What is a Collateral Contract?
A collateral contract is a type of contract that exists in addition to the main contract, and is typically used to support, confirm or form part of the terms of the main contract. A collateral contract is normally formed by one party making a representation to enter into a transaction, and the other party to the transaction accepting that representation, often because they have been made to persuade or encourage the accepting party to make the transaction. The collateral contract does not need to be written but, like any other contract, it must be enforceable. Therefore, not every collateral contract exists in reality – the effect of a collateral contract cannot create rights that may not exist. For example, if the collateral contract is that, irrespective of what the main contract states, a third party will be available to perform under the terms of the collateral contract , the collateral contract will be unenforceable if the third party has no obligation to make themselves available.
In order to identify a collateral contract it must be determined that: If both parties to the collateral contract are repeat players in the industry, industry standards may be relied on to establish that common law proscription is not applicable. However, where one of the parties is an unsuspecting consumer the language of the collateral contract must be clear in stating that the terms are separate to those of the main contract. The consumer must also not be confused about where the contractual duties lie. Although there are exceptions to these rules in the form of the Parol Evidence and the Entire Agreement Rules, which provide that where the collateral contract is proven by parol evidence and does not contradict the main contract, the collateral contract may be enforceable, at common law the parol evidence and entire agreement rules will only apply if the parol evidence is explicit in its exclusion of these rules.
Components of a Collateral Contract
The essential elements of a collateral contract are the same as any other contract: an offer, acceptance, consideration, and an intention to create legal relations. An offer may not be in any particular form, but it must be clear, unambiguous, and no room for doubt as to its meaning. Acceptance is similarly not dependent upon any prescribed form, save that it must be communicated in some appropriate way. Consideration is required and must take the form of a detriment or a benefit to the party providing the same. Lastly, parties will usually be considered to intend that a contract brings about a legally binding agreement; however, this intention is rebuttable where the circumstances indicate otherwise. It is important to remember that any collateral contract formed is separate from the main contract. Any breach thereof or misrepresentation in respect of it is actionable in damages independent of the main contract.
Requirements and Validity of a Collateral Contract
Collateral contracts, to be enforceable, must exhibit the following ingredients: the parties intend to create a contractual relationship, the terms of the collateral contract are not vague or uncertain, the parties have legal capacity to enter into the contract (see for example The Commonwealth Bank of Australia v Barker), the parties have placed themselves legally in the position of a contracting party (as opposed to being in a third party relationship), and the contract is supported by consideration (Kitchen v Bellerive Developments Pty Limited).
A collateral contract intended to alter the terms of the main contract will only be effective if it is clear that the parties intended to alter the original contract. In Myconostica v Zweckel, the Court found that the supplier’s behaviour in including the dishonesty clause in their invoice and the buyer’s acquiescence acted to amend the contract. The issue of whether the two contracts were distinct or were to be read together was resolved in favour of reading them together. It was found that it was the supplier’s intention to amend the contract by the manner in which the two contracts were executed.
The fundamental importance of the incorporation of collateral promises into a contract lies in the fact that those promises are enforceable as contractual terms and therefore give rise to rights and obligations between the parties (Cooke v Haldin). If a statement made by a party to another relating to the subject matter of a contract is incorporated into the contract, then that statement will be taken to be an express term of the contract. As a consequence, damages may be awarded for any unjustifiable breach. A mere pre-contractual representation, however, will not be considered a term of the contract but may still be actionable as misrepresentation.
Collateral Contracts in Practice: Notable Cases
In the case of Harvela v Royal Trust, the issue was whether an original offer made in a cover letter to the first defendant directed to the first defendant alone created a collateral contract with that party. The collateral contract would be tied into the subsequent process of valuing a company on the basis of the offer made. The clauses which were agreed to in the cover letter were not agreed to by the second defendant. Reasoning: The fact that the offer was sent to the first defendant alone meant there was no intention for this offer to be conditioned on a competitive bid. Rather, the court found the offer and acceptance sufficient to form the collateral contract with the first defendant, and the second defendant could not participate in the process.
In the case of Oscar Chess Ltd v Williams, the dealer sold a used car described as a 1973 model, but the make/model was not indicated on the sales contract. Since the dealer was an expert in buying/selling and restoring vintage cars, and had been asked whether he was aware of the model he was selling, the court found there was a collateral contract that the car was, in fact, a 1973 model. Thus the dealer had a duty to accurately state the model, and the plaintiff could not rely on the statement that the model was only an opinion.
In Smith v Hughes, the purchaser examined fabrics, but expressed no objection to the fabrics specified by the seller. The seller’s brochure listed the properties of the fabric, including that it would be flame-retardant and not fade. In fact, these statements about the fabric were not true. The court found that the seller had a duty to disclose if the product did not have the qualities the contract required. Thus the plaintiff was able to recover damages when the products were not flame-retardant nor color-fast.
Pros and Cons of Collateral Contracts
Collateral contracts can be beneficial for many parties in business and commercial transactions. Such benefits may include the provision of an additional cause of action, the possibility of bringing a claim against a person who would not otherwise have been a party to the contract, and/or securing payment for a breach of an onerous term. Where a person is induced by a fraudulent misrepresentation to enter into a contract with a party, it will be possible for him or her to sue both that party and also the third party who made the fraudulent statement inducing the contract. Hence, a collateral contract would be useful.
