Credit Management – Legal Issues

1 The nature of a contract

Definition

A contract is an agreement, supported by consideration, made with intention to create legal relations.

The essential elements within this definition are:

• Agreement. This requires:
  

  • An offer

  • Acceptance of the offer

• Consideration (something of value exchanged or promised)
  

• Intention to create legal relations (not just an informal arrangement)
  

• Capacity. This means that the parties to the contract must have the mental   capacity to enter into a legal agreement. For example, they must be old enough.
  

Offers

An offer is made by the offeror, who will be bound by that offer if it accepted by the offeree. Offers can be:

• Express, such as if you said to someone “I will sell you this car for $6,000.”
  

• Implied, such as bidding at an auction, or taking an item to a shop check-out and allowing it to be scanned and charged to your account.
  

Note that most contracts do not have to be in any particular form eg most can be oral as well as written. However, contracts for the sale of land, consumer credit contracts and certain a limited number of others have to be written.

An offer must be distinguished from an invitation to treat. This is where one party makes it known that they are ready to receive an offer. For example, products on supermarket shelves with prices attached do not constitute offers: these are invitations to you to offer to buy the articles by placing them in your basket and proceeding to the checkout. Similarly, sales adverts in catalogues, newspapers and on the Internet are not offers: they are invitations to treat.

Offers can be terminated by:

• Acceptance. Once an offer has been accepted by one person it is not then available to be accepted by another. Acceptance means that agreement has been reached.
  

• Rejection. Express rejection will terminate the offer but also any attempt to negotiate or making a counter offer is also rejection. Note that simply asking for more information does not count as rejection.
  

• Revocation (withdrawal) of the offer before it is accepted.
  

• Lapse. For example, the offeror had stipulated that the offer will lapse in five days if acceptance has not been received.
  

• Death of the offeror where the offer was for personal services ie only the offeror could carry out the contract.
  

• Failure of a condition that attached to the offer. For example, an offer to sell an item on credit subject to satisfactory credit references.
  

Acceptance

Acceptance must be unqualified and unconditional, otherwise it will constitute a counter-offer that will terminate the original offer.

Acceptance can be given in writing or orally or be construed by conduct, but silence cannot constitute acceptance. The offeree has to do something to indicate acceptance.

Consideration

Offer and acceptance are not enough to form a contract: consideration is also needed. This means that both sides of the contract must give to or do something for the other side (or promise to do so). The exchange of considerations could be:

• Money for goods
  

• Goods for goods
  

• Money for a service
  

• Money to escape an obligation etc
  

Consideration must not be in the past. Past consideration refers to value that was promised before the contract was negotiated. So, if you tidy an elderly neighbour’s garden and she then promises that she will then pay you $20, the payment cannot be enforced because tidying the garden was not dependent on receiving $20. The tidying is in the past.

An action to enforce a contract or to claim damages can only be enforced by someone who has given consideration.

The consideration given must have some value (sufficient) but does not need to match or be even close to the value being received (does not need to be adequate).

A deed can make a promise enforceable without consideration. It must make clear that it is intended to be a deed, be validly executed and be delivered as a deed. For an individual in England and Wales, execution normally requires a signature witnessed by someone who attests it; a seal is not required.

Terms, warranties and conditions

A term is any provision that is part of a contract. Terms specify the details about what each promised to do. Most terms are expressly agreed between the parties but there can also be implied terms.

Terms divide into conditions and warranties. A condition is vital to a contract and if breached will give the innocent party the right to repudiate (terminate) the contract and to claim damages. A warranty is less fundamental than a condition. The breach of a warranty will not cause the contract to end, but can give rise to damages.

1.1 Legal credit terms

• Agree and communicate the credit limit, due date, payment method, dispute procedure and any interest/security terms before supply. An invoice issued later does not automatically add new terms to an existing contract.

• For UK business-to-business debts, statutory late-payment interest is normally 8 percentage points above Bank of England base rate; an agreed contractual rate can alter the remedy. Check which terms and law apply rather than assuming every customer is subject to the same rules.

2 Misrepresentation

A misrepresentation is a false statement of fact or law which induces one party to enter into a contract.

The statement must be:

• False.
  

• Relating to fact or law.
  

• Induces one party to enter a contract.
  

Contracts based on misrepresentations are voidable, if wished, by the innocent party – meaning that the parties are returned to their original positions.

There are three types of misrepresentation:

• Innocent: the maker honestly believed the statement was true and had reasonable grounds for that belief up to the contract. Rescission may be available; a court may award damages instead of rescission.

• Negligent: the maker lacked reasonable grounds for believing the statement was true. An honest belief alone does not make the misrepresentation innocent. Damages and rescission may be available.

• Fraudulent: the maker knew the statement was false, had no belief in its truth, or was reckless about whether it was true. Damages and rescission may be available.

3 Breach of contract

This occurs when one party does not fulfill their obligations under the contract. There are some defences available (such as if the contract becomes illegal to perform), but generally a breach will lead to a remedy. Remedies are:

Damages: generally, monetary compensation for losses caused by the breach.

Specific performance: the court orders the party in breach to carry out their obligations.

Injunction: the court orders the party in breach not to break the contract (eg if an employment contract specified that a leaving employee must not work for a rival for 1 year).

Quantum meruit: the injured party can claim on the basis of work done under, say, an abandoned contract.

Action for the price: Where, under a contract of sale, the goods have passed to the buyer and the buyer neglects or refuses to pay for the goods according to the terms of the contract, the seller can take legal action against the buyer for the price of the goods.

Where the price is payable on a specified day irrespective of delivery and the buyer neglects or refuses to pay such price, the seller can take legal action for the price, although the property in the goods has not passed and the goods have not been appropriated to the contract.

4 Statute

The Sale of Goods Act 1979 applies to business-to-business sales. The Consumer Rights Act 2015 applies to business to consumer sales. This section of the notes applies to business-to-business sales as that is where credit arrangements between the parties is most common.

The quality of the goods sold must be satisfactory meaning that the standard that they meet a standard that a reasonable person would regard as satisfactory, taking into account the price, description and any other relevant factors.

If the purpose of the goods known to the seller, then the seller is obliged to make sure the goods provided are fit for that purpose, if it is reasonable for the buyer to rely on the seller's expertise.

An important alternative agreement on the transfer of ownership is a Retention of Title clause. This means that the supplier retains ownership of the goods until full payment for the goods has been received.

A retention-of-title term should be incorporated into the contract before supply and identify the goods concerned. It can help protect the supplier if goods remain identifiable and unpaid, but its wording and effectiveness matter; a signed clause does not guarantee recovery in insolvency.

5 Insolvency and bankruptcy

Insolvency occurs when an individual or company can no longer meet their financial obligations to lenders and suppliers as debts become due. Insolvency can arise from poor cash management, a poor business operation or plain bad luck (such as being hit by the effects of a global epidemic). Before insolvency proceedings are started, an insolvent company or person will probably try to reach arrangements with creditors, such as setting up alternative payment arrangements or exchanging debt for shares.

Insolvency describes a financial condition and can affect individuals or companies. In England and Wales, bankruptcy is a formal process for individuals; liquidation winds up a company. Assets may be realised and distributed according to creditor priorities, so an unsecured supplier may recover only part of a debt or nothing. Administration is a company procedure which may seek rescue. Debt release is subject to the procedure and does not mean every obligation automatically disappears.

6 Legal steps in collecting a debt

• Confirm that the debt is due, accurate and supported by the contract, invoice and delivery evidence. Remind the customer, resolve genuine disputes and consider a reasonable repayment plan.

• If informal steps fail, send the required pre-action demand and consider mediation or a court money claim. In England and Wales, small claims is a court procedure/track, not a separate court. A judgment may still require enforcement.

• Choose action proportionate to the amount and ability to pay. Insolvency procedures have special conditions and costs; obtain suitable advice before using them. Other jurisdictions have different rules.

7 Data protection

UK personal-data rules are governed by the UK GDPR and the Data Protection Act 2018, as amended. EU GDPR is a separate regime. Credit records about identifiable people, including sole traders and named company contacts, can be personal data.

Personal data includes relevant electronic records and structured manual records. Company information is not itself personal data, but information identifying people within those records can be.

Keep credit information lawful, fair and transparent; use it for stated purposes, collect only what is needed, keep it accurate, retain it only as long as necessary and keep it secure. The organisation must be able to demonstrate compliance (accountability).

• People have rights over their information, including access and correction. Erasure, objections and restrictions depend on the circumstances; a request does not automatically require deletion of records needed for a lawful purpose.

• Access to credit records should be limited to authorised staff. Explain their use, correct errors and protect shared data. International transfers must meet the applicable UK data-protection safeguards.

A lawful basis is needed for using personal data. Consent is one possible basis; it is not always required. Depending on the circumstances, managing a customer contract, complying with a legal obligation or legitimate interests can provide another basis. Choose and document an appropriate basis.

8 Chapter 13 questions

Question 1

What are the essential elements of a valid contract?

Question 2

What are the six ways in which an offer can be terminated?

Question 3

What is consideration?

Question 4

You gave a neighbour's daughter help with studying for an accountancy exam. The girl passed the exam and the family was so delighted that they promised to pay you for your assistance. However, after several months no money has yet been received.

Could you use contract law to enforce payment?

Question 5

An art gallery tells a client that they believe that the paintings of a new artist will substantially increase in value. This is their honest, genuine judgement On the basis   of this the client buys a painting, but subsequently its value drops sharply.

Is the art gallery guilty of misrepresentation?

Question 6

What are specific performance and injunctions?

Question 7

What is a retention of title clause in a contract?

Question 8

What is the GDPR?