Businesses need to know if they have entered a contract or if a condition has been fulfilled for a contractual obligation to become effective. That’s why it’s important that those tasked with negotiating and enforcing your commercial contracts know what is meant by a ‘condition precedent’, and what is required of your business or the other contracting party to fulfil the condition precedent.
- What is a condition precedent?
- What is a condition subsequent?
- What happens if a condition precedent is breached?
- Why use conditions precedent in commercial contracts?
- Examples of conditions precedent
- The wording of a condition precedent in a commercial contract
- Issues to consider when using conditions precedent
What is a condition precedent?
A condition precedent is a condition of a contract which must be fulfilled for either the contract to be valid or certain contractual obligations to come into effect. As a result, it is vital that the parties to a contract understand what is meant and required by any conditions precedent and that they agree what will happen if such conditions are not satisfied. Failure to understand a condition precedent could result in a commercial dispute, so it’s best to take the time to understand condition precedents and how they could impact your specific contractual arrangements.
What is a condition subsequent?
The satisfaction of a condition precedent results in the contract or a certain obligation in the contract becoming valid and binding. However, a condition subsequent has the opposite effect. Where there is a condition subsequent a contract which is already valid, and binding will terminate if the condition subsequent is not satisfied.
What happens if a condition precedent is breached?
If there is a breach of a condition precedent (that is, a failure to satisfy the condition) the contract or certain contractual obligations will not come into force. In some situations, failure to meet the condition precedent means there is no binding contract.
Normally, if a party breaches a term in a contract it will result in them being liable to pay damages to the non-breaching party. Where a contract has been breached, the contract will usually still be valid and binding and the commercial position of the parties under the contract will not change. The situation is to be contrasted where there is a suitably drafted condition precedent in a contract. For example:
- Contract without condition precedent - damages payable
Party A enters into a contract with Party B and a term of that contract states that Party A will provide £1million to Party B for use in research and development, and that such sum is to be paid by a certain date. The contract, having been signed, is valid and binding on both parties. Party A fails to pay the money to Party B. Party A is therefore in breach of the contract. Party B is entitled to claim for damages which will place them in the financial position in which they would have been had the contract been properly performed, that is, if the payment of £1million had been made by the contractual date.
- Contract with a condition precedent
Party A enters into a contract with Party B and the payment provision states that the contract is conditional upon Party A paying £1million to Party B for use in research and development, and that such payment to be made by a certain date. Again, the specified date passes, and Party A doesn’t make the payment to Party B. In this case, because the condition has not been satisfied, the contract is not effective, and no further action is required (unless certain clauses are stated to be binding notwithstanding non-satisfaction of the condition).
Why use conditions precedent in commercial contracts?
The use of condition precedents is crucial if you are a contracting party and some matters are outside your control or power. That’s because ordinarily, a breach of contract would result in the non-breaching party bringing a claim for damages against the party in breach. A condition precedent can be used where the payment of damages would not adequately compensate the non-breaching party, or where failure to satisfy the condition precedent means that the contract would be irrelevant.
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Examples of conditions precedent
Conditions precedent come in various guises and can be used in many different types of contracts. Here are some examples of condition precedent:
- The contract or certain obligations under it may be dependent on third party consent being obtained. For example, from a local authority, the FCA or shareholders.
- Financing arrangements, such as a loan agreement, may be required to be in place before the contract or certain obligations under it can take effect.
- Loan agreements that require various conditions to be met before the borrower can drawdown under the facility.
- Inter-related contracts with one contract being conditional on another being entered into. A sub-contract may require the main contract to be awarded to a certain party before it can take effect, or a transfer agreement may only become effective once an asset purchase agreement has been executed.
- Liability or claim clauses may include conditions precedent. Failure to satisfy a requirement to provide notification of the claim within a certain time period could prevent the bringing of the claim. If there is a condition precedent in a liability or claim clause commercial solicitors recommend that specialist legal advice is taken as quickly as possible, the aim is to preserve your rights and to avoid any commercial disputes over whether the claim procedure was correctly followed.
The wording of a condition precedent in a commercial contract
Although the decision about whether to include a condition precedent in a commercial contract is a business decision, it’s crucial that the condition precedent is carefully drafted by your commercial solicitor and that your business understands exactly what is meant by the condition precedent and how it is triggered.
A number of factors need to be thought about and documented when dealing with conditions precedent. Poor or unclear contract drafting, or failure to include key components, can result in the courts having to decide what the parties intended. In the event of a commercial dispute leading to court litigation the court will consider the contract on a case-by-case basis, looking at the circumstances to determine if the parties intended the obligation to be either a condition precedent (breach of which would result in the contract having no effect) or a contractual term (breach of which would result in damages).
To reduce the risk of commercial disputes the wording in the contract must be both clear and certain about:
- Whether there is a condition precedent.
- the nature of the condition precedent and exactly what must be done to fulfil the condition precedent.
- the consequences of not fulfilling the condition precedent.
The use of the phrase ‘condition precedent’ is not strictly required in the contract for something to amount to a condition precedent, but considering case law it is usually advisable to include it. In addition, consistency throughout the document whenever a condition precedent is referred to is also key to minimising the risks of disputes over condition precedents.
Issues to consider when using conditions precedent
It is important that the parties to the contract agree with the inclusion of a condition precedent condition in the contract and understand what is required of them and when as failure to satisfy a condition precedent can have profound consequences.
The main points to consider when using a condition precedent are:
- What is the condition?
This needs to be clearly set out so that each party is on the same wavelength as to what is required. For example, is it to obtain £X amount of funding or is the condition precedent to obtain £X amount of funding by way of a bank loan? It is imperative that the terms of the condition are clearly drafted to avoid the courts having to second-guess the parties’ intentions.
- Are certain steps to be taken to fulfil the condition and should evidence of these steps be provided?
Setting out the steps required to fulfil the condition may, in some cases, be helpful and assist the parties to understand exactly what is required of them. However, you should not assume that setting out the explicit steps required to fulfil a condition precedent will always be to your advantage. In some cases, stating the desired outcome may be enough with the parties being able to reach that outcome any way they choose. Evidence of the steps taken by a party to satisfy the condition could also be a requirement in the contract, but consideration should be given to whether this is necessary or will just create additional work for your business.
- Does the condition precedent have to be completely satisfied or can the parties use best or reasonable endeavours?
The use of ‘endeavours’ wording can also have important consequences and so specialist commercial legal advice should be obtained before agreeing to such wording. Read our article on Interpreting Endeavours Clauses for further information.
- What is the deadline to fulfil the condition?
A date the condition must be fulfilled should be agreed. Failure to include a date will result in the condition having to be satisfied within a reasonable time. The definition of ‘a reasonable time’ will be decided on a case-by-case basis and so leads to uncertainty for the parties.
- Who decides whether the condition has been satisfied and how?
Can satisfaction of the condition be determined by one of the contractual parties or is documentary or other evidence required? This depends on the actual condition as, for example, receipt of third party written consent may be sufficient to satisfy the condition precedent that a third party has given their consent without needing the other contracting party to agree that the condition precedent has been met.
- What happens if the condition precedent is not satisfied?
Failure to satisfy the condition precedent can lead to the contract not becoming effective, but this needs careful consideration. A commercial solicitor can advise on whether the entire contract will fall away or if certain conditions, such as confidentiality, should survive despite the condition precedent not being met. Alternatively, the contract could be drafted for the contract to terminate immediately on failure to satisfy the condition precedent or to enable one party to choose to terminate the contract. You will also need to consider if it is in your business interests for one party to be able to waive the condition precedent requirements, resulting in the contract becoming binding, despite the condition not having been satisfied or enabling them to agree an extension to the condition deadline. Consideration should also be given as to whether one party must compensate the other for any costs incurred as a result of non-fulfilment.
The use of conditions precedent in a contract can be advantageous, particularly where the obligations are onerous or pivotal to the agreement. You should ask your commercial solicitor to carefully consider their use and the precise wording of each condition precedent to best protect your business interests.