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12 July 2016
In Globe Motors Inc v TRW Lucas Variety Electric Steering Ltd(1) the Court of Appeal was asked to consider the correct contractual interpretation of a long-term supply agreement. In its judgment, the Court of Appeal indicated obiter that including an 'in writing only' variation clause in a contract does not prevent subsequent variation of the contract orally or by conduct in certain circumstances.
Appellant TRW LucasVarity Electric Steering Ltd had agreed to purchase all of its requirements for certain electric motors for cars from first respondent Globe Motors Inc. Second respondent Globe Motors Portugal was a subsidiary of Globe incorporated for the purposes of the actual supply of electric motors to TRW under the agreement.
The exclusive supply agreement between the parties was long term. The products that it concerned were specified in the agreement and additional products could be added by mutual agreement. The agreement contained a clause which permitted 'engineering changes' to the products, so as to permit the parties to keep up to date with the latest changes and developments in technology in the industry. TRW would propose such engineering changes and Globe was obliged to accept them.
At first instance the court found that TRW had breached the agreement by purchasing improved second-generation motors from another manufacturer (DEAS Emerson). The court agreed with Globe that these were motors that Globe could and would have produced for TRW by making the engineering changes (as defined) contemplated by the agreement. As such, they fell to be classified as 'products' as defined in the agreement and under its terms TRW had been bound to purchase them exclusively from Globe. The subject of TRW's appeal was the judge's interpretation of the term 'products'.
Further, the contract contained a clause (Article 6.3) that required any variation to the agreement to be made in writing. At first instance the court found that, notwithstanding this clause, it was in fact possible to vary the terms of the agreement orally. The court decided that Article 6.3 had been varied or waived by the parties' conduct. Specifically, the court stated that in the parties' dealings under the agreement over a long period, they had operated as if Globe Motors Portugal was a party to the agreement. TRW appealed this decision, asserting that the court was bound by the earlier Court of Appeal decision in United Bank v Asif, which had upheld an 'in writing only' variation clause.
TRW submitted that the process for determining whether a motor was one of the products covered by the agreement required a positive answer to one of the following questions:
TRW stated that unless the answer to one of these questions was affirmative, it was free to obtain the motor from whomever it wished. In the event, the answer to each of the above questions was negative.
Globe submitted that the definition of 'products' had to include motors that would meet the second-generation motor requirements, if those requirements could be produced by engineering changes to the first-generation motors. Globe argued that this was the case regardless of whether the parties actually went through the engineering changes process specified under the agreement. Otherwise, TRW could walk away from the agreement at any point simply by changing the specifications of the motor required.
The first-instance court agreed with Globe that a motor that had not actually undergone the engineering changes process fell within the definition of 'products' if it hypothetically could have done. TRW argued that this erroneously extended the definition of 'products' and was wholly contrived.
Court of Appeal
The Court of Appeal emphasised the long-term nature of the agreement. It found it understandable that the first-instance court wished to interpret the contract in a way that reflected what it considered to be the 'commercial matrix' underlying it. However, particularly because of the agreement's long-term nature, the Court of Appeal considered it necessary to construe it in such a way as to enable flexibility to meet changing circumstances. It made reference to Total Gas Marketing Ltd v Arco British on this point, which suggested that a flexible approach to interpretation may best reflect the reasonable expectations of the parties. It is for the parties to a long-term contract to ensure that they insert clauses which deal with the particular problems encountered by those that enter into such contracts.
The agreement specified that TRW had either to agree the addition of a new product or, at its volition, propose engineering changes to existing products in order to enable a motor or assembly not within the detailed specifications to qualify as 'products' under the agreement.
The Court of Appeal pointed to the "asymmetry" of the agreement's Article 4.1, which provided that TRW reserved the right to propose an engineering change and Globe had to agree. In contrast, if Globe proposed an engineering change it had to obtain the written approval of TRW. As such, the court considered that the agreement should not be interpreted as compelling TRW to go through the engineering changes process so as to give Globe the opportunity to create second-generation motor engines. This would be the same as empowering Globe to require engineering changes to bring the resulting motor or assembly within the definition of the 'products' in the agreement. To do so would be inconsistent with the tenor of Article 4, which made clear the intended asymmetrical nature of the relationship between Globe and TRW in this respect.
As the agreement was for exclusive, long-term supply, the Court of Appeal stated that it could be argued that there was an implied obligation on TRW to give Globe an opportunity to show that it could provide an improved second-generation motor. However, the court cautioned that parties to such contracts should not seek to achieve by implication that which might be achieved by an inappropriate approach to interpretation. It followed that, since 'products' did not include the improved second-generation motors, TRW had not breached the agreement by buying such motors from a third party.
The Court of Appeal's interpretation of 'products' rendered obsolete the question of the effectiveness of variation clauses. Nevertheless, it made obiter comments on this subject. Reference was made to two key recent cases:
TRW argued that reasons of principle and policy favour recognising 'in writing only' variation clauses and preventing contractual variations that do not comply with them. TRW also argued that such clauses provide certainty and avoid false or frivolous claims that oral agreements have been reached. The Court of Appeal rejected these arguments, asserting that such a clause "does not prevent [the parties] from later making a new contract varying the contract by an oral agreement or by conduct". In the present case it was held to be open to the court to find variation based on evidence of "open, obvious and consistent dealings over a long period" which evidenced the parties' intention to include Globe Motors Portugal as a party to the agreement. The court emphasised that this is a matter of discretion in each case and that a variation should be found only where the evidence (on the balance of probabilities) establishes that such variation was indeed concluded.
This case clearly underlines the need to take extra care to have an eye to the future when drafting long-term contracts. Had the definition of 'products' been broader, the decision of the first-instance court might have been upheld. Further, the judgment demonstrates the ways in which a court may find the long-term nature of a contract relevant to interpretation in circumstances where the issues in dispute were not adequately covered by express drafting.
The court's obiter comments on variation clauses give some clarification in this area of the law in light of the most recent conflicting Court of Appeal decisions. The case notes the practical advantage of attempting to limit the manner in which parties can vary contracts, but nevertheless concludes that this is insufficient to completely override the principle of party autonomy. Nonetheless, there remains practical value in such 'in writing only' variation clauses; at the very least, they encourage the parties to ensure that any agreed variation is recorded in writing, thus helping to avoid future disputes about what was or was not agreed, and they set the bar higher for those arguing in favour of a variation that does not fall within the scope of the clause.
For further information on this topic please contact Simon Hart or Sarah Shaul at RPC by telephone (+44 20 3060 6000) or email (email@example.com or firstname.lastname@example.org). The RPC website can be accessed at www.rpc.co.uk.
(1)  EWCA Civ 396.
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