Unit 2 Contract Law

IN BRIEF...

The success of an internal domestic market depends on the validity of contracts supporting
commercial relationships. Understanding how contracts are formed and operate are key to the
success of every business. Professionals advising businesses are asked to negotiate, prepare and
advise on different types of contracts.

In the law of contracts, the Latin principle pacta sunt servanda is the starting point. This phrase
means that agreements must be kept. Parties must perform their obligations and promises when
they have binding contracts.

Under English common law, parties are generally allowed the freedom to enter any agreement
they wish. However, this freedom is not without restriction.

Valid contracts start with the essential elements, namely, the intention to enter into a contractual
agreement, offer, acceptance and consideration. The question of how to protect a party once a
valid and enforceable contract is breached is fundamental.

Professionals will need to assist their clients in deciding which remedies are best to protect the
interests of their clients.

Domestic contracts are regulated by domestic courts. However, globalization has now added new
dimensions to the domestic contract. Clients will need to know which courts have jurisdiction to
hear and resolve their disputes even if their contracts are restricted to domestic relationships.

WHAT’S IN THIS UNIT?

Essential elements of a contract►► how to create a legal relationship, an offer, acceptance,

and consideration

Structure and parts of a contract►► identify the types of clauses in contracts and their
function

Third party rights, Term and Termination►► understand third party rights, assignment,
novation and termination

Breach of Contract and Remedies►► become familiar with types of breaches and remedies
and the duty to mitigate losses

ANNEXURE►► a MEMORANDUM OF UNDERSTANDING (MOU)

Lesson 1 - Essential Elements of a Contract
Introduction
Under common law, to have an agreement there must be an offer and acceptance. Acceptance
must be in the exact terms of an offer. In other words, the offer and acceptance must be a mirror
image.

Agreements may be either in writing or oral. There are some types of contracts that must be in
writing to be enforceable (for example contracts dealing with real property).

Agreements may be unilateral or bilateral. A unilateral agreement is one where a party

promises to do or not do an act, but the other party does not make a promise in return.
A bilateral agreement means that one promise by one party is exchanged for another promise
by the other party to the agreement.

Having an agreement in writing does not mean the contract is enforceable per se. To be
enforceable the agreement needs to be formed and contain four essential elements. The elements
needed for an enforceable contract are an intention to create a legal relationship,
an offer, acceptance, and consideration.

Intention to create legal relationships

The intention to create legal relationships is judged objectively. Domestic or social agreements
are presumed not to be intended to have legal consequences. An invitation to my house for
dinner is not intended to create a legal obligation. On the other hand, a business which caters for
weddings does. Any breach by the catering company will have legal consequences.

Offer
An offer needs to be expressed as a definite promise. This makes it different from an invitation
to treat. An invitation to treat can be defined as an invitation for the other party to make you an
offer.

A party who makes an offer is called the offeror. The party to whom the offer is made is
the offeree.

If the offeree changes the original offer, this is a counter–offer. The offeree now becomes the
offeror of a new offer. The counter–offer extinguishes the original offer which cannot be
revived.

Knowing how to ask for more information on the original offer without making a counter–offer
is an essential skill all negotiators need. Generally, a request for information will not be counter–
offer.

WHAT IF…
... I go to the Chanel shop and pick up a Chanel suit which is
incorrectly priced at £500 instead of £5,000, can I insist on paying
only £500 for the suit?

Invitation to treat An invitation to treat is not an offer but rather an invitation to another party
to start negotiations. There are four types of invitations to treat, such as auctions, public tenders,
a display of goods on shelves, or in clothes stores and advertisements.

Revocation or lapse of offers For unilateral contracts, the offeror can revoke the offer any
time before the offeree starts to perform. In bilateral contracts, the offeror may revoke the offer
prior to acceptance. The decision to revoke an offer must be communicated to the offeree.
Acceptance
A party accepting an offer must communicate their acceptance to the offeror. Acceptance is an
unequivocal statement saying that a party agrees to all the terms of the latest offer on the table.

Common law has developed special rules about acceptance and when it takes place. Sometimes
it operates when a party receives notice of acceptance. Other circumstances, acceptance may
occur when a party posts the acceptance. This is known as the postal acceptance rule.

The parties may stipulate other methods for acceptance, which override the postal acceptance
rule. For example, using telex, electronic messaging and telephone may mean that acceptance
takes place on receipt.

