not aware of presence of these terms on TryOnLine’s stationery until her lawyer pointed them out.  They are printed in grey ink in about 6-point type, Mrs Smith has poor eyesight, and she had no cause to look on the reverse of the only document that was sent to her when the contract was set up, namely a statement confirming that £99 was being deducted from her account under a direct debit arrangement.
• No reference to the terms and conditions was made in the initial sales call (as far as Mrs Smith recalls) or subsequently until the contract was terminated.  No cooling-off period was mentioned, as required by EU consumer law.

Readers of this blog were generous with their suggestions on how to deal with this problem.  Chris Shelley pointed out some case law that discussed when excessively long durations in consumer contracts might be considered unenforceable under consumer protection legislation.  Francis Davey pointed IP Draughts to the terms of Government licences for telecommunications service providers, which required the initial period of customer contracts to be limited to 12 months.  IP Draughts’ colleague Victor Warner gave some very practical advice that pressurising old ladies in this way could result in criminal or civil sanctions for harrassment under the Protection from Harrassment Act 1997.  With luck, IP Draughts might have eventually stumbled across the case that Chris mentioned.  It is doubtful whether he would have spent enough time to find the other areas of law that our readers mentioned.

Mrs Smith’s solicitor threw all of these items and more into a real stinker of a letter to TryOnLine, hoping to get them to back off and cancel their invoice.  Instead, Mrs Smith received another invoice from TryOnLine for £0.00 plus a £3.00 surcharge for sending a paper invoice.  We will give them the benefit of some very considerable doubts, and assume that this was an invoice “in the system”, reflecting their general incompetence and disorganisation, and not a coded response to the solicitor’s letter.

TryOnLine’s formal reply to the solicitor’s letter raised an interesting line of argument.  They commented that most of the solicitor’s letter was based on the premise that the contract with Mrs Smith was a consumer transaction.  They pointed out that they marketed themselves as suppliers of telephone lines to small businesses, and not to consumers.  (When Mrs Smith’s solicitor looked at their stationery again, he noticed a strap line about this that he had glossed over before.)  They alleged that Mrs Smith had confirmed that she was in business at the time the contract was made.  They asked the solicitor to confirm whether Mrs Smith was in business.  They hinted, without quite saying it, that if it transpired that Mrs Smith was not in business, they would have a cause of action against her for misrepresentation.  They also appeared to be hinting that they were expecting an offer of settlement.

Responding to this letter required some thought.  On the one hand, TryOnLine had cold-called Mrs Smith at home, in relation to her domestic telephone line, which was the sole land line going into her home, which she shares with her daughter.  They persuaded her to cancel her (non-business) telephone contract with BT.  When she terminated her contract with TryOnLine, she reverted to a non-business contract with BT.

However…

Mrs Smith is a semi-retired, or almost completely retired, dancing teacher.  Her teaching is now limited to 2 hours on a Saturday morning in a community centre in a nearby village.  The telephone line is used in connection with this “business”.  On a small point of detail, Mrs Smith does not claim any part of the cost of the telephone line as a business expense.  She does not recall having a conversation with TryOnLine about her business activities.

Looking at some of the European case law on the question of when someone is acting as a consumer, it seems that small-scale activities of this kind might be disregarded by the courts.  There is also some old English case law under the Unfair Contract Terms Act 1977 which points in a similar direction.

Mrs Smith’s solicitor carefully explains all this in a further letter to TryOnLine, and points out that Mrs Smith has no intention of paying them any money.  He suggests that the facts have now been exhaustively explored, and that no purpose would be served by further correspondence.  He indicates that there would seem to be two alternatives.  Either TryOnLine confirm that, now they understand the full picture, they withdraw their invoice, or litigation must now be commenced.

TryOnLine reply with a face-saving formula, stating that, as Mrs Smith has retired from business, they are closing the account.  The clear inference of this letter is that they won’t be chasing for payment of the invoice.  At some point, when he has time, Mrs Smith’s solicitor will confirm this in writing.

So, thank you everybody who came up with suggestions.  A small book could be written about the law in this area and how it can be applied when dealing with suppliers who engage in sharp practice.  IP Draughts is not volunteering to write the book any time soon.