Hubbry Logo
Collateral contractCollateral contractMain
Open search
Collateral contract
Community hub
Collateral contract
logo
8 pages, 0 posts
0 subscribers
Be the first to start a discussion here.
Be the first to start a discussion here.
Collateral contract
Collateral contract
from Wikipedia

A collateral contract is usually a single term contract, made in consideration of the party for whose benefit the contract operates agreeing to enter into the principal or main contract, which sets out additional terms relating to the same subject matter as the main contract.[1] For example, a collateral contract is formed when one party pays the other party a certain sum for entry into another contract. A collateral contract may be between one of the parties and a third party.

It can also be epitomized as follows: a collateral contract is one that induces a person to enter into a separate "primary" contract. For example, if X agrees to buy goods from Y that will, accordingly, be manufactured by Z, and does so on the strength of Z's assurance as to the high quality of the goods, X and Z may be held to have made a collateral contract consisting of Z's promise of quality given in consideration of X's promise to enter into the main contract with Y.

Elements of a valid collateral contract

[edit]

A party to an existing contract may attempt to show that a collateral contract exists if their claim for a breach of contract fails because the statement they relied upon was not held to be a term of the main contract. It has been held that for this to be successful, the statement must have been promissory in nature.[2] Remedies may be awarded for breach of a collateral contract.

Promissory in nature

[edit]

A collateral contract is one where the parties to one contract enter into or promise to enter into another contract. Thus, the two contracts are connected and it may be enforced even though it forms no constructive part of the original contract.[2] In JJ Savage and Sons Pty Ltd v Blakney a mere expression of opinion was held insufficient to be satisfied as a promise. In Crown Melbourne Limited v Cosmopolitan Hotel (Vic) Pty Ltd a statement by a landlord made to intending tenants when negotiating a lease that they would be "looked after at renewal time", would not bind the landlord to offer a further five year lease.[3]

Intention to induce

[edit]

The promisor must have expressly or impliedly requested about the main contract and his promissory statement must have intended to induce the entry of the other party into the main contract.[4] According to Lord Denning MR, a collateral contract is held binding "when a person gives a promise, or an assurance to another, intending that he should act on it by entering into a contract'.[5]

Consistency

[edit]

A collateral contract, if forged between the same parties as the main contract, must not contradict the main contract. That is, if the term was agreed upon prior to the completion of the formal contract (but was still included as a term, and could not be executed until completion of the second term), the first term will still be allowed.[6] Essentially the collateral contracts cannot contradict any element of the main contract nor the rights created by it.[7]

Letter of credit

[edit]

A theory sustains that is feasible to typify letter of credit as a collateral contract for a third-party beneficiary because letters of credit are prompted by the buyer's necessity and in application of the theory of Jean Domat the cause of a letter of credit is that a bank issue a credit in favor of a seller to release the buyer of his obligation to pay directly to the seller with legal tender. There are in fact three different entities participating in the letter of credit transaction: the seller, the buyer, and the banker. Therefore, a letter of credit theoretically fits as a collateral contract accepted by conduct, or in other words, an implied-in-fact contract.[8] it is shortly called as LOC

[edit]

Privity of contract

[edit]

Collateral contracts are an exception to the privity of contract doctrine,[9] which provides that a contract cannot impose obligations or confer rights on a non-contracting party.[10] However, in circumstances where a collateral contract is established between a third party and one of the contracting parties, the Court may allow rights or impose obligations on the non-contracting party, as illustrated in the earlier tortious case of Donoghue v Stevenson.[11]

Parol evidence rule

[edit]

Common law recognises collateral contract as an exception to parol evidence rule, meaning that admissible evidence of a collateral contract can be used to exclude the operation of the parol evidence rule. Practically, it is rare to find collateral contract as an exception as it must be strictly proved; and the burden of proof is only eased if the subject matter with which the main contract deals is more unusual.[12]

Notable cases

[edit]

In the English case of Barry v Davies, it was held that an auctioneer and a buyer had formed a collateral contract.[13] It was held that even though the main contract does not involve the auctioneer, benefits given to the auctioneer for increasing the price of a bid constitutes a good consideration.[13]

In Hoyt's Pty Ltd v Spencer, a landlord has promised orally not to exercise the right to termination in the principal contract if tenant signed the contract; landlord ended up terminating the main contract, whereas tenant's appeal was dismissed by the Court.[6]