Even if the parties agree to the terms of their contract, the contract may be unenforceable if the
terms are too uncertain. We say the contract is void for uncertainty.

Consideration

Consideration is usually expressed in monetary terms, such as price but it can also be an
exchange of services and/or goods. It involves a bargain. We do not need consideration if we are
making a gift, a gratuitous promise, or a donation. We could also use a deed to dispose of the
gift or make the promise or give the donation.

Consideration is a difficult concept for civil lawyers. It can be defined as an act or a promise
given in exchange for the other promise in the agreement.

DID YOU KNOW?

Under English common law, price is not an essential element in a
contract. Where the parties fail to insert a price in their contract, the
Courts will imply a reasonable price or a reasonable value for the
performance. This is called quantum meruit.

Other important matters

Capacity For a contract to be enforceable, both parties must have capacity to enter into the
contract. Categories of people who cannot enter into a contract include minors, people suffering
from mental incapacity and people under the influence (drugs or alcohol) at the time of
execution.

Illegal contracts and against public policy Under English law, there is a principle
of freedom to contract. This means that parties are free to stipulate contracts on terms without
restrictions agreed between them. However, the Courts do recognise some types of contracts
which will be unenforceable because they involve doing something against the law or public
policy. For example, any contract which involves the commission of a crime, tort or fraud,
bribing public servants, contravening laws, defrauding the tax office, imposing restraints of trade
or cartel behaviour and interfering with the administration of justice, will be unenforceable.

Setting a contract aside

Mistake An agreement may also be set aside by the Court or declared void if one of the parties
entered into the agreement by mistake. A contract may be void ab initio, meaning that the
contract was never entered into. Alternatively, mistakes about attributes or quality of the goods
or services may make the agreement voidable. Where a document has been signed by mistake
and is fundamentally different in nature from what the parties believed they were signing they
may ask the Court for a rectification order. This is called a non est factum plea.
Misrepresentation If a party is induced to enter into a contract by a false statement of fact,
they may have a remedy for actionable misrepresentation. The party who is induced by false
misrepresentation is the misrepresentee. A misrepresentation makes the contract voidable. The
misrepresentee may set aside or rescind the contract and claim damages. Where the
misrepresentee delays, waives or approves the conduct of the misrepresentor, they may lose the
right to seek damages. Misrepresentation may be fraudulent, negligent or innocent. Different
types of misrepresentation may lead to different types of remedies being available to the
innocent party.

Undue Influence A party entering into a contract because of undue influence may have the
contract set aside. Undue influence results from a relationship between parties where one party is
in a position to put pressure or influence the other. A common type of relationship where there
may be undue influence may be between husband and wife. Undue influence is an equitable
doctrine with links to duress.

Duress Duress is a common law concept. Courts will not enforce promises extracted under
pressure, threat or coercion. Coercion means that the promise was not given freely. Duress can
be personal such as threats to a person, threats to property, or economic threats where financial
interests are at risk. Promises given under duress are voidable and have no legal efficacy.

Additional terms Additional terms may be implied into contracts. In the UK, contracts for
the sale of goods are governed by the Sale of Goods Act. In the US, contracts for the sale of
goods are governed by the Uniform Commercial Code (UCC).

CAN YOU REMEMBER?

What are the four essential elements for a valid contract?

What is an invitation to treat?

Lesson 2 - The structure and parts of a contract
Introduction
A written or oral contract will contain terms and conditions. Terms and conditions are promises
which both parties agree to be bound by. Terms and conditions may be expressed or
implied. Expressed terms means that the parties reduce the terms and conditions to writing or
expressly state them. Parliamentary statutes and the Courts can also introduce implied terms and
conditions to agreements to give them validity.

Parts of a contract

Preliminary
This section contains clauses containing the title or heading of the contract, names of the parties,
commencement date, the recitals, definitions and interpretation of the contract.

Operative
This section is the main body of the contract. It contains the operative clauses or provisions, such
as conditions precedent if any, agreements, representations, warranties, indemnity clauses,
exemption of liability and limitation of liability clauses.

Boilerplate and end parts

The final section of the contract includes a set of standard clauses known as boilerplate clauses,
execution clauses, signatures and any schedules or annexures mentioned in the body of the
contract.

Preliminary section
Recitals can be found at the beginning or at the end of the contract. Recitals are used to put the
contract into context and explain why the parties entered into or stipulated the contract. Recitals
also known as the preamble or the ‘whereas’ clauses. Recitals need to be drafted with care and
diligence to avoid ambiguity and contradiction with the operative clauses.

Definition clauses are used to give terms used in the contract an agreed meaning as adopted by
the parties to the contract. All definitions should be clear and unambiguous. Once defined, that
term will appear with a capital letter in the body of the contract. This signals to the reader that
the word now carries a designated meaning in accordance with the definition in this section of
the contract.

Interpretation clauses provide guidance on the interpretation and construction of the contract.
Examples are headings used throughout the contract that are mere aids and do not form part of
the contract and “words denoting the singular include the plural meaning and viceversa”.

Operative section
Conditions precedent are conditions that need to be satisfied before the agreement comes into
effect and can include the payment of a deposit, obtaining an import licence or arranging for a
letter of credit.

Agreement defines the rights and obligations of each party to the agreement. In an agreement to
sell, this is as simple as saying: “The seller agrees to sell and the buyer agrees to buy the
product or service offered for sale”.

Representations are statements covering facts and legal matters which one party asks the other
party to make. These are legally binding and therefore legal consequences will follow if the
representations are later found to be untrue or inaccurate. For example, the representation that
using a certain face cream will eliminate wrinkles.

Warranties are promises made by the parties that certain statements or facts contained in the
agreement are true. The importance of a warranty depends on the type of agreement executed by
the parties. For example, a warranty about turnover and the profitability of a business contained
in an agreement to sell that business would be of great importance to the buyer. Generally, where
warranties are breached, the innocent party is entitled to remedies such as damages, replacement
or repair in the case of goods and services. A breach of warranty does not normally allow the
innocent party to terminate the contract.

Indemnities are not warranties. Indemnities are used to indemnify (compensate) a party if they
incur a loss when a particular situation or event arises. Common types of indemnity clauses often
deal with the infringement of intellectual property rights.

Exclusion or Exemption of Liability Clauses Exclusion of liability clauses, also known as

exemption of liability clauses, are common in commercial agreements.
An exclusion or exemption clause aims to exclude liability and/or remedies that otherwise
would be available to the non-breaching party. For example, a manufacturer excluding liability
for injury in the case of incorrect use of their product.

Limitation of liability clauses As an alternative to excluding liability, the parties may agree to
limit the liability in the event of a breach. These clauses will also be scrutinized by the Courts to
ensure that they are not contrary to any minimum liability standards set out in any legislation.
Usually, a clause limiting liability to the value of the goods or service is acceptable.

Boilerplate and end parts

Prevail clauses operate when a dispute between the parties breaks out and specifies which
party’s terms are to prevail (within the operative terms).

Entire or whole agreement clauses are aimed at keeping the agreement between the parties
within the four corners of the contractual document.

No authority clauses control any amendments made to the original agreement by restricting
those authorized to make amendments. Authorized persons (e.g. directors) may be nominated to
make amendments by using the specified methods mentioned in the contract. This normally
requires all amendments to be in writing.

Non-Waiver clauses are used to prevent a waiver. When a party breaches a clause in the
contract, the innocent party may decide to waive its rights, either to seek damages or termination
of the agreement, in that one case. To avoid the breaching party from using this as an excuse in
subsequent cases, the parties insert a non-waiver clause that allows the non-breaching party to
take action if a subsequent breach occurs.

Insolvency clauses are activated when a party becomes insolvent or bankrupt and are often
linked to a retention of title clause. Insolvency is also one of the grounds for terminating a
contract.

Choice of Law and jurisdiction clauses specify which law will be applied to the contract if
there is a dispute and which Court is vested with jurisdiction. In contracts involving an English
party, the law of England and Wales will apply and the jurisdiction of the English Courts will be
the appropriate forum for the dispute.
Service of Notice specifies where notice is to be served, what method is to be used and the time
frame for serving notices. Traditional methods of delivering and posting notices have now
become obsolete and have been replaced with facsimile transmissions and emails.

Impossibility, Force Majeure, Frustration, Acts of God Parties may find it impossible to
perform their contractual obligations because the subject matter no longer exists or
circumstances beyond their control make performance impossible. When there is a force
majeure, the parties are mutually released from their obligations and are not required to perform
the contract.

CAN YOU REMEMBER?

What are the three main sections of a contract?

What does force majeure mean?

