Shipbuilding: Is the Contract binding?

The parties to a potential shipbuilding project may often conduct pre-contract negotiation by in-person meeting or electronic means (telephone, telex, or email). In the latter case, there have been disputes on whether the terms of such negotiation were subject to the signing of a memorandum of agreement with terms to be mutually agreed, or whether the contemplated memorandum of agreement was simply to record the terms of a binding contract reached between the parties.

In Okura & Co Ltd v Navara Shipping Corp SA [1] the parties entered into a contract for the construction and sale of a ship. The buyer canceled the contract because of delays. Subsequently, the parties negotiated a new contract by telephone calls and telex. A memorandum of agreement (MOA) reflecting the terms in the telex was drafted but it included a term that was inconsistent with the telex. This was rejected by the shipbuilder and the MOA was never signed. During the trial, the buyer argued that there was a binding contract that was wrongfully repudiated by the shipbuilder, while the shipbuilder contended that there was no binding contract. The judge at first instance, Neill J decided that there was a binding agreement between the parties as all essential terms had been agreed and the signing of a written memorandum of agreement was not a condition precedent to the formation of a binding contract. However, as the shipbuilder subsequently repudiated that agreement, this ended the contract. On appeal, the Court of Appeal found that there was no concluded agreement. According to Lord Denning MR: “Everything was provisional only. The parties were not to be bound unless and until they signed an agreement ... Item 11 of the telex clearly contemplated that there should be a memorandum of agreement in mutually acceptable terms ... The telex itself was not binding. It was a preliminary to a future document which was to be binding when signed. The future document was drafted, but it was never signed. It was never agreed by the parties”.

However, it is important to note that each case will be decided based on its own particular facts. In Damon Compania Naviera SA v Hapag-Lloyd International SA [2], it was held that the parties’ agreement was binding as all the terms of the sale were agreed, and the execution of the memorandum of agreement was not pre-requisite to a binding contract. The sale of three ships from sellers to two brothers was negotiated through their respective brokers. By 8 July 1977, the main terms of the agreement, incorporating the Norwegian Saleform Agreement (NSA) with a sale price, were finalized through the exchange of telexes. Under the NSA, the buyers had to pay a deposit of 10% of the purchase money upon signing the contract. The sellers had the right to cancel the contract if the purchase money was not paid in accordance with the agreement, and the deposit was forfeited to them plus compensation for any loss and for all expenses together with a 5% annual interest.

As the brothers had intended to buy the ships in the name of a company specially incorporated for this purpose, they informed the sellers of the name of a Panamanian company on 1 August. Accordingly, the memorandum of agreement was amended. The brothers were appointed directors, chairman, and treasurer of the company, which gave them authority under Panamanian law to negotiate and conclude contracts on the company's behalf. The existence of the contract was acknowledged in telexes of 3 and 5 August sent on behalf of the brothers. Despite the seller’s request, no memorandum of agreement was signed, nor was the deposit paid by 12 August. On 15 August, buyers were notified that the sellers had withdrawn from the contract and reserved all their rights for compensation. 

The arbitrator found that a concluded contract was made between the parties. The court of appeal dismissed buyers’ appeal on the grounds that: (a) the provision for the payment of the deposit was not a condition precedent to the formation of a contract but was a fundamental term of the contract concluded on 8 July 1977; (b) the contract had been concluded with the intention of substituting the buyers by a novation, and as a result of the nomination of the buyers on 1 August and the subsequent ratification of the contract on 3 and 5 August it was binding on the buyers.

Whether a contract is binding on the parties will depend on the circumstances of each particular case. In the case of RTS Flexible Systems Ltd v Molkerei Alois Muller GmbH & Co KG, [3] Lord Clarke was of the view that whether a contract is binding on the parties will not depend on the subjective intent of the parties, but on their words or conduct, and whether it can be concluded objectively that they intended to enter into legal relations, and have agreed to all the terms they regarded or the law requires for forming a relationship that was legally binding.

In Pagnan SPA v Feed Products Ltd [4], Lloyd LJ summarised the principles (which were cited with approval by the UKSC in RTS Flexible Systems Ltd v Molkerei Alois Muller GmbH & Co. KG, as follows:

“(1) In order to determine whether a contract has been concluded in the course of correspondence, one must first look to the correspondence as a whole...

(2) Even if the parties have reached agreement on all the terms of the proposed contract, nevertheless they may intend that the contract shall not become binding until some further condition has been fulfilled. That is the ordinary ‘subject to contract’ case.  

(3) Alternatively, they may intend that the contract shall not become binding until some further term or terms have been agreed...  

(4) Conversely, the parties may intend to be bound forthwith even though there are further terms still to be agreed or some further formality to be fulfilled...   

(5) If the parties fail to reach agreement on such further terms, the existing contract is not invalidated unless the failure to reach agreement on such further terms renders the contract as a whole unworkable or void for uncertainty  

(6) It is sometimes said that the parties must agree on the essential terms and it is only matters of detail which can be left over. This may be misleading, since the word ‘essential’ in that context is ambiguous. If by ‘essential’ one means a term without which the contract cannot be enforced then the statement is true: the law cannot enforce an incomplete contract. If by ‘essential’ one means a term which the parties have agreed to be essential for the formation of a binding contract, then the statement is tautologous. If by ‘essential’ one means only a term which the Court regards as important as opposed to a term which the Court regards as less important or a matter of detail, the statement is untrue. It is for the parties to decide whether they wish to be bound and, if so, by what terms, whether important or unimportant. It is the parties who are, in the memorable phrase, coined by the Judge [at page 611] ‘the masters of their contractual fate’. Of course the more important the term is the less likely it is that the parties will have left it for future decision. But there is no legal obstacle which stands in the way of the parties agreeing to be bound now while deferring important matters to be agreed later. It happens every day when parties enter into so-called ‘heads of agreement'.”

  1. [l982] 2 Lloyd's Rep 537. (CA).

2. [1985] 1 Lloyd’s Reports 93 (CA).

3. [2010] UKSC 14, Per Lord Clarke at 45.

4. [1987] 2 Lloyd’s Rep 601.