Written contracts allocate risk and responsibility between parties, with the intention of providing certainty and helping parties to achieve their intended commercial outcomes. However, in many cases the operational arrangements between parties change over time and a variation to the contract is required.
Recent litigation in both New Zealand and the United Kingdom, and our own experience with clients, indicates that contract variations are often not well managed. Frequently we see situations where a contract has not been varied in accordance with the terms of the underlying document, or in accordance with legal requirements. The resulting consequences may range from misunderstanding or confusion between the parties to protracted litigation. Poorly managed variations can also be an issue for commercial parties who wish to divest part or all of their business and need to provide information about their contracts to potential purchasers as part of the due diligence process. Unravelling variations that have not been adequately documented can be time consuming, expensive, and strain the relationship between the parties.
So, what can you do to better manage contract variations in your business?
The first point to note is that a contractual variation is not always necessary. Minor and temporary changes can often be managed pragmatically, and do not justify a formal contract variation (although any waiver provision in the contract may be relevant). It is important to consider the specific situation at hand and the implications for each party.
Where a contract variation is required, the first step is to check the underlying contract terms. Many contracts contain a clause that prohibits changes being made unless those changes are agreed in writing (also called a 'non-oral modification' clause).
Non-oral modification clauses
Non-oral modification (NOM) clauses have recently come under scrutiny in both the United Kingdom and New Zealand courts, with the United Kingdom courts (in particular) debating whether NOM clauses may be unenforceable on the grounds that they are contrary to the common law doctrine of freedom of contract.
The extent to which such clauses bind the parties (preventing them from orally agreeing changes to the contract) is not entirely settled in New Zealand. However, the United Kingdom Supreme Court recently considered the issue and confirmed that NOM clauses will have effect (except in limited circumstances where the conduct of the parties would render it inappropriate to apply the clause). In our view this decision is a good one and provides increased certainty for businesses. The flexibility of permitting oral modifications can be unwelcome in business, as it can:
- Detract from contractual certainty, as there are often misunderstandings about 'what was said and agreed'
- Cause difficulties from a contract management perspective in large organisations, particularly where oral variations are agreed by employees who have apparent authority to bind the organisation, but are not authorised to do so under the organisation's delegations policy.
If a NOM clause is included in a contract (and we would usually recommend they are), any variation to that contract needs to be recorded in writing and signed by appropriate representatives of each party. Those representatives may be specified in the non-oral modification clause.
Before attempting to agree and record any variation, it can be helpful to clarify your proposed approach with the counterparty. By way of example, you might want to send a short email explaining that you consider a variation is needed to your contract, confirming that you are preparing a variation, and specifying that the variation will only be agreed and legally binding once it is executed by specified individuals.
In recording the variation it is important to:
- Clearly set down the specific terms of the contract that are being changed and what the change is
- Consider whether there are flow on effects that mean consequential changes are required to other parts of the contract
- Specify when the variation takes effect
- Confirm that nothing else is being amended in the contract (other than those terms set out in the variation).
You will also need to consider whether any payment (or other consideration) will be made in respect of the variation. Are both parties receiving something as consideration for the variation? Generally consideration is required for a contract to be legally binding, although this too has been the subject of litigation. If no consideration is passing it may be safer to record the variation in the form of a deed; however it is important to note that this decision has ramifications for how the document is executed.
Once the variation is agreed and signed off by both parties, it is critical that the parties adjust their operations to align with the variation.
We recognise that contracts are often signed and then put away in a bottom drawer. However, there is always value in dusting them off occasionally and having processes in place that support regular reviews of your key contracts to ensure that they continue to deliver what your business needs.
If you require any advice or guidance in the context of drafting or varying your commercial contracts please contact any member of our corporate and commercial team in Auckland, Wellington or Christchurch.