Contract (Formation and Remedies) (Scotland) Bill: business and regulatory impact assessment

Purpose and intended effect

Background

2. Contract law impacts on day to day economic life in relation to all types of transactions and for businesses and individuals alike. It is therefore important economically and socially that the contract law regime in Scotland is fit for 21^st century conditions. As remarked by a Scottish judge with special reference to contract law’s business context:

“The object of our law of contract is to facilitate the transactions of commercial men, and not to create obstacles in the way of solving practical problems arising out of the circumstances confronting them, or to expose them to unnecessary pitfalls.”^[1]

3. That there may be issues with the present law in this regard was identified in 2008 in a report by the Business Experts and Law Forum.^[2] This highlighted a lack of comprehensibility and accessibility in Scots law as a major factor for businesses in opting for English law in the drafting of their contracts.

4. Contract law has four main jobs:

• enabling parties (individuals or other legally recognised persons), to make arrangements with other such parties that will be obligatory in law between them (formation of contract);
• determining what the substance of the parties’ contractual obligations is where that is disputed between them (interpretation);
• providing means by which the obligations in the contract can be enforced by a party should another party not carry out its side of the bargain (remedies for breach of contract); and,
• regulating the general freedom of contract, by providing rules on when obligations apparently undertaken by the parties are not treated as binding them, or obligations are imposed upon them (contractual penalties).

5. The SLC’s Report on Review of Contract Law: Formation, Interpretation, Remedies for Breach, and Penalty Clauses (“the Report”), published on 29 March 2018, covers each of these aspects of the law of contract.^[3]

6. A separate Discussion Paper was published in relation to each of these four areas (formation in March 2012, interpretation in February 2011, remedies in July 2017 and penalty clauses in November 2016). Each Discussion Paper suggested either restatement and reform of the law (formation and remedies) or reform of the law only (interpretation and penalties). The suggestions were made on the basis of a comparison of these four aspects of Scots contract law with various international comparators, in particular the Draft Common Frame of Reference: Principles, Definitions and Model Rules of European Private Law (“DCFR”).^[4] The aim of the exercise was to carry out a health check of the Scots law of contract against these international comparators, in order to determine whether the law in this area required modernisation and simplification. Consultees welcomed the exercise, not least because it might lead to greater use of Scots law to govern contracts. For example, the Law Society of Scotland in their response to a consultation on a draft of Part 1 of the Bill commented that:

“we [also] support the objective of ensuring that Scottish contract law keeps pace with the DCFR. Irrespective of Scotland’s position within the EU, it is clearly desirable to have a law of contract which measures up to international comparators. Among other documents, such as the Unidroit PICC,^[5] the DCFR is a useful part of that process.”

7. Following this exercise and consultation in relation to the various suggestions for reform and restatement, the following recommendations were made in the Report:

• providing a statutory restatement of the law of formation of contract suitable for modern conditions (for example, in relation to electronic communications), with reform of the law in particular by abolition of the postal acceptance rule;
• allowing the law of interpretation of contract to develop further under the framework now established by the courts in the Supreme Court judgments in Arnold v Britton^[6] and Wood v Capita Investments^[7] (both of which cases were decided following publication of the SLC’s Discussion Paper on interpretation);
• reforming aspects of the law of remedies (i.e., mutuality, restitution after rescission for material breach, and contributory negligence as a factor restricting damages for breach of contract), but not proceeding with a statutory restatement of and reform of certain other aspects of the law of remedies for breach of contract;
• in respect of the law of penalty clauses, allowing the Supreme Court judgment in Cavendish Square Holding BV v Talal El Makdessi and ParkingEye Limited v Beavis^[8] to bed in rather than embarking on further legislative reform.

8. The Bill restates and reforms aspects of the law of formation of contract (Part 1) and reforms aspects of the law of remedies for breach of contract (Part 2).

Formation of contract

9. The policy behind this part of the Bill has been developed in light of responses to the 2012 Discussion Paper on Formation of Contract and the SLC’s own further work on the subject (including a consultation on a draft of what is now Part 1 of the Bill carried out in autumn 2017).

10. Part 1 comprises a comprehensive statement of the law on formation of contract, including a number of specific reforms. This is driven in particular by improving the law’s accessibility to all types of users, within and without the legal profession. Bringing all (or at least as much as possible) of the law into one place will simplify its use. For example, commenting on the SLC consultation on the draft Bill in 2017, Gillian Craig then of MacRoberts observed: “The reform and codification of the law of contracts has been long overdue.”^[9] Pinsent Masons commented in their response to the 2012 Discussion Paper that:

“We consider that it would be useful to have a statutory statement of the law of formation of contract in Scotland as the existing law of contract has been strained to work with modern practice.”

11. Clear statements of general principles will also assist in solving such recurrent problems as the “battle of the forms” where each party purports to contract on its own standard terms only. Further, in a number of areas the law of formation is uncertain because there is no direct Scottish authority in point (for example, the impact of a party’s insolvency during a formation process). A comprehensive statutory scheme ensures that such questions have authoritative answers.

12. One of the most significant reforms in Part 1 is the provision which would abolish the postal acceptance rule (first established in the early 19^th century). Under the rule, a contract entered into through letter or telegram can be held to be concluded when acceptance of the offer is posted. This is inconsistent with the general principle that communications take effect only when they reach their addressee and with the expectations of business people and consumers, who do not anticipate being bound in contract without their knowledge. The rule causes uncertainty, confusion and difficulties with the law of contractual formation, and in legal practice is commonly excluded by express provision. Its removal was unanimously supported by consultees. Part 1 also sets out a rule for electronic communications based on the general principle of “reaching”, removing uncertainty and bringing the law into line with 21^st century conditions.

13. Law firm blogs commenting on Part 1 of the Bill during the 2017 consultation were supportive of these reforms. For example, CMS’s Law Now blog noted:

“The Bill aims to provide clarification and align law of formation of contract with modern common practice, moving away from archaic rules and implementing provisions to reflect today’s wide range of modern communication methods.”^[10]

14. CMS also commented that the postal acceptance rule was “out dated”.^[11] Gillian Craig observed that:

“The 21^st century is a new-age digital era which requires updated and relevant protections to reflect today’s electronic communications.”^[12]

15. Shepherd and Wedderburn remarked:

“Having been imported into Scots law from England when Charles Dickens was just a lad, this 19^th-century rule belongs to a bygone age where the postal system was the primary means of communication between parties transacting at a distance. In the digital age, there is clearly no longer a justification for retaining special protection for acceptances sent by post.”^[13]

Interpretation

16. A Report on this subject was published by the SLC in 1997,^[14] but was not implemented, partly because it appeared that significant developments in judicial thinking on the subject took place in England and Wales the same year. These developments were led by Lord Hoffmann in the House of Lords and so were of influence in Scotland. They involved the court in an arguably wider use of “context” to interpret legal documents.^[15] The SLC returned to the subject in 2011 as a result of the uncertainty which the Scottish courts in particular seemed to feel in dealing with the ‘Hoffmann approach’. The SLC’s 2011 Discussion Paper suggested reform to allow the court to take account of the parties’ common intention, relevant surrounding circumstances, and the nature and purpose of the agreement.

17. However the SLC took the view that, as the law appears to have become more settled since the appearance of the 2011 Discussion Paper, now is not an appropriate time to recommend legislative reform of the law of contractual interpretation and the law should instead be left to develop in the courts.

Remedies for Breach of Contract

18. As noted above, although there was some significant support for the idea of a statutory statement of the law of remedies (for example, from the Senators of the College of Justice), given it met with much more opposition than the proposal for a restatement of formation of contract, the SLC concluded that now was not the time to proceed with this proposal. Similarly, and for the same reason, the SLC decided not to proceed with reform of the law of damages for breach of contract to deal with problems of non-patrimonial loss, “transferred loss”, or the contract-breaker’s gains from its breach.

19. Part 2 of the Bill contains provisions which reform certain areas of the law of remedies concerning: (a) mutuality, (b) restitution after rescission (termination for breach) and (c) contributory negligence.

Mutuality

20. These provisions clarify an existing difficulty in relation to the principle of mutuality (that is, where both parties have rights and duties under the contract, these rights and duties are interdependent, or reciprocal, and the enforceability of one party’s rights is conditional upon the same party performing its own duties). The difficulty is the consequential rule that a party which has not performed or is not willing to perform its obligations cannot compel the other to perform. Two recent but contrasting Inner House decisions^[16] suggest significant difficulties in understanding the scope of this rule.

