Introduction to Terms

Introduction

In every contract, a significant part of its content contains terms.They are statements that sets out the commitments between the contracting parties, such as their rights and obligations, or procedures to be followed. Examples of the most common terms include consideration (i.e. the price paid) and the subject matter (i.e. the goods or services provided) of the contract.

During negotiations and the entering into contracts, some statements can be expressly written, made orally, or not even made at all.  Not every statement exchanged between the parties during negotiation constitutes a contractual term, but a representation instead.  On the contrary, contractual terms can take the form of express and implied terms.  Contractual terms are classified into 3 different classes with distinct significance and legal consequences, such that it is vital to understand how terms are interpreted.

After reading, you should –

  1. Understand that a contract contains both express and implied terms
  2. Understand the difference between contractual term and representation
  3. Understand that not all the terms are of equal importance
  4. Have a basic idea of how courts interpret disputed terms
Summary of Contractual Terms
  1. Express and Implied Terms
Express TermsImplied Terms

Express terms are terms :
(1)  written
(2)  orally communicated
by the parties themselves.
 
In the business world, it is common to have all the terms in written forms; but it is not a requirement that all terms are written for most types of contracts.
Implied terms are terms NOT expressed by the parties, but are nevertheless read into a contract due to:

(1) business efficacy
(2) Custom
(3) Statute (e.g Sale of Goods Ordinance)

Written Terms and Signed Contracts

Every party is bound by the terms of any legal documents (not only contracts) he signed, even if he did not read the terms, except for unusual and onerous terms that the signer is reasonably unaware of and the party relying on the term did not take reasonable steps to draw the signer’s attention before signing.

It is prudent to always read the terms of any legal documents carefully, ask the drafting party for explanations, and negotiate over undesirable terms, before offering your signature.

Written Terms and Unsigned Contracts

Even if unsigned, a term will be incorporated into contracts if 3 preconditions are ALL satisfied :

  1. The signer had notice of the term before / at the time of contracting;
  2. The term was contained in a notice that a reasonable person would understand to have contractual effect; and
  • The relying party took reasonable steps to draw the term to the signer’s attention.

2. Terms and Representations

The distinction between terms and representations determines the breaching party’s obligations.

Statements exchanged between contracting parties before the entering into contract could amount to either terms, representations or mere puffs.

Whether a statement is a term or mere representation is a matter of intention.

To protect your own contractual rights, it is always prudent to ensure all the agreed statements are included in the written contract.

If the parties have indicated that a particular statement is to be regarded as either a term or representation, the issue is settled. However, where such intention is not indicated, several guidelines may be applied to determine the intention:

3. Three different classes of terms

Terms are classified into three categories:  conditions, warranties, and innominate terms.

The significance of the terms and the legal consequences upon their breach depend on which of these three categories the terms fall into.

A) Conditions are terms of fundamental importance.

Consequence of breaching

Breaching conditions always amount to a declaration that the breaching party no longer intends to fulfil his future obligations under a particular contract.

The innocent party may treat contract as repudiated, and will be:

  • free from rendering further performance of contract, terminate the contract and recover damages for loss of bargain
  • entitled to sue for damages for breach of term

What constitutes a condition?

  • If parties expressly stipulate a term as a condition (but may be challenged as not intended as a condition objectively)
  • If expressly provided in statute   ( e.g. implied conditions as to goods’ merchantable quality under Sales of Goods Ordinance (Cap.26) )
  • A term specifying timely performance of contractual obligation is essential to the contract

(e.g. by specifying a date and time / by requiring performance expeditiously)

B) Warranties are less important terms than conditions.

Warranties do not go to the root of the contract and they can be breached without such serious consequences.

Consequence of breaching

When terms of warranty are breached, innocent party :

  • cannot terminate the contract;
  • but can sue for damages only to the extent for losses caused by breach of the warranty

What constitutes a warranty?

Usually, warranties are written statements of assurances or promises.

C) Innominate Terms cannot be classified as “conditions” or “warranties” until after such terms are breached.

Consequence of breaching

The consequences of breaching an innominate term depends on the seriousness of the impact inflicted on the innocent party.

Normally, the consequence of breaching an innominate term will be the same as a breach of warranty, unless the breach deprives the innocent party of substantially the whole benefit under the contract, in which case the consequence will be same as breach of condition.

What constitutes an innominate term?

It is inappropriate to pinpoint certain terms as innominate as it calls for consideration of the consequences of breach and whether the innocent party has been deprived of “substantially the whole benefit” of the contract.

4. Interpretation of terms

Where written terms are clearly stipulated, parties will have no problem with interpretation. However, it is not always the case for commercial contracts, where it involves complicated terms that are difficult to understand. As such, it is important to understand the approach taken by Hong Kong courts to interpret disputed terms. [1]

Where possible, the mutual intent of the parties will be determined solely from the written terms of the contract.

  1. Interpretation is to ascertain the meaning of what a reasonable person would have understood the parties to mean;
  2. Every contract must be read in its “factual matrix” – i.e. the background which would have affected the way in which the language used in the contract would have been understood by a reasonable man;
  3. Pre-contractual negotiations between the parties should be excluded;
  4. The meaning of words in the contract is not the same as the literal meaning of words, but the meaning reasonably understood against the relevant background;
  5. Words should reflect their natural and ordinary meaning in commercial common sense, disregarding any party’s subjective intention.  Linguistics mistakes will not be readily accepted by courts.

Tips in Drafting to Avoid Disputes

  • avoid excessively harsh and severe terms in the contract
  • ensure the contract works as a whole, not to focus on individual words or provision
  • keep a record of pre-contractual negotiations
  • include an “entire agreement clause” if wish to exclude any pre-contractually negotiated statements

[1] Hong Kong courts have consistently followed the approached interpretation of commercial contracts based on the five Chartbrook principles laid down by the House of Lord  (2009 UKHL 38).

 

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