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Understanding ‘Subject to Contract’

We are often asked whether or not an agreement for a tenancy has come into effect when only one of the parties has signed it or some other variation on this theme has occurred. It is commonly thought that if only one party has signed then the party that has not signed is not bound by the agreement. If the parties have clearly agreed to a tenancy and that has been reduced to writing then the fact of a signature is irrelevant. The verbal agreement is sufficient to create a tenancy.

To avoid this occurring it is common to use a phrase such as “Subject to contract” or “Subject to lease”. This also means that any other discussions or offers made are subject to their incorporation in the final lease agreement. However, there some other consequences of the use of this phrase which are not so favourable and it may not always be the best course of action.

First it is worth examining precisely what the Courts understand the situation to be when the “Subject to Contract” formula is used. The Courts construe the formula in accordance with the conveyancers understanding of the phrase. This is that a negotiation for a conveyance of land which is expressed to be ‘subject to contract’ is not complete until there is an exchange of contracts. There is an entire set of procedures for such exchange which are set out and agreed between solicitors. It is this position that allows for such situations as ‘gazumping’ where the seller suddenly pulls out of a deal because they have had a higher offer. In the case of Salomon v Akiens, the Court of Appeal had to consider whether this formulation should also be applied to a lease agreement. The Court was clear that there was practically no circumstances in which a negotiation for a lease should be seen as any different from that for a sale and therefore the ‘subject to contract’ formula should apply equally to both.

Practical Consequences
What does this mean in practice? In the case of Longman v Viscount Chelsea the Court made clear that this means that the “relationship does not become binding … until there is an exchange of lease and counterpart, before which either party can withdraw”. In other words, until both the landlord and tenant have signed the agreement, the agreement has been executed, and the signed agreement has been passed to the other side then either party is free to withdraw without any penalty whatsoever.

Ending the Formula
Of course, there are other ways in which the ‘subject to contract’ formula can be dealt with. The parties could agree that the formula should no longer apply which is a common device in commercial or high-value leases where the parties will enter into an agreement to make an agreement. Alternatively, the parties can perform an action which sets the formula to one side. The most obvious of these is provision of the keys and the acceptance of rent and deposit payments. The formula comes into force once either party expresses an offer or acceptance of an offer as being ‘subject to contract’ and will remain in force even if following correspondence does not bear the same formulation until it is specifically brought to an end as described above.

Recovery of Expenses
The use of the formula also has implications for the recovery of costs and expenses. Where a party expends monies on the basis of an agreement which is subject to the formula it will be very hard to recover any monies expended on the basis of that agreement. As the High Court made clear in Regalian Properties v
London Dockland Development Corpn
each party must accept that any monies spent are a calculated risk and there will be no recompense if no contract results. This is not to say that agents cannot take steps to ameliorate this risk and a well- drawn up holding deposit agreement is a great help in this regard. Despite the fact that costs cannot be recovered in respect of actions taken under a belief that a contract that is subject to the formula was to be entered into there is no reason why a separate agreement taking a holding deposit from an applicant cannot be enforced. Such an agreement would typically cover the costs of referencing, preparing the agreement and would therefore protect the landlord from incurring agents costs with no prospect of recovering them. Such an agreement has the added benefit of ensuring that the agent will be paid for their time as well!

Other Formulas
There are other, more limited, formulas of a similar nature which may also be of value. The most commonly seen of these is probably ‘subject to references’ or some such phrase. This will have an effect similar to the ‘subject to contract’ formula but will be more limited and will effectively expire once satisfactory references have been received or the parties make clear that they have moved beyond that stage. By choosing to ignore them and agreeing a finalised contract, for example. The exact point at which these more limited formulas cease to be effective is not as certain due to the lack of Court decisions on the topic. In each case it will have to be decided at what point it was intended that the formula should come to an end and whether actions were taken to make it clear that it should no longer be effective.