WHAT IF…

... We have a new outbreak of COVID-19 in the world and the

World Health Organization declares a second pandemic. Could this
be a force majeure ? Why or why not?
Lesson 3 - Third Party Rights, Privity of Contract, Assignment, Novation,
Term and Termination
Third Party Rights and Privity of Contract
Under common law, a person who is not a party to the contract cannot generally enforce or rely
on its protection. This party is called a third party and this is the common law doctrine
of privity of contract. For example, if a manufacturer of a ginger beer soft drink sells a bottle to
a customer, the contract is between the manufacturer and the customer. Now imagine that the
customer offered that ginger beer drink to her friend and her friend suffers nervous shock
because she finds a snail in the bottle. Can her friend bring legal action against the manufacturer
for her nervous shock? The answer is no. This is because the friend did not have a contract with
the manufacturer. In other words, privity prevents her from enforcing the contract because she is
not a party to it and did not provide consideration.

One way to overcome privity is the use of an agency agreement, also called an agency
arrangement. An agent is instructed by a principal. If the agent follows the instructions of the
principal completely, then the agent will be covered and protected by the principal’s contract.
This means that the agent will have all the benefits including any limitation of liability clauses in
the principal’s contract.

WHAT IF…

... an agent does not follow the instructions of the principal. Would
they still be covered by the principal’s contract?

For example, imagine that an Italian museum agrees to lend one of its Caravaggio paintings to a
famous British museum for an important exhibition. Under the agreement, the British museum
must organise and pay for the delivery of the painting from Rome to London. There is a clause in
the contract that says that if the painting is damaged, the British museum will pay a maximum of
€100 in damages. This contract is signed by both museums. The British museum asks a delivery
company in Rome to take the painting to London. On its return flight from Heathrow, the
painting is accidentally dropped, and a 747 airplane runs over it. The painting is damaged, and
the Italian museum asks for €100 million in damages. The British museum claims it has a
limitation of liability clause which specifies that a maximum of €100 will be paid. The delivery
company says, it too has a maximum liability of €100 because it was the agent of the British
museum. The agency arrangement between the British museum and the delivery company means
that the delivery company, even though a third party, can benefit from the limitation of liability
clause of €100. This is how the concept of privity of contract can be overcome by using agency
agreements.

Assignment
An assignment is a transfer of some right or obligation to a new party. The party who assigns is
called the assignor and the party receiving the assignment is the assignee. To have an effective
assignment, three requirements need to be satisfied:

1. the assignment must be absolute

2. the assignment must be in writing
 3. the assignor must give written notice of the assignment to the other original party against
whom an assigned right may be enforceable.
An absolute assignment means that the right is assigned unconditionally to the assignee. The
law imposes some limitations on the types of rights that may be assigned. Some contracts may
even contain specific clauses which prohibit the assignment of rights outright. In other cases, the
assignor may need the consent of the other party to make a valid assignment.

An example of a typical non-assignment clause is :

“The parties cannot assign any right or obligation under this Contract to any other third party
without the prior written consent, of the other party.”

Assignment clauses are also typical in lease agreements. Lease agreements are entered into
between a landlord (owner of the land or building) and a tenant. An example is when the tenant
uses the landlord’s premises to run a business and pays the landlord rent. Now imagine we are
the owners of a famous hamburger restaurant and we wish to sell this restaurant. The new buyer
would want to continue running the hamburger restaurant from the same premises because we
have built up a reputation in that location. To give permission to the new buyer to use the
landlord’s premises, we would need to assign our current lease to the new buyer. The assignment
of our lease would be governed by the UK Landlord and Tenant (Covenants) Act 1995.

A typical clause in a contract for lease would be:

“A lessee must not assign this lease without the lessor’s written consent.”

We would need the consent of the landlord, and the landlord may not refuse to give us consent
unreasonably. Sometimes, at this point landlords prefer to novate (replace) the lease agreement
instead of having an assignment.

Apart from leases, we also find non-assignment clauses in employment contracts. This is because
usually a specific person is hired to do specific tasks or perform personal duties. If I agree with a
world-renowned surgeon to do surgery on me, I would not be happy to find out she has assigned
our contract to a first-year medical student.

Similarly, imagine a famous Opera soprano who is booked to sing at a wedding. The opera
soprano would be unable to assign her contractual duties to an amateur music student. This
would be a breach of contract.

Novation
Novation is another way of passing a contract to another party. To novate means to make new.

Novation allows parties to substitute a new contract for the one already existing. The new
contract may be between the same parties or may introduce a new party and/or substitute one of
the existing parties. A novation is not the same as an assignment. This is because an assignment
means the original contract continues. A novation means the original contract is replaced with a
new contract.

DID YOU KNOW?

Another name for clauses in a contract is term. Be careful not to

confuse this with the term of the contract, meaning the duration of
the contract. This contract has a term for delivery (clause ). The
contract has a term of three years (duration ).
Term The term of the contract is the duration of the contract. In order words, how long the
parties want their contract to last. Some contracts may have a duration of a few months (six
months) or a long-term duration (15 years). The term of the contract usually appears at the
beginning of the contract and in the termination clause itself.

This is an example of a term clause:

“The Contract will be valid for a period of five years, commencing on 22 June 2020 and
terminating on 21 June 2025.”

Termination
A contract may be terminated before the agreed date. Most contracts have a termination clause.
This clause states that if any of the events listed in the termination clause occur, the contract may
be terminated by the innocent party. Events which may give the innocent party the right to
terminate the contract include (a) where one party gives notice to the other that it does not wish
to continue with the contract, (b) where one party commits a material breach or (c) where one of
the parties has financial problems such bankruptcy or liquidation.

An example of a termination clause may be:

10 The parties may terminate this Contract by

10.1 sending a notice of termination to the other party six months before the end date of this
Contract.
10.2 sending notice where the other party has committed a material breach of the terms of this
Contract.
10.3 sending notice where the other party is placed into liquidation or goes into bankruptcy.

CAN YOU REMEMBER?

What is the difference between an assignment and a novation?
What is privity of contract?
Lesson 4 - Breach of Contract
Introduction
A term or clause is a statement which contains a promise. Contractual terms give benefits or
impose duties on the parties to the contract. Once the contract is signed, parties are expected to
perform their obligations in accordance with the contractual terms and conditions.

If a term is broken or, as lawyers say, breached, the non-breaching party may claim remedies to
compensate for damages or losses suffered as a consequence of the breach. However, a party
may also be in breach of contract if their performance is “defective”. Defective
performance means that the party has failed to meet the required standard of performance or
that performance is not up to the standard expected.

A party who fails to perform or refuses to perform an obligation under a contract without a
lawful excuse will be prima facie in breach of the contract. The onus would be on the breaching
party to see if they can find a lawful excuse in the force majeure clause. Events found in
the force majeure clause are fires, failure of suppliers or subcontractors, strikes or other labour
disputes that interfere with production, floods, earthquakes, tornadoes, political unrest, riots, and
currency devaluation. Covid-19 has become an additional event of force majeure. Existing
contracts will need to be amended to include it as one of the lawful excuses releasing a party
from the contract.

This is an example of a current force majeure clause found in most contracts:

“Neither party shall be liable for any failure to perform their obligations pursuant to this
contract in the event that such failure is due to or results from flooding, earthquake, riot, civil
unrest, war or other Acts of God, or any other cause beyond a party’s reasonable control. This
shall include any electronic or communications failure but excludes any failure due to any
breach of duty of care or a party’s financial position.”

A repudiatory breach happens when a party says that it will not perform its obligations under
the contract. We also call a repudiatory breach an anticipatory breach. Where a party
repudiates a contract, the non-breaching party has different options available to them. They may
either terminate or affirm the contract. If they choose to terminate the contract, both parties will
be released from any future obligations or further performance. The Contract has now ended.
The non-breaching party still has the right to sue the breaching party for damages. If a party
affirms the contract, this means that the non-breaching party chooses to continue with the
contract and the contract remains in force.

Fundamental breach To be classified as a fundamental breach the injured party needs to show
that they have been deprived of a substantial part of the benefit they hoped to obtain under the
contract.

WHAT IF…

... a party acts too quickly and terminates a contract for a minor
breach? What may the Court decide to do?
Options available to the non-breaching party for a minor breach
Where there is a breach of a non-essential term or a minor breach, the non-breaching party may
waive their rights and continue with the contract. Remember, a carefully drafted non-waiver
clause will allow the non-breaching party to retain the right to seek remedies for any future
breaches. When exercising the non-waiver clause, a party needs to avoid any operation of the
principle of promissory estoppel. Estoppel prevents a party from denying the truth of a
statement made or denying the existence of facts. An example might be if someone offers free
accommodation in exchange for babysitting children. If this promise is then denied, the remedy
for the innocent party is promissory estoppel. There are many varieties of estoppel but
promissory estoppel is an equitable estoppel. It applies when one party to a contract promises the
other that they will not enforce their rights under the contract.