However, where a party has entered into an onerous contract (e.g. a confidentiality agreement), even though he had been deceived into doing so by a fraudulent misrepresentation, he could only sue for damages. Recovery for the tort of deceit is limited to a party suffering loss consequential upon the fraud or deceit, such as legal costs incurred in investigating the fraud or the deceit. If the term can be viewed as a "condition" of the contract, it will be a breach of condition and plaintiff will obtain a right to rescind the contract. However, when assessing condition, one has to bear in mind the degree of seriousness of the breach of condition and the damages caused by it , as a breach of an "innocent" condition will not grant plaintiff an unfettered right to terminate.
In "admissibility" of collateral contracts, there are two important rules that should be borne in mind when considering whether evidence will be admissible: The person seeking to introduce the evidence would have to show that the evidence he wants to use could not have been intended to be included in the contract document, and therefore not reasonably be expected to be disclosed in that contract, i.e. it was not really the intention to incorporate that particular evidence in the contract, but was or could have been part of a separate collateral contract. Furthermore, where the contract has been placed in writing, the terms of the written contract would be used to interpret a collateral contract, in order to prevent a situation where both verbal and written contracts would be enforceable, thus nullifying the written contract.
These considerations should however not detract a person from entering into collateral agreements or contracts, as they become extremely useful in avoiding claims being time-barred, allows wider rights of recovery, and sometimes provides for the possibility of actual performance of the contract should plaintiff succeed on a specific performance argument.
Crafting and Negotiating a Collateral Contract
When it comes to drafting and negotiating collateral contracts, parties must be meticulous in their approach to avoid any ambiguity that could lead to conflict down the line. Below are some best practices that can help ensure clarity and understanding:
Be explicit about the scope of the collateral agreement: Clearly outline which provisions of the main contract extend to the collateral agreement. Glynn v. Midas South, LLC emphasizes that parties should consider whether the collateral contract contains express language making it "incidental to" the main contract.
Define the relevant terms: Avoiding ambiguity is crucial. If a term or clause is intended to have a particular meaning, it should be defined explicitly in the collateral agreement. This will help mitigate any potential conflicts as to the intended meaning of the provisions in the collateral contract.
Ensure that the collateral agreement is consistent with the main contract: Avoid including terms or clauses in the collateral agreement that conflict with or modify the terms of the main contract. This can lead to uncertainty between the parties and may impact the intention to create an irrevocable obligation.
Include a clear representation about the existence of the collateral agreement: Despite what may appear in the collateral agreement, a clear representation about the existence of the collateral agreement should be included in the main contract. For example, include the following words: "The Contracting Party represents that [ ], and that the representations shall survive termination of this Contract."
Maintain a clear record of documents exchanged between the parties: Keep a precise record of any drafts or proposals submitted by either party. It may be extremely helpful if a disagreement arises in the future. Overall, maintaining a clear record of documents exchanged between the parties may save a substantial amount of resources in a dispute.
Avoiding pitfalls when creating a collateral agreement is also important. A common mistake related to a collateral agreement is the lack of intention to create an irrevocable obligation. For example, in the case of Glynn v. Midas South, 2015 NCBC 32, 2015 WL 5098973, the North Carolina Business Court found that the trial court lacked subject matter because there was no credible basis that a collateral agreement existed.
Collaterals in Various Jurisdictions
Collateral contracts have varying degrees of recognition and enforcement in different jurisdictions. While the principles underpinning collateral contracts are generally accepted, adherence to them may differ in terms of enforcement against certain categories of parties (such as public bodies) and the circumstances in which they are enforced and recognised as enforceable contracts (as in the case of pre-contractual representations, such as misrepresentations).
Practitioners should be very careful when dealing with situations where a pre-contractual representation forms part of the contract. Some jurisdictions do not recognise a collateral contract when the statement was in breach of an earlier collateral contract. In some jurisdictions, the remedies for a collateral contract breach are damages and/or an injunction.
In some civil law jurisdictions, the doctrine of Collateral Contract has been adopted. It is noteworthy that in certain countries, a contract can be in writing, oral or even tacitly agreed to be recognised as enforceable.
In many civil law countries, the doctrine of pre-contractual liability has developed. This involves a wide concept of fault, which requires that the party should have acted in good faith and used due diligence.
Countries like Spain, Germany, France and the Czech Republic agree with the main principles of English Law regarding the existence of pre-contractual obligations and recognize them. Such obligations are also enforceable, where failure to comply with them results in liability in damages. In Spain, a person is liable under a "culpa en contrahendo" if he acts in bad faith in negotiations which precede the making of the contract.
In French law, the courts have the power to compensate an aggrieved party, irrespective of whether a binding contract exists for a loss caused by a party failing to act in good faith during pre-contractual negotiations.
In some countries, like Egypt, the particular circumstance of the matter is relevant, and the court may weigh the degree of fault in each individual case.
Closing Thoughts: The Significance of Collateral Contracts
In the modern era, collateral contracts continue to play a vital role in both personal and commercial contexts, whereby they are increasingly relied upon in order to address the various legal complexities that may arise. As technology continues to advance, and as the law continues to evolve, so too will the relevance and importance of these contracts. For legal practitioners , an ability to clearly understand and work with collateral contracts is both necessary and essential in order to pre-emptively set out the boundaries of a party’s obligations as well as to protect the potential liabilities which the party may incur. The use of these contracts will undoubtedly continue to be widespread into the future as a result.