The incorporation of terms into a contract

In commercial transactions, it is quite common for a contract to incorporate terms from another contract or document instead of stating them in full in the contract itself. This saves time and reduces the length of contracts. This column looks at how this is done and some of the challenges that arise under common law and Chinese law, particularly when a contract incorporates standard terms prepared by one party.

A term may be incorporated into a contract either on an implied basis or an express basis. An example of implied incorporation is where the parties to a contract for the sale of goods or services have established an ongoing business relationship through a course of dealings, and the relationship is regulated by a set of agreed terms (either written or unwritten).

Express incorporation occurs where a contract expressly states that the terms from another contract or document will be incorporated into, i.e. become part of, the contract. An example is where two commercial parties enter into two or more contracts and the terms of one contract – e.g. the governing law and jurisdiction clause – are incorporated into another contract:

Clauses 18 (governing law) and 19 (jurisdiction) of the Loan Agreement are incorporated into this Deed, except that references to “Agreement” are replaced with “Deed”.

Another example is where a sublease incorporates the terms of the head lease:

The terms of the head lease are incorporated into this sublease, except as varied in schedule 2 of this sublease.

Incorporation of terms also occurs on an indirect basis when a party to a contract agrees to perform the obligations of another party under another contract, as is the case when a subcontractor in a construction project agrees to perform the obligations of the head contractor as follows:

We confirm that we will perform your obligations under the [head contract] insofar as they relate to the subcontracted work as though we were a party to the [head contract].

A couple of challenges arise when terms are incorporated into a contract:

• Which terms are incorporated?
• What should happen in the event that there is an inconsistency between the incorporated terms and the terms of the contract into which they are incorporated?

The above challenges are more likely to arise where a contract does not state expressly which terms are to be incorporated and does not amend the terms to fit the contract. Instead, the terms are incorporated on a general basis as in the following example:

The terms of the Head Lease are incorporated into this Sublease mutatis mutandis.

The Latin phrase mutatis mutandis means “with all necessary changes” and is based on the Latin word muto, meaning “to change”. The literal meaning of the phrase is “with those things having been changed that need to be changed”. Today, it tends to be replaced by plain language phrases such as “with the necessary changes (or modifications)”. Although it is convenient to use such a phrase, it is safer to make express reference to the incorporated terms and to amend them to fit the contract as in the first two examples above.

In circumstances where a contract uses the phrase mutatis mutandis or “with the necessary changes”, courts in common law jurisdictions such as Australia and the US have held that it is necessary to consider the intention of the parties and the purpose of the contract to determine the extent to which the parties intended to incorporate terms and make changes. Difficulties can arise where the other contract or document contains certain clauses, e.g. an arbitration clause, and there is a dispute over whether the parties intended that those clauses would be incorporated.

A basic principle that is generally recognised is that terms incorporated from another document will only become part of a contract to the extent that they are consistent with the contract. If there is any inconsistency, the express terms of the contract will prevail.

In many commercial transactions, one of the parties will incorporate its own standard terms and conditions. This often happens in the context of the sale of goods, where the vendor of the goods incorporates its own terms and conditions of sale. For a discussion about terms and conditions, see China Business Law Journal volume 3 issue 8, page 97: Terms and conditions.

An important question that arises in this regard is whether there is an obligation on the party that prepared the standard terms to draw the standard terms to the attention of the other party and to provide a copy. The position under the common law and under PRC law is considered below.

A former partner of Linklaters Shanghai, Andrew Godwin teaches law at Melbourne Law School in Australia, where he is an associate director of its Asian Law Centre. Andrew’s new book is a compilation of China Business Law Journal’s popular Lexicon series, entitled China Lexicon: Defining and translating legal terms. The book is published by Vantage Asia and available at law.asia.