References

[edit]
Revisions and contributorsEdit on WikipediaRead on Wikipedia
from Grokipedia
A collateral contract is a legally binding secondary agreement that exists alongside and is induced by a primary , where the consideration for the collateral is the act of entering into the main agreement. Often oral or written, it typically involves promises or representations made by one party to another that do not form part of the primary but serve to encourage its formation. For a collateral contract to be enforceable, it must satisfy several key elements: it must be independent of the primary yet consistent with its terms, promissory in nature (constituting a clear rather than mere ), made with the to induce the other to enter the main agreement, and supported by valid , which is usually the execution of the primary itself. These requirements ensure that the collateral is not subsumed into the main and can stand alone as a distinct obligation. Prominent English has shaped the doctrine of collateral contracts. In De Lassalle v Guildford 2 KB 215, the court held that a landlord's oral assurance to a tenant that a was free from drainage defects constituted a collateral contract, enforceable separately from the written agreement, as it induced the tenant to proceed. Similarly, in Esso Petroleum Co Ltd v Mardon QB 801, the Court of Appeal recognized Esso's estimated petrol throughput figure as a collateral that induced the of a service station, allowing the lessee to claim damages for its inaccuracy despite it not being a term of the main . Collateral contracts play a crucial role in jurisdictions by providing a mechanism to enforce pre-contractual statements or warranties that might otherwise be excluded by the , which generally bars extrinsic evidence from varying written contracts. They promote fairness in negotiations, particularly in commercial contexts where oral inducements are common, but their application requires careful proof of intent and consistency to avoid challenges.

Introduction

Definition

A collateral contract is a separate, enforceable agreement that accompanies a primary contract, typically involving a promise by one party to induce the other to enter into the main agreement. In common law, it functions as an independent contract where the consideration is the act of entering the primary contract, such as a promise stating, "If you enter this contract, I will provide additional assurance." Key characteristics include its independence from the main contract while remaining subsidiary to it, ensuring the primary agreement's validity without merging into its terms. It requires , often satisfied by the party's entry into the main contract itself, and may be oral or written, though enforceability is stronger in written form. Unlike terms integrated into the primary contract, a collateral contract addresses pre-contractual representations or promises that were not incorporated into the main agreement, allowing enforcement as a distinct obligation. This distinction preserves the integrity of written primary contracts while permitting supplementary assurances. The term "collateral contract" originates in English as an exception to the . It was notably articulated in early 20th-century cases, emphasizing its role in upholding ancillary promises.

Historical Background

The collateral contract doctrine originated in 19th-century English as a means to enforce oral or ancillary promises made alongside primary written agreements, particularly amid the era's stringent formalities surrounding formation and . This approach allowed courts to uphold side agreements that might otherwise be excluded, addressing gaps in commercial transactions where verbal assurances played a key role. A pivotal influence was the contemporaneous development of the during the 1800s, which prohibited extrinsic evidence from altering integrated written contracts but carved out space for independent collateral contracts to prevent manifest , such as in landlord-tenant or vendor-purchaser scenarios. By recognizing these as separate enforceable obligations, courts balanced evidentiary restrictions with equitable considerations, ensuring that pre-contractual representations could still bind parties when they induced the main agreement. In the 20th century, the doctrine evolved significantly through judicial expansion to meet growing commercial demands in sectors like and , where complex dealings often involved supplementary promises beyond the primary document. Equity principles further shaped this growth, mitigating the formalities of by affirming the autonomy of collateral contracts and their role in fostering fair dealings, even as challenges from rules like privity persisted. This period saw broader application, adapting the concept to diverse contractual contexts while preserving its function as a tool for . Modern recognition of collateral contracts remains predominantly judge-made law, rooted in precedents rather than comprehensive statutory codification, though analogous protections appear in legislation such as the , which scrutinizes the reasonableness of clauses attempting to exclude such agreements, like entire agreement provisions.

Essential Elements

Promissory Nature

The promissory nature of a collateral contract requires that the ancillary statement or assurance constitute a binding promise, rather than a mere , , or casual representation, with the parties intending to create legal relations through it. This distinguishes it from non-binding statements, ensuring the collateral agreement functions as an enforceable independent of the primary contract. In this context, consideration for the collateral promise is typically provided by the promisee's act of entering into the main , which induces reliance on the ancillary assurance and thereby supplies the necessary exchange of value to render it binding. This must be sufficient, though not necessarily adequate in value, as courts assess it based on the presence of detriment to the promisee or benefit to the promisor. For enforceability, the promise must be sufficiently definite and certain in its terms to form a valid contract, capable of objective interpretation by a reasonable person. Examples include explicit guarantees of product quality, such as assurances that materials will perform without defect for a specified duration, or commitments to provide additional services not covered in the main agreement, provided they are clear and not vague. Without this promissory character and definiteness, the statement fails as a collateral contract and may only support a claim for misrepresentation rather than breach of contract.

Intention to Induce

In collateral contract law, the promissory statement must be made with the specific intention to induce the other party to enter into the main contract, distinguishing it from mere representations or casual assurances. Courts apply an objective test to determine this intention, assessing whether a reasonable person in the position of the promisee would understand the statement as one intended to encourage reliance and formation of the primary agreement. This approach focuses on the words and conduct of the parties rather than their subjective beliefs, ensuring that the collateral promise carries legal weight only when it demonstrably motivates the contractual commitment. Evidence supporting the existence of such inducement typically includes the timing of the statement, which must occur pre-contractually during negotiations, alongside proof of the promisee's actual reliance on it and a clear causal connection to their decision to proceed with the main contract. For instance, statements made as warranties or assurances directly tied to the primary transaction's terms can establish this link, provided they form an integral part of the inducement process rather than ancillary commentary. This evidentiary framework ensures that the collateral promise is not isolated but actively influences the broader contractual relationship. The burden of proof lies with the claimant, who must demonstrate that the collateral promise materially influenced their entry into the main contract, often through a materiality test evaluating whether the statement would have affected a reasonable person's decision. to meet this threshold results in the promise being as a collateral contract. Limitations apply strictly: incidental statements lacking an inducive purpose, such as general sales talk or non-promissory representations, do not qualify, as they are deemed insufficient to create binding obligations.

Consistency Requirement

The consistency requirement mandates that a collateral contract's terms must be compatible with the main contract, ensuring they neither contradict nor vary its express provisions or integration clause. This upholds the of the primary agreement by preventing subsidiary promises from undermining the parties' documented intentions. Courts enforce this to balance the need for supplementary assurances with the reliability of written contracts, allowing collateral terms only as non-disruptive additions. Judicial rationale for this requirement stems from the desire to avoid eroding the main 's authority while permitting enforceable side agreements that genuinely supplement it. For instance, if the main includes an integration clause declaring it complete, a collateral promise cannot introduce conflicting obligations, as this would effectively rewrite the primary terms. This approach preserves contractual certainty and deters attempts to introduce inconsistent oral assurances post-execution. However, it accommodates legitimate supplementary s, such as warranties on product quality that do not alter core sale conditions. To test consistency, courts evaluate whether the collateral promise enhances or merely restates the main contract without alteration, focusing on direct conflicts like opposing performance duties or inferred inconsistencies from omissions in the primary document. Non-conflicting examples include ancillary guarantees, such as a seller's oral assurance of timely delivery that aligns with but does not override the main contract's delivery timeline. If the collateral term introduces a novel absent from the main agreement, it may still qualify provided it does not negate existing terms. This examination typically involves reviewing the overall context to confirm the collateral agreement operates independently yet harmoniously. Exceptions arise where the main contract remains silent on a particular matter, permitting broader collateral terms that fill gaps without inconsistency. In such cases, courts may uphold the subsidiary if it addresses uncontroverted aspects, like additional service assurances in a silent equipment sale agreement, thereby extending protection without challenging the primary framework.

Applications

Letters of Credit

Letters of credit share similarities with collateral contracts in that they involve a secondary by a bank to pay the (typically the seller or exporter) upon the buyer's default or fulfillment of specified conditions, thereby inducing the seller to enter into the primary contract. However, they are distinct instruments under , governed by rules such as the Customs and Practice for Documentary Credits (UCP 600, published by the in 2007 and current as of 2025), which emphasize their independence from the underlying agreement (Article 4). This arrangement provides the seller with assurance of payment, mitigating the of non-payment in transactions where trust between parties may be limited, such as international sales. The bank's undertaking is promissory in nature and aligns with some elements of collateral contracts by offering a clear commitment that supports the main agreement without being part of it, though their enforceability stems from specific commercial principles rather than general doctrine. Mechanically, a is issued by the buyer's bank (the ) at the buyer's request and directed to the seller as the , with the underlying sales contract serving as the primary agreement between buyer and seller. The may involve an advising or confirming bank in the seller's country to notify the and potentially add its own of . is triggered by the presenting conforming documents, such as a or , proving shipment or compliance, without the bank inquiring into the underlying transaction's performance. The buyer's obligation to reimburse the provides the necessary for the bank's promise, rendering it enforceable as a distinct obligation. The enforceability of a stems from its independence from the main sales agreement, ensuring the bank's promise stands alone even if disputes arise in the primary . This autonomy principle prevents the beneficiary from being drawn into buyer-seller conflicts, promoting reliability in . Globally, these instruments are standardized under UCP 600, which defines a credit as an irrevocable undertaking by the to honor a complying , explicitly emphasizing separation from underlying disputes (Article 4); as of November 2025, discussions on potential revisions continue but no new version has been adopted. One key advantage of letters of credit in cross-border transactions is their role in reducing risk for sellers by substituting the bank's worthiness for the buyer's, enabling deals that might otherwise be unfeasible due to geographic or political uncertainties. This mechanism enhances liquidity and confidence in , with banks often requiring the buyer to provide collateral or fees upfront to secure the issuance. By focusing on documentary compliance rather than goods quality, letters of credit streamline payments and minimize litigation over substantive issues in the main contract.

Other Examples

In commercial transactions, collateral contracts often manifest in sales warranties where a manufacturer provides an oral or written guarantee regarding product durability to induce a distributor to enter into a primary supply agreement. For instance, a seller might assure that machinery will operate without failure for a specified period, forming a separate enforceable promise that supports the main contract's execution. This structure ensures the inducement is legally binding, distinct from implied warranties under sales laws. Real estate transactions frequently involve collateral contracts through assurances from agents or sellers about property conditions, separate from the formal purchase . An agent's verbal commitment that a building has no structural defects can serve as for the buyer's agreement to proceed with the sale, creating a obligation enforceable if breached. Such promises address pre-contractual representations that might otherwise fall outside the deed's scope. In processes, tenderers may offer collateral commitments to use particular materials or meet quality standards as an inducement to secure the primary building contract. These side agreements bridge gaps between the bidder and project stakeholders, ensuring performance obligations extend beyond the tender terms. Collateral warranties in this context often link contractors directly to funders or end-users, providing remedies for non-compliance. Employment agreements can incorporate collateral s via employer promises of ancillary support, such as relocation assistance, to encourage acceptance of the hiring . For example, an offer to cover moving expenses or temporary housing induces the employee to relocate, forming a distinct agreement enforceable independently if the primary terms are met. These inducements must be clearly documented to avoid integration into the main under merger clauses. In modern digital services, collateral contracts appear in guarantees of software compatibility or within technology licensing agreements. A might promise seamless integration with existing systems to persuade a client to sign the primary service , creating a secondary for updates or fixes if compatibility issues arise. Such assurances are increasingly vital in SaaS arrangements, where pre-contractual representations ensure operational reliability.

Privity of Contract

The doctrine of establishes that only parties to a can enforce its terms or be held liable under it, a principle reinforced by the House of Lords in Dunlop Pneumatic Tyre Co Ltd v Selfridge & Co Ltd AC 847, where a third party was denied the right to sue on an agreement to which it was not privy. Collateral contracts provide an exception to this doctrine by enabling a third party, such as a beneficiary of a promise, to enforce rights against a promisor even without being a party to the main , provided the third party has provided consideration. The mechanism operates through the formation or performance of the primary serving as the consideration for the collateral promise made to the third party, thereby creating a separate enforceable agreement alongside the main one. However, this exception is not absolute; a collateral contract must still satisfy all essential elements of a valid , including offer, , and , and it cannot override the terms of an integrated main contract without clear evidence of independence. In , the Contracts (Rights of Third Parties) Act 1999 introduced statutory reforms that partially codify protections similar to those offered by collateral contracts, allowing a third party to enforce a expressly intended for its benefit, thereby mitigating the strictness of the privity rule without fully supplanting exceptions.

Parol Evidence Rule

The parol evidence rule is a foundational principle in common law contract jurisprudence that prohibits the admission of extrinsic evidence—such as oral agreements or prior writings—to contradict, add to, or vary the terms of a written contract intended as a complete and final expression of the parties' agreement. This rule was authoritatively stated by Innes J in Mercantile Bank of Sydney v Taylor (1891) 12 LR (NSW) 252, where he observed: “Where a contract is reduced into writing, and appears to be entire, it is presumed that the writing contains all the terms…and parol evidence to show any other terms will be rejected.” The rule aims to provide certainty and finality to written instruments, preventing parties from later disputing or expanding their obligations based on unrecorded understandings. Collateral contracts provide a key exception to the by being recognized as independent agreements ancillary to the main written contract, thereby permitting the introduction of extrinsic of their terms if they meet specific criteria. Unlike mere negotiations, a valid collateral contract is enforceable as a separate , allowing oral or extrinsic to prove it, provided the collateral promise was intended to induce entry into the main contract and remains consistent with its terms. This exception avoids the rule's bar because the collateral agreement is not deemed merged into the writing but stands apart, as illustrated in De Lassalle v Guildford 2 KB 215, where an oral assurance regarding property drains was upheld as a collateral despite the existence of a written . For of a collateral contract to be admissible, courts apply a stringent test: the alleged collateral term must not contradict or vary the explicit provisions within the "" of the main written contract but may address gaps or silences therein. Judicial scrutiny is rigorous, demanding clear and convincing proof of the collateral agreement's and terms to guard against fabricated claims that could undermine the written contract's . Merger clauses, which declare the writing to be the entire agreement, reinforce the of integration and may restrict admissibility but do not categorically preclude of a truly separate collateral contract supported by robust . This exception embodies a equilibrium in contract law, safeguarding the reliability and sanctity of written agreements while permitting the enforcement of genuine ancillary promises that facilitate and reliance in transactions. By distinguishing integrated terms from distinