Contract variations - beware 'no oral modification' clauses

Supreme Court upholds enforceability of 'no oral modification' clauses.

What's the issue?

Many contracts contain a clause preventing oral modification of its terms. The aim of including such clauses (known as 'no oral modification' or 'NOM' clauses), is to ensure that contractual variations are clear to both parties and signed off by the appropriate people. In many commercial contracts, for example, IT contracts, it is common practice to agree variations orally or by conduct. While it can be practical to do this if the project proceeds smoothly, it can also lead to disputes where there is disagreement as to the nature or validity of an oral variation. A particular issue is what happens when an oral agreement is purportedly made despite the existence of a NOM clause in the contract.

What's the development?

The Supreme Court overturned the Court of Appeal’s decision that a NOM clause did not prevent a valid contractual variation by oral agreement. The Supreme Court held that a NOM clause should be given legal effect. As a result, variations which are made orally or by conduct are unlikely to be binding on the parties where the contract contains a NOM clause and the formalities under it (usually for variations to be agreed in writing) have not been followed or the NOM clause has not been dis-applied by the parties (either expressly or by necessary implication).

What does this mean for you?

This is a significant decision in the context of IT contracts where attempts to vary contractual terms orally or by conduct are commonplace. It can often be the case that those responsible for the day to day performance of the IT contract have authority to agree variations during the life of the project (for example in respect of changes to functionality requirements, delivery milestones and payment schedules) unaware that the governing contract contains a NOM clause in the standard terms preventing them from doing so. This then leads to disputes about the variation, its terms and whether it was intended to be legally binding on the parties. It will now be even more important following this decision for the project manager of an IT contract to become familiar with the governing contract and ensure that formalities for agreeing contractual variations are complied with.

A project manager in an IT contract responsible for monitoring performance of the contract should review its terms regularly and ensure that any variations are being made in compliance with a NOM clause where one exists. It would also be advisable to bring the NOM clause to the attention of the counterparty during the contractual negotiations to ensure its inclusion reflects the intentions of the parties and that there is no practical reason to remove it from what is often treated as a standard clause. Further, any agreement to dis-apply the NOM clause in respect of a particular contractual variation needs to be expressed clearly at the time of making the amendment or, if by implication, this will need to be out of necessity.

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In Rock Advertising Limited v MWB Exchange Centres Limited [2018] UKSC 214, the Supreme Court held that NOM clauses should be given legal effect so as to prevent parties from trying to vary a contract otherwise than by complying with the formalities under it (i.e. agreements in writing). Any attempts to vary a contract orally or by conduct will not be binding where the contract contains a NOM clause unless the parties expressly or by necessary implication agreed to dis-apply it.

Rock entered into a licence with MWB to occupy office space in London for a fixed term of 12 months. The licence contained a NOM clause stating that all variations to it must be agreed, set out in writing and signed on behalf of both parties before they would take effect. Rock fell into arrears with its licence payments and the company’s sole director proposed a revised schedule of payments to a credit controller employed by MWB. The schedule deferred part of the payments due and spread the accumulated arrears over the remainder of the term resulting in slightly less monies due to MWB. A dispute then followed as to whether the revised payment schedule was an agreed variation to the licence agreement or simply a proposal in a continuing negotiation. MWB denied any variation to the licence and sought to rely on its original terms terminating and bringing a claim to recover the rent arrears. The claim turned on whether the licence variation was binding on Rock and MWB preventing MWB from enforcing its original terms and sue for the rent arrears.

The County Court decided that although an oral agreement had been made to vary the licence in accordance with the revised schedule, it was ineffective because it was not recorded in writing and signed on behalf of both parties as required under the NOM clause. MWB was, therefore, entitled to claim the rent arrears from Rock without regard to the variation. The Court of Appeal overturned this, finding that the oral agreement to revise the schedule of payments was a contract variation which also amounted to an agreement to dis-apply the NOM clause. As such MWB was bound by the variation and not entitled to claim the rent arrears at the time when it did in light of the revised payment schedule.

The Supreme Court has now overturned the Court of Appeal’s decision finding that the law should and does give effect to a contractual provision requiring specified formalities to be observed for a variation, usually set out in a NOM clause. The Supreme Court held that to ignore such a clause overrides the parties’ intentions. Further, a NOM clause does not operate so as to prevent any variations being made to a contract; changes can be made but only if the formalities for variations agreed by the parties at the time of entering into the contract are complied with.

The Supreme Court identified three important business reasons for including NOM clauses in contracts:

• they prevent attempts to undermine written agreements by informal means
• they avoid disputes as to whether a variation was intended and its exact terms given that oral discussions can easily give rise to misunderstandings and crossed purposes
• including formalities for recording variations makes it easier for companies to police internal rules restricting the authority to agree them.

The Supreme Court also found that there is no conceptual inconsistency between a general rule allowing contracts to be made informally and a specific rule that effect will be given to a contract requiring variations to be agreed in writing.

The decision provides welcome clarity on the legal effectiveness of a NOM clause. It is now clear that the court will uphold such a clause providing certainty for commercial parties as to the binding nature of contractual variations. The Supreme Court acknowledged that there was a risk that a party could act in accordance with a contract as varied and then not be able to enforce it. The doctrines of estoppel, however, could avoid a party suffering an injustice ( although in this case estoppel defences were not available to Rock). The Supreme Court also considered circumstances where it would not be necessary to insist on strict compliance of a NOM clause. It seems that the NOM clause will prevent oral variations from being legally binding unless the parties have agreed to dis-apply the NOM clause itself either expressly or by necessary implication. It is important to note, however, that the natural inference from the parties’ failure to observe the formal requirements of a NOM clause is not that the parties intended to dispense with it but that they overlooked it or did it knowingly. In Rock, there was no evidence that the oral agreement between Rock and MWB included an agreement to dis-apply the NOM clause to allow the oral variation - there was no mention of it at all.