Statutory Rights
Consumers have statutory rights under the UK Consumer Rights Act 2015. The statutory rights
enjoyed by consumers may, in certain circumstances, give a wider range of remedies than under
common law principles. These rights may include the right to reject, have repaired, have
replaced, have a price reduction, or have a repeat performance if the goods or services are found
to be defective.

Remedies
When there is a breach of contract, the non-breaching party may be entitled to either damages
under common law and/or equitable remedies.

Common Law Damages

Under common law, a non-breaching party will be entitled to damages. The right to have an
award of damages as compensation is a right which the law recognizes automatically. Note that
although damages are available as of right, the quantum or the amount of damages, will be
determined by a judge. The non-breaching party will need to prove its damages.

Full compensatory damages are known as restitutio in integrum. By compensating the non-
breaching party, the judges try to protect the expectation or perceived advantage the parties
hoped to obtain by entering into the contract in the first place.

If a party cannot prove their damages, the court may award nominal damages. This is a token
amount and can be as low as £10. Courts wish to discourage parties from bringing legal action to
simply vindicate their rights and may order the claimant to pay the defendant’s costs of the
legal proceedings. This can turn out to be a very expensive outcome.

Damage We need to be careful when we talk about damage not to confuse it with the word
“damages”. Damage is the loss or harm suffered whereas damages is the amount awarded to
compensate a party which has suffered damage. For example, if someone is the victim
of defamation, they will have suffered damage to their reputation, and they will receive
damages from the Court.

Liquidated damages are a specified amount of damages parties may decide to insert in their
contracts. This sum will be payable to the non-breaching party if a breach occurs. Liquidated
damages are inserted into the contract when the parties are negotiating and should reflect an
agreed estimate of losses. They are recoverable provided they are a fair and reasonable estimate
of probable losses. If they are disproportionate, the Courts may consider them to be penalty
clauses and declare the clause unenforceable or void. We often find liquidated damages clauses
in many construction and engineering contracts.
Equitable remedies
Other types of remedies may be available to the non-breaching party which come from the
equitable jurisdiction of the Court. Equitable remedies are awarded where damages are
inadequate or inappropriate.

Equitable remedies include specific performance and injunctions. For example, if someone
agrees to sell you a painting such as a Picasso, if they change their mind and refuse to sell it, the
Courts can force the sale with an order for specific performance. When asking for an equitable
remedy, claimants must remember that judges will exercise their discretion and will take several
factors into account. This will also include the conduct of the parties. So unlike common law
remedies, equity looks to create equality between the breaching and non-breaching party.

Other important concepts in the law of contracts

Mitigation Parties to a contract have a duty to reduce their loss or injury if there is a breach.
This is called mitigating the loss. An award of damages may be reduced if there has been a
failure to mitigate by the non-breaching party.

Remoteness Remoteness describes a situation where the damages or losses could not have
been in the reasonable contemplation of the parties when they were negotiating the terms and
conditions of the contract. A non-breaching party will not be able to recover losses if they are
considered to be too remote.

Contributory Negligence A Court may apportion or reduce the damages awarded to take into
account any negligence on the part of the claimant. This is called contributory negligence. A
claimant is somebody who starts legal action in the Court.

CAN YOU REMEMBER?

What is the difference between damage and damages?

What are liquidated damages clauses?
CASE STUDY: COULD THE FLU SEE YOU IN COURT?
A COMMON LAW PRECEDENT-MAKING CASE IN THE LAW OF CONTRACTS

Carlill v Carbolic Smoke Ball Company [1892] EWCA Civ 1 is an important case in English
contracts law. Carbolic Smoke Ball Company (Carbolic) – the manufacturer of a flu remedy –
placed an advertisement in a newspaper claiming that its smoke ball would protect against
influenza (flu). The smoke ball was a rubber sphere filled with carbolic acid (phenol). Vapour
would be puffed into the nose through a connecting tube when the ball was squeezed. Carbolic’s
advertisement offered a reward of £100 to customers who caught the flu after using their smoke
ball.

“£100 reward will be paid by the Carbolic Smoke Ball Company to any person who contracts
the increasing epidemic influenza […] after having used the ball three times daily for two
weeks. £1,000 is deposited with the Alliance Bank, Regent Street, showing our sincerity in the
matter. During the last epidemic of influenza many thousand carbolic smoke balls were sold as
preventives against the disease, and in no ascertained case was the disease contracted by those
using the carbolic smoke ball.”

