The premise for the principle of freedom of contract is that the parties could make agreements on a wide variety of subjects and choose those terms that they agree as convenient for the fulfilment of the contract. Court normally refrain from questioning the substance of bargains and would ensure only that the parties have observed appropriate formalities. The principle of freedom of contract is similar to the civil law rule of pacta sund servanda that has regulated the domestic, international and transnational commercial agreements. While interpreting the contract, the courts have to be objective because in the process of interpretation the courts should not create new contracts. Courts would seek to ascertain either what the parties intended or if this is not forthcoming from the terms of the contract then apply the test of how the words would be understood by a reasonable person. Thus contract law is a series of abstractions formed by individual autonomy and judicial deference. But the principle is not unfettered. The legislations limit the scope of contract for protecting social welfare and consumer protection statutes. This gave the courts scope to develop exceptions which is discussed in detail in this paper.
Courts began to police the fairness of agreements, developing new doctrines like unconscionability that allowed them to intervene to protect parties with unequal bargaining power. The fact that the principle of freedom of contract continues to share the stage with competing principles should not be surprising. Law always reflects a community’s values and the continuing conflict in our societies between individual freedom and public control. The conflict is unavoidable in a liberal democracy and the best approach is to make reasonable compromise after a case by case analysis. The nature of such compromises will keep changing as the society’s interests evolve leading to the liberal or restricted application of the principle. In this paper the principle of freedom of contract is examined on basis of the hypothesis that the theory of freedom of contract leads the courts to passively enforce the intentions of the parties. In reality, however, the law of contract gives the courts scope to use discretion and do what is fair and reasonable between the parties. However the paper does not conclude that the principle has been watered down by interference from the court of law but has only assisted in exceptional circumstances when the bargaining power of the parties are not the same or when unreasonable and unconscionable contracts are formed. It would be anomalous to conclude that the principle of freedom of contract is far removed from practice. In fact where commercial agreements are entered into by equally competent parties the court do not read anything more to the contract than what was intended by the parties while entering into the contract. The paper examines the principle from general contract law perspective and also analyses special contracts such as the contract of sale, insurance, carriage of goods and agency.
The general principle of the contract law gives prominence to the concept of intention of parties when entering into a contract. This assumption leads to the development of the thought that the parties are individuals with reasoning and are free to enter into any form of contract so long as there is consensus. The intention of the parties is significant in determining whether there is consensus ad idem among the parties entering into the contract. The emphasis on the intention of the parties is logical where a term is implied in fact.
Under common law any person is entitled to exercise any lawful trade subject to restraint of trade for public policy reasons. This doctrine extends to contracts restricting the way in which a tradesman carries on business on a piece of land, and to restraints imposed by the rules or practices of professional or other bodies controlling particular activities. In Petrofina (Great Britain) Ltd v Martin, it was held that the agreement which restricts the supply of motor fuel only to one particular supplier was valid because it did not affect public policy and parties have voluntarily entered into the contract. The doctrine of restraint of trade whether partial or general restraint, will be good only if they are reasonable and is within the circumscribed limits of the interest of the public, the covenantee and the covenantor. Any restriction upon the freedom of contract to which the restraint of trade doctrine applies must be shown to be reasonably necessary for the purpose of the freedom of trade. A restraint reasonably necessary for the protection of the covenantee must prevail, unless some specific ground of public policy can be clearly established against it. In Russell v Amalgamated Society of Carpenters and Joiners where the area from which the employers, not parties to the agreement, could obtain workmen was held unreasonably restricted.
The principle of freedom of contract and the enforcement of contractual promises against the promisor arises out of the economic necessity of compelling observance of bargains and the moral justification that promise was freely given. The evolution of this principle can be traced back to the Slade’s case where the action of assumpsit (where the essence of the undertaking was considered while interpreting commercial contracts) was applied. The action of assumpsit was abolished in the 19th century and left behind the principle of the freedom of contract which evolved over the years with some carve outs and exceptions. The courts still consider the principle of the freedom of contract vital but certain assumptions need to be fulfilled such as equality of bargaining power and legality of the contract. Also to some extent, the law has interfered with or excused a party from literal performance of his promise. This is especially true when we consider the doctrine of frustration. Nevertheless it remains generally true that the law of contract does not lay down rights and duties, but rather imposes a number of restrictions subject to which the parties may create by their contract such rights and duties as they wish. Much of the litigation is for determining the construction of the contract to determine what the promisor promised. The earliest case law on the freedom and sanctity of contract was in 1795 in Cutter v Powell where a seaman who was to be paid his wages after the end of a voyage died just a few days away from port. His widow was not able to recover any of his wages because he had not completed performance of his contractual obligation.
The civil law principle of pacta sund servanda means the promises and prior commitments must be fulfilled and is similar to the principle of freedom of contract. Pacts and clauses are law between the parties and imply that the non fulfillment of respective obligations is a breach of the pact. The role of the courts is minimal to balance the principle of freedom of contract and protect the weak contracting parties.
Giving efficacy to a contract
While giving efficacy to contracts, the courts have construed the intention of parties but the courts do not cross the line and create new contracts thereby giving any one of the contracting party a new advantage. A term is implied where it is necessary in the business sense to give efficacy to the contract. The well known tests for construing the contract are:
- the intention of the parties; or
- the test of a reasonable person.
The intention of parties test bolsters the principle of freedom of contract as the courts would be enforcing obligations on parties as envisaged at the time of entering into the contract. However the second test i.e.: the reasonable person test somehow stands antithetical to the principle of freedom of contract. The test may find use under certain peculiar circumstances, reflecting implications in law.
An implied warranty or a covenant in law, as distinguished from an express contract or warranty is really founded on the presumed intention of the parties, and upon reason. The implication which the law draws from what must obviously have been the intention of the parties is drawn with the object of giving efficacy to the transaction.
The importance of good faith
During the 19th century the English courts had a much more relaxed attitude towards the good faith and other elements of the contract, holding the freedom of contract principle as the sine qua non for parties to deal with the promises made. The courts now strike down agreements on the grounds of illegality, incapacity, mistake, duress, misrepresentation, implied terms, frustration and unfairness. Using the principles of equity, the courts have diminished the severity of the common law principle. The courts look beyond the form of the contract and look at the intention of the parties to construe a contract. According to Professor Summers, the American Restatement bestows a general and residual duty of good faith contractual performance which may be enforced in the absence of any more specifically exigible contractual provision or statutory superimposition. But this argument is not without criticism. Without the backing of the good faith principle the principle of freedom of contract would seem unfettered where the parties are free to write their own contracts and that the law does not have a role to import any terms or conditions other than those expressly agreed or necessarily implied by the parties.
The courts have time and again interfered with the terms of the contract even in the absence of duress or undue influence if the terms of the contract are harsh or unconscionable. It not just sufficient to establish that one party has a better bargaining power. It has been held in Burmah Oil Co v Bank of England that equity will not intervene merely because one party has superior bargaining power. There should be some form of economic duress or unilateral mistake as to the terms of the contract. Under English law, relief is given to one, who without independent advice, enters into a contract on terms that are very unfair or transfers property for a consideration which is grossly inadequate, when his bargaining power is grievously impaired by reason of his own needs or brought to bear on him by or for the benefit of the other. There were views based on the thesis that in order to interfere with the principle of freedom of contract on the grounds of unconscionable bargain, there should be statutory basis such in the case of unfair consumer trade practices, extortionate credit bargains, swinging exclusion clauses and unfair terms. But subsequent case law decided by the Court of Appeal suggests that the exception to the principle of freedom of contract to protect weaker contracting party (inequality of bargaining power) has survived. The remedies available in respect of unconscionable bargains are subject to the same rules as applicable under undue influence that was laid down in Allcard v Skinner. A party will not be granted relief against an agreement on the basis of unconscionable bargain unless he can show impropriety by the other party in the manner in which the agreement was reached and the terms of the agreement.
In Boustany v Pigott, the Privy Council laid down the following principle. It is not sufficient to attract the jurisdiction of equity to prove that the bargain is hard, unreasonable or foolish. The party claiming unconscionable bargain has to prove that the contract is unconscionable in the sense that one of the parties has imposed an objectionable term in a morally reprehensible manner that is to say in a manner which affects his conscience. Therefore unconscionable does not just reflect the terms of the bargain but looks at the behavior of the stronger party which may be tainted by moral culpability or impropriety. Unequal bargaining power or objectively unreasonable terms does not provide a basis for equitable interference in the absence of unconscientious or extortionate abuse of power. As a matter of fairness the strong should not be allowed to push the weak to the wall. Thus a contract cannot be set aside as an unconscionable bargain against a party who is not guilty of actual or constructive fraud. Even if the terms of the contract are unfair in the sense that the contract favors one party more than the other party, equity will not provide any relief unless the beneficiary is guilty of unconscionable conduct. The party seeking the relief must establish unconscionable conduct viz. that unconscientious advantage has been taken resulting in a disabling condition or circumstance.
Unreasonable conditions in the contract of insurance
A stipulation in a policy may be capricious or unreasonable leading to non enforceability of a fundamental term of the contract. This view does not reconcile with the principle of freedom of contract under English law. This exception is however relevant when the contract terms concluded between an insurer and a consumer is unfair. A condition in an insurance policy which is contrary to public policy is unenforceable, for example a condition by which the insurers impliedly undertake to pay the insured’s personal representatives if the insured under a life policy kills himself while not mentally disordered. But a condition that prevents the policy holder from joining military services is not against public policy i.e.: it cannot be considered that exclusion of cover to a person joining military services cannot be deterrence from performing national duty. Where the conditions are such that it is impossible to perform the conditions from the outset then such conditions are simply disregarded as they are a nullity.
‘Subject to contract’ term
‘Subject to contract’ is a phrase which points to a prima facie evidence for declaring that a concluded contract does not exist. The circumstance in which the parties may enter into such agreement arises when all the terms have not yet been negotiated and agreed. This allows a huge scope for thorough negotiation among contracting parties. However when analyzing some of the case laws one gets an impression that the courts have at times entered into the realm of contracts and added new dimensions to the agreements. In Boyle v Lee, Finlay CJ (Hederman J concurring) and O’Flaherty J held that there was no concluded contract because the parties did not agree everything they thought essential. In Embourg case it was held by a unanimous judgment that a contract stated in the documentation such as the estate agent’s and the solicitor’s letters as subject to contracts until the contract is exchanged between the parties and meant that no binding contract came into existence because no exchange was made. This was the view the court took despite the fact that both the parties had signed the copies of the formal contract drawn up by the vendor’s solicitors. However a more liberal view was taken in Moran v Oakley Park Developments Ltd where it was held that contract will be enforceable under the doctrine of part performance if the court is satisfied that a concluded oral agreement has been reached between the parties to the contract.
Therefore the phrase ‘subject to contract’ purports to deny the existence of the concluded contract and protects the parties in negotiations. The Law Reform Commission also considered the possibility of enforcing such agreements. After examining the implications on the freedom of contract principle the Commission felt that if an agreement were to be enforced as soon as the price were agreed, there would have to be some mechanism for settling other terms. The Commission noted that the Working Group on Land Law and Conveyancing Law had failed to come up with a statutory set of conditions and that a court or arbitrator would be able to settle terms in simple cases only. Generally such phrases like ‘subject to contract’ are seen in contracts of sale.
The contract of sale allows for contracting out of the implied terms by express provisions and this is recognized as valid under the Sale of Goods Act 1979. Most of the implied terms deal with the quality of the goods. Under the Sale of Goods Act there are implied terms relating to the title to the goods for the vendor, terms regarding quality and fitness, sale by description implies that the goods match the description and in cases of sale by sample the goods are to match with the sample examined by the purchaser. Under the Supply of Goods and Services Act 1982 there is implied terms relating to care and skill, time of performance and consideration.
The habit of ousting the implied terms by express contractual provision had become a widely practiced technique at all levels of commerce, and had received a steadily growing impetus from the ubiquitous appearance of standard contracts on the economic scene. In fact restrictions preventing the use of exemption clause for contracting out of implied terms in a contract of sale can be seen only in cases of consumer sales. However attempts to contract out of the implied term with respect to the title of the property were held to be void in all contracts of sale. Thus a term excluding or restricting the seller’s liability for breach of any of the implied terms would not be enforceable to the extent that it is shown that it would not be fair or reasonable in the circumstance of the case to allow reliance on such terms.
Contract of sale of goods
The sale of goods is an important branch of the contract law which deals with the sale and purchase of movable assets and relies heavily on the principle of freedom of contract. The seller and buyer normally enter into a contract, oral or written for performing their respective obligations for the purpose of concluding the transaction of sale. The principle of freedom of contract was preserved by the Sale of Goods Act 1893 where it is expressly provided that any right, duty or liability arose under the contract of sale by implication of law could be negatived or varied by express agreement or by the course of dealing between the parties or by usage, if such usage can bind both the parties to the contract. This provision was retained in the subsequent Sale of Goods Act 1979. But the 1979 Act further limited the application of the principle of freedom of contract by subjecting it to the Unfair Contract Terms Act 1977 which limits the extent to which the parties to a contract may negative or vary the rights, duties and liabilities arising there from. This principle also finds place in the Supply of Goods and Services Act 1982.
The concept of consumer protection gives a different twist to the principle of freedom of contract. Laws that attempted to enforce fair trading was formulated to protect an honest trader from other unfair competing traders. In a consumer level transaction there is significant difference in the bargaining positions of the buyer and the seller. There is no statutory definition for the term ‘consumer’ and in the European Union law the term ‘consumer’ is usually limited to any natural person, under English law the term ‘consumer’ is not limited to individuals under the Unfair Contract Terms Act 1977. Even the Consumer Protection Act 1987 contains no statutory definition of the term ‘consumer’. By virtue of the Unfair Terms in Consumer Contracts Regulation 1999, ‘consumer’ means any natural person who is acting for purposes which are outside his trade, business or profession.
Standard form contracts
The commercial organizations may normally have standard form contracts where the terms are already laid down and it is expected that the party contracting with the commercial organization has to enter into the standard form contract. In such a circumstance there is no scope for any form of negotiation and the principle of freedom of contract is has no application except to the extent that the party may exercise discretion to refuse to enter into the standard form contract. In many cases the standard form is formulated by the trade association or as laid down in the statute. These standard terms may further be circumscribed by the concept of public policy.
To an extent the standard form of contract helps to save time and allocate risk appropriately in commercial transactions. Such contracts commonly have certain boiler plate provisions such as the clauses relating to arbitration, consideration, choice of laws, definitions, exclusions, force majeure etc. Since this arrangement affects free negotiability of the terms of the contract, standard forms are subject to the test of reasonableness and some exclusion clauses limited or abrogated.
The exclusion clause is found in a contract where the parties wish to exclude statutory provisions under certain circumstance. Even if the statute does not deal with the status of the exclusion clause, there is no general rule that the courts can interfere to prevent giving effect to the exclusion clause if there is nothing unreasonable or unconscionable. But such exclusion clauses cannot protect a person from his own frauds. Even though the courts do not have a general power to strike out exclusion clauses, the following are some of the situations where the courts of law felt that it was appropriate to interfere with the principle of freedom of contract.
- A contracting party seeking to rely on an exclusion clause to save himself from liability in contract or tort to the other contracting party must show that it was incorporated as a term of the contract, which usually involves the taking of reasonable steps to bring it to the notice of the other party.
- Similar principles of incorporation of the terms of the contract apply to the exclusion by non-contractual disclaimer of tort liability.
- An exclusion clause is to be construed strictly against the party who introduced it and seeks to rely on it (the contra proferentum rule);
- Whether a clause amounts to an exclusion clause is a matter of substance and effect, so that a similar attitude is taken to indemnity clauses inserted for the same purpose.
- There is no objection to the public policy grounds to excluding rights of set-off.
- If an equitable remedy is sought, the discretion of the court cannot be fettered by a contractual provision.
- Where there is a contract between A and B containing an exclusion clause, a third party, X, will not be allowed to shelter behind the clause in the absence of clear evidence that he is a party to the contract and that the clause was intended to protect him. Similarly the burden of an exclusion clause in such a contract will not generally be imposed on him.
- The courts may either seek to establish the effect of the contract as a whole, taking into account the exclusion clause in defining the obligations of the parties or the exclusion clause may be regarded as a defence, in which case the court might establish the prima facie ambit of the contractual obligation without the exclusion clause and then consider the effect of the exclusion clause on that prima facie liability.
- The exclusion clause should be clear to give effect to and to deprive one of the contracting parties of all contractual force with respect to the stipulations in the contract.
The task of the courts has been to look at the event and the consequent breach in order to ascertain from the words and conduct of the parties which created the contract between them what their presumed intention was and what should be their legal rights and liabilities whether they should be either original or substituted upon the occurrence of an event of that kind. The basis for the interference to the principle of the freedom of contract is only to the extent of deriving the intention of the parties and determines what was actually excluded and what were retained.
Under the law of equity, the contracting party is relieved from the penalty clause where the intention of the penalty is to secure the payment of a sum of money or the attainment of some other object, and when the event based on which the penalty is made payable can be adequately compensated by payment of interest or otherwise. The true ground of relief against penalties arises from the original intention of the parties in the case. In Photo Production Ltd v Securicor Transport Ltd it was held that an agreement must not impose upon the breaker of a primary obligation a general secondary obligation to pay to the other party a sum of money that is manifestly intended to be in excess of the amount which would fully compensate the other party for the loss sustained by him in consequence of the breach of the primary obligation. In Jones v Society of Lloyds, Lloyds devised a reconstruction and renewal settlement offer to provide financial assistance to Lloyd’s names in meeting their accrued liabilities to Lloyds. The settlement included a ‘finality amount’ which was a sum, less than the amount owed by the name, that was required to be paid in order to discharge their liability to Lloyds and a clause in the agreement provided that if an accepting name failed to pay his finality payment then the settlement credits would be lost and he would, therefore, be required to pay the entirety of his liability. It was held that the mechanism was a reverse of the penalty clause and that it was a conditional benefit.
Penalty clauses do not find favor before a court of law where it related to penalty in a money bond, payment of money by installments such as hire purchase agreements or for doing or omitting to do a particular act. There should be sufficient reasons for the court to interfere with the freedom of contract and will not generally, merely because a person has made an improvident contract, relieve him from its consequences. The relief is granted only where compensation can be made for the breach.
The power to strike down a penalty clause in a contract does not reconcile with the principle of freedom of contract and is designed for the sole purpose of providing relief against oppression for the party having to pay the stipulated sum. It has no application in the cases where there is no oppression. Equity and common law allows interference where the contract is unconscionable or oppressive. Such circumstances arise as a result of :
- the degree of disproportion between the stipulated sum and the loss likely to be suffered by the plaintiff. This factor is relevant for determining the oppressiveness of the terms of the defendant.
- the nature of the relationship between the contracting parties. This factor is relevant for determining the unconscionability of the plaintiff’s conduct in seeking to enforce the penalty clause.
Before such relief is granted, the courts have to ascertain whether the sum specified in the contract as payable in the event of breach of contract is a penalty or liquidated damages, that is whether at the time of entering into the contract the predominant contractual function of the provision was to deter a party from breaking the contract or to compensate the innocent party for the breach of contract. In Nutting v Baldwin