21. Part 2 of the Bill therefore contains provisions which clarify that party A, who is in breach of a contract with party B, is nevertheless entitled to exercise any right or to pursue any remedy arising out of B’s breach, provided that B’s breach occurs before the contract is lawfully terminated for A’s breach. This is provided that B is not lawfully withholding its performance in response to A’s breach. B also cannot be required to perform obligations that fall due after the contract is terminated for A’s breach.

Rescission

22. Part 2 of the Bill also contains provisions which clarify the law in relation to mutual return or restoration of performances previously rendered under a contract by the parties (restitution) as a consequence of rescission (termination) of the contract for breach. “Rescission” is a remedy for breach which a party can invoke without the assistance of a court to bring a contract to an end. The party simply declares itself no longer bound under the contract, so that it may lawfully refuse to carry out any further obligations under the contract. The Bill makes it clear that where parties have rendered performances under a contract but not received counter-performances reciprocally due under the contract before it is terminated by one for the other’s breach, there should be restitution of the unreciprocated performances. The Bill goes on to make detailed provision for the restitution of particular kinds of performances, such as payment of money and transfer of goods.

Contributory negligence

23. Finally, Part 2 also contains provisions which clarify the law in relation to contributory negligence and breach of contract. Contributory negligence, which is (in short) contributory and blameworthy conduct of the pursuer which has contributed to the loss sustained as a result of the defender's conduct, has long been available as a defence in delictual claims for damages, leading to reduction of the amount to be awarded to the pursuer. But its availability as a defence to claims for damages based on breach of contract has been an open question for some time. The Bill introduces a form of contributory negligence as a defence for all claims of damages for breach of contract. The Bill amends section 5 of the Law Reform (Contributory Negligence) Act 1945 to make the definition of “fault”, subject to a new provision which has the effect of extending the definition to include “breach of contract”. Therefore the defence will arise under section 1(1) of the 1945 Act where the pursuer in a claim of damages for breach of contract suffers loss partly through its own fault (which may or may not be a breach of contract or other legal wrong), and partly through the breach of contract by the other party. The damages recoverable in respect of the breach will be reduced to the extent the court considers just and equitable, having regard to the pursuer’s share in the responsibility for the loss.

Party autonomy

24. The principle of freedom of contact allows contracting parties the power to make their own rules about when obligations come into existence between them, about their enforcement and also about remedies for breach of those obligations. Sections 1 and 16 of the Bill recognise this principle by providing that (with the exception of the section abolishing the postal acceptance rule and various other more general Bill sections, such as interpretation and commencement provisions) the provisions in both Parts 1 and 2 are default in nature rather than prescriptive or mandatory. Therefore the rules apply when the parties themselves have not otherwise provided (i.e., where parties have not contracted out of them).

Penalty clauses

25. This area of law was previously considered by the SLC and a Report published in 1999.^[17] The recommendations made in the 1999 Report were not implemented, however, after the Scottish Government conducted a public consultation about it in 2010. Instead the Government invited the SLC to reconsider the matter as part of the review of contract law in light of the DCFR.

26. Under Scots and English law between the end of the 19^th century and 2015, a distinction was made between clauses which genuinely pre-estimated the damages payable on a breach of contract, and clauses which did not. The former were referred to as liquidated damages and were enforceable, while the latter were referred to as penalty clauses and were unenforceable.

27. In 2015 the cases of Cavendish Square Holdings BV v Makdessi and ParkingEye Ltd v Beavis^[18] came before the UK Supreme Court and were heard together. The decision in these cases marked a significant development. While the Court resisted calls for abolition of the penalties rule, it made radical adjustments to the law in England and Wales and (it is generally accepted) in Scotland also. The new approach is that while as a matter of public policy the law sets its face against the imposition of a punishment of one contracting party (debtor) by another (creditor) by way of a penalty clause, it is no longer a general pre-condition of a clause’s enforceability that it be a pre-estimate of the financial loss which the creditor will suffer as a result of the conduct for which the penalty is incurred. While such a clause remains generally enforceable, the question is whether the clause offers protection for a legitimate interest of the creditor that is not extravagant, exorbitant or unconscionable.

28. The 2016 Discussion Paper examined these cases and the criticism that the decisions had attracted from both commercial law practitioners and academic lawyers. It suggested three options for reform and a clear majority of consultees favoured leaving the courts to develop the law further. The SLC therefore concluded in its Report that it should not recommend legislative reform of the rule ahead of seeing how the law develops after the Cavendish/ParkingEye cases. There is insufficient evidence that the decision is creating major difficulties in legal practice, while the judicially reformulated rule is still capable of striking down clauses seen as excessively penal in their effects.

Objectives

29. The objective of the SLC’s contract project was to ensure that the four aspects of contract law referred to in the section above were as clear, certain and up-to-date as possible. If parties negotiating a contract are being advised by lawyers, this enables the advice to be given with a reasonable degree of confidence; and this will also hold good where contracting parties in dispute about the contract’s meaning seek professional advice on the matter. However, many contracts are made, carried through, and become the subject of disputes between parties who have no professional assistance. For such parties it is even more important that the language of the law is clear so that it is relatively readily understood by lawyer and non-lawyer alike.

30. The Scots law of contract has largely developed by judicial decision and juristic writing. A disadvantage of this is that a relatively small legal system like Scotland may not produce sufficient case law to enable the law of contract to keep moving with the times, while the law’s accessibility to those without legal training or knowledge of its sources is limited. There are also problems of gaps (or incompleteness) in the common law and of differences of view between jurists as to what the law is. The first problem arises where there are no, or only very few, judicial decisions on a particular issue. The second may arise from the same difficulty, but it can also arise from decisions which cannot readily be reconciled with each other. The result can be varying analyses of the law by both judges and jurists, with no way for the user of the law to determine which view is to be preferred.

31. Therefore the aim in recommending both the statutory statement of the law of formation of contract and the reforms in the Report has been to produce rules that are as clear and certain as possible, in a form that is as accessible as possible, to lawyer and layperson alike. The Scottish Government has sought to remove rules that are no longer justified in contemporary conditions (for example, the abolition of the postal acceptance rule) and to supply ones suitable for these same conditions (such as when electronic communications take legal effect). The Scottish Government has also looked to produce clear answers on matters where differences of view have persisted over time with no resolution in sight (such as fundamental change of circumstances during contract formation). Finally the Bill seeks to fill gaps, or remedy incompleteness, where such difficulties seem to cause real problems for legal practitioners and others using the law.

32. An objective of the Bill is therefore to increase legal certainty and clarity in relation to the law of formation of contract and in relation to the reform of the areas of the law of remedies for breach of contract referred to above (and also congruent with what persons who may lack legal advice would reasonably expect the law to be). On the abolition of the postal acceptance rule and the statement of a rule on electronic communications, a further objective is the modernisation of the law.

33. The economic impact of the Bill is unlikely to be adverse and will, in some respects, be positive (see Benefits section below). A particularly positive aspect will be the removal of uncertainty in the law which could otherwise only be resolved by judicial decision obtained at the expense of litigating parties.

Formation

34. The most significant recommendations in the Report concern formation of contract. A clear majority of consultees who responded to the Discussion Paper on Formation favoured a statutory statement of the law of formation and abolition of the postal acceptance rule, both of which are provided for in Part 1 of the Bill.

35. A comprehensive statutory statement of the law on formation of contract will enable any party wishing to do so to know what steps Scots law requires for a contract to exist, and will be a visible demonstration of the Scottish Government's commitment to up-to-date business and consumer-friendly rules on the formation of contracts. One desirable effect of that might be the encouragement of parties otherwise unconnected to the system to contract under Scots law. Further, a large part of the statutory restatement of the law on formation will be to the same effect as the present law, meaning again that little if any change to current practice is needed.

36. The view noted above, that adverse economic effects are unlikely, is based firstly on the belief that the reform proposals in relation to such matters as the postal acceptance rule will simply bring the law into line with existing business practice, in which the rule is commonly excluded by parties. But it will remain possible for those who wish a contract to be concluded upon posting an acceptance (such as on-line traders), to provide for this in their terms of business. The provisions in the Bill, like the present law, are ‘default rules’ which leave it open to parties who wish to do so to set out their own rules as to how a contract is to be formed between them. Therefore if a party perceives a particular rule or set of rules to have adverse effects upon its interests in particular circumstances, that party could devise an alternative scheme to which the law would give effect, provided that any other parties involved submit to the scheme and it does not fall foul of any other legislation (for example, the law on unfair terms, which can also be relevant to non-contractual notices, or the law on capacity to contract).

Remedies for breach of contract

37. Further significant recommendations in the Report relate to individual reforms in some areas of the law of breach of contract. Part 2 of the Bill contains provisions on (a) aspects of mutuality of contract, (b) restitution after termination, and (c) contributory negligence.

Mutuality

38. As noted above, there is a need to clarify the law on when a party (A) in breach of contract may nonetheless make a claim of breach against the other party to the contract (B). In responding to the SLC’s proposal for reform of the law in this area in its 2017 Discussion Paper, the Faculty of Advocates commented:

“We consider that simply because Party A is in breach of contract does not mean that it is not entitled to treat any part of the contract as remaining in full force and effect. If the contrary was the case, this would result in a great deal of unnecessary practical complication.”

39. The Law Society of Scotland commented that a breach scenario can arise for a wide range of reasons and that party A in the above scenario should not be considered to have forfeited the right to pursue remedies arising out of party B’s breach and occurring before termination in respect of A’s breach.

40. The effect or objective of the reform is to clarify and simplify as far as possible this area of law and avoid confusion that has arisen from conflicting decisions of the courts on the matter.

Restitution after rescission

41. This too is an area of law on which there are inconsistent judicial decisions and differences of view amongst jurists and practitioners. The 2017 Discussion Paper considered it clear in principle that where parties have rendered performances under a contract but not received the reciprocal counter-performances, and the contract is then rescinded (terminated) for breach, there should be restitution of the performances in question. There was near unanimous agreement to this proposition from consultees. The Discussion Paper also asked whether, if consultees agreed, the system of rules set out on this matter in the DCFR provided a satisfactory clarification of the right approach to the issue. There was majority agreement to this also, albeit some thought that the DCFR drafting could be improved upon.

Contributory negligence

42. The 2017 Discussion Paper noted that it has been held that the Law Reform (Contributory Negligence) Act 1945 (“the 1945 Act”) applies as a defence to some but not all claims for breach of contract. On this approach, the contract-breaker’s breach must itself be negligent. The Report further notes an argument that the 1945 Act does not apply at all in breach of contract cases, and that the cases saying that it does are wrongly decided. If the first view of the present law is correct, its dependence on the nature of the breach before the other party’s contribution to its own loss can be taken into account leads to strange anomalies. The contract-breaker must argue that its breach constituted negligence while the other party must claim that it did not. If the second view is correct, there is potential unfairness in that a party’s contribution to its own loss cannot be taken into account in assessing the contract-breaker’s damages liability.

43. The 2017 Discussion Paper therefore suggested three different options to consultees: (i) leaving the courts to develop the present law in light of cases; (ii) introducing contributory negligence as a defence in purely contractual claims, but only where the debtor failed in a duty of reasonable skill or care; or (iii) introducing contributory negligence as a defence for all contractual claims. The Discussion Paper proposed proceeding with the third option and a majority of consultees agreed. For example, Morton Fraser commented that:

“We agree that contributory negligence should be introduced as a defence to all contractual claims”.

44. The Bill therefore amends the 1945 Act to extend the availability of contributory negligence as a defence, to all claims for breach of contract. The objective is to enable courts to take account of blameworthy conduct of a party which can be shown to have contributed to the loss it suffered alongside breach by the other party, whether the first party’s actions (or omissions) occurred before or after the breach.

Rationale for Government intervention

45. Left to itself, the common law in relation to formation of contract and the specified areas of the law of remedies for breach of contract which the Bill reforms can only be changed by decisions of an appropriate court and only if suitable cases arise.

46. The alternative is to introduce a modern, clear statute, which deals with all of the issues referred to above in a way not possible in any single court case. This is what the Bill does.

47. A majority of respondents to the SLC’s Discussion Papers on formation of contract and remedies for breach of contract also supported a comprehensive statutory restatement of the law in relation to formation of contract, the abolition of the postal acceptance rule and reform in the areas of (a) mutuality, (b) restitution after termination, and (c) contributory negligence. They were in favour of such a restatement and these particular reforms, largely to increase legal certainty and clarity and to simplify and modernise these areas of law.