After seeing the advertisement, Mrs Carlill purchased one of the balls and used it three times
daily for nearly two months. However, on 17 January 1892, she contracted the flu. She
demanded the reward of £100 from Carbolic. Carbolic ignored her first letters sent by her
husband, a solicitor. Following her third letter of demand, Carbolic wrote back denying that their
product was defective and refused to pay.

Mrs Carlill brought a claim in Court. Her barrister argued that the advertisement constituted an
offer and her reliance on it was a contract. Therefore, there was a breach of contract and Carbolic
was liable for that breach. Carbolic, on the other hand, claimed that this was not a serious
contract and was merely a sales gimmick (strategy).

PIT STOP

Answer the following questions related to the text you’ve just read.
1
What disease was the carbolic smoke ball said to protect against?
2
Who was promised a reward of £100?
3
Why did Carbolic place £1,000 in a bank account?
4
What happened to Mrs Carlill after she bought and used the smoke ball?
5
How did Carbolic respond to Mrs Carlill’s demands for the £100 reward?
6
What did Carbolic claim in Court?

The case made its way to the Court of Appeal. The three judges of the Court held that there was
a fully binding contract because:

(1) the advertisement placed by Carbolic was not a unilateral offer to the world. Rather it
was an offer restricted to those customers who bought the smoke ball because of the
advertisement;
(2) the customer accepted the offer when they followed the user instructions given by
Carbolic;
(3) the customers provided good consideration by purchasing or even merely using the
smoke ball in that this benefited Carbolic through more sales;
(4) Carbolic’s claim that it had deposited £1,000 with Alliance Bank was a representation
that it had an intention to be legally bound to the terms of its offer.

Conclusion: Mrs Carlill was entitled to receive her £100 reward. Carbolic had a contract with
whoever accepted their offer even if Carbolic did not know them personally.

PIT STOP

Match the elements of a contract (1-4) with features of Carlill v Carbolic Smoke Ball
Company (A-D).

1 Intention 3 Acceptance

2 Offer 4 Consideration

A
The advertisement for the smoke ball placed by Carbolic
B
Mrs Carlill purchasing and using the product
C
The sum of £1,000 deposited with the bank by Carbolic
D
Mrs Carlill following the instructions for use
1 ...... 2 ...... 3 ...... 4 ......

Why does this case matter?

Carlill v Carbolic Smoke Ball Company made unilateral offers binding where the recipient of the
offer follows the instructions of the offeror. Up until this case, offers were only usually made
directly to one party in order to bind the offeror and offeree. Offers had to be made from one
party to another not to the world at large. Previously, offers made without a target had been held
to be too vague to constitute an offer. Now, when advertising a product or a service, a party
needs to be careful about the promises they make. Even where they do not know the identity of
the party that accepts their offer, they will be bound to honour promises made.

Hoover Company
Another case which had disastrous results was the Hoover Free Flights promotion in the 1990s.
The British division of Hoover Company (Hoover) offered two complimentary free return flights
to America to customers who purchased any Hoover product valued at more than £100. The
promotion was aimed at trying to boost Hoover’s declining sales. Hoover did not expect the
promotion to be such a huge hit. They were flooded with new customers who bought Hoover
products specifically to take advantage of their free flight offer. Hoover realised that this
promotion was going to cost them millions and so cancelled the promotion and refused to give
customers, who had already filled out their ticket request coupons, their tickets. The customers
started protesting and legal action against Hoover followed.

The Court held that Hoover was contractually bound to honour their advertisement. It cost
Hoover many millions of dollars and Hoover had to sell the European branch of the business to
its competitor, Candy. Hoover never recovered from this advertising disaster.

To avoid the Hoover outcome and overcome the precedent set by Carlill, advertising is now
carefully worded. Offers are made conditional using the words While stocks last or Subject to
Terms and Conditions or See in Store for Terms of This Offer. Conditional offers allow
companies to control the financial consequences of their promotional discounts or
complimentary gifts. Conditional offers are not unequivocal. The offeror of a conditional offer
can legally impose limits such as “Until Stocks Last”, “Offer expires on” or “One per customer”
without breaching the contract.

OVER TO YOU!

What do you think of the outcomes of Carlill and Hoover? Did the
Courts come to a fair and just conclusion? Why or why not?