Understanding Subject to Contract

It is commonly thought that if one party has signed a tenancy agreement then the party that has not signed is not bound by it. However, if the parties have clearly agreed to a tenancy a verbal agreement is sufficient to create a tenancy, the signature is merely agreeing the terms of this agreement.

To avoid this occurring it is common to use a phrase such as “Subject to Contract”. This also means that any other discussions or offers made are subject to their incorporation in the final lease agreement. However, there are some consequences if 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 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 received 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.

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.

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
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