Overuse
Some agents use the ‘subject to contract’ formula everywhere. This is bad practice and quite dangerous. In Shirlcar Properties Ltd v Heinitz the landlord sought to give notice to trigger a rent review contained in a tenancy agreement but used the phrase ‘subject to contract’ in the letter giving the notice. The review notice was held to be invalid because the tenant could not know if the landlord was bound to accept the higher rent proposed in the notice. Therefore the use of this formula where it throws doubt on the contents of the communication is very dangerous.

Practice Points
Agents should consider in every case what is best for their client. In higher value properties where the landlord is unlikely to wish to pull out of the deal unexpectedly it may be best to avoid use of the ‘subject to contract’ formula to ensure that the tenant is tied into the contract as early as possible. In other circumstances, where the landlord is uncertain of the tenant or may want to pull out of the deal it may be wise to use the formula in order to preserve the landlord’s position. Alternatively, it might be best to start negotiations ‘subject to contract’ but then agree at a later stage that the deal is finalised and that the formula should no longer apply, although this may be difficult where a deal is moving fast. As always, agents should take great care in the representations they make and how they are made to avoid invoking or rescinding the formula unintentionally. Equally, agents should not use the formula across the board by including it in all emails or letters by default.

Points to note

  • Once the Subject to Contract formula has been invoked it will stay in force until it is specifically rescinded or the lease or tenancy has been signed and exchanged.
  • Either party can withdraw from the contract without penalty while the formula is in force.
  • Agents holding deposit agreements are not affected and therefore recovery can be made from this for expenses such as referencing etc.
  • The formula should not be used automatically in every case and should be tailored to the specific requirements of each letting.
  • Make sure you have a solid holding deposit agreement setting out what charges the tenant is liable to pay.
  • Don’t use the formula where it is not appropriate

Scotland

The position regarding the use of ‘subject to contract’ in Scotland is rather different. Scots law tends to allow contracts to be created rather more easily than is the norm south of the border. It is also rather less enamoured of the ‘subject to contract’ formulation. In Erskine v Glendinning it was held that an acceptance of a deal which was qualified “subject to lease drawn out in due form” was entered into notwithstanding this phrase. Therefore, the use of ‘subject to contract’ remains a phenomenon which applies south of the border only.

5 Comments

  • Kay 20th October 2010 at 9:33 am

    We agreed over the phone to a tenancy agreement with an agency and are supposed to go in to the office on Saturday to sign the contracts and pay the first months and deposit.

    However we have also put an offer on a house that could be available for us to move in next month. If our offer gets accepted, we would not to rent.

    We’ve received a letter today stating our appointment and the money we need to take.

    At the top it says “Subject to Contract”

    If I have read correctly in this blog this means we can legally pull out without any come back from the agency.

    Am I right?

    Anyone??

  • PainSmith 21st October 2010 at 9:08 am

    You can pull out before you sign the agreement with no comeback by the landlord. However, if you have a holding deposit agreement with the agent then that may require you to pay monies.

  • confused 21st April 2011 at 6:48 pm

    Hi, Im a landlord who has vebally agreed an offer of rent and the tenant/applicant has paid the holding deposit – which has been returned. The agreement was subject to references which has not been processed as of yet because i have decided to still remarket the property again to obtain a higher rent. Does this mean that the agreement is concrete – and that i need to commence a tenancy with this tenant?

    Please help

    Many thanks

    Munna

    • PainSmith 27th April 2011 at 8:25 am

      I am afraid that based on what you have written I can not say. A agreement does not have to be in writing to be binding. So if you offered a tenancy and upon that promise the perspective tenant acted to his detriment i.e. gave notice at his current place then yes he may have a tenancy. If you are unsure I would go speak to the CAB or a local solicitor.

  • Steve 24th May 2013 at 5:56 pm

    The last comment was a long time ago so I don’t know if this will receive a response but I wonder if you could help. I flew to Scotland, viewed a flat through a letting agent, applied for the flat & was offered the property. I paid a holding deposit, had my ID photocopied, completed the required forms and was told the property was taken off. I have now been told the landlord has chosen to rent the flat to someone they know. Have we already entered a contract? I start a job in 2 weeks and have no way of travelling back to Scotland from England to find a new place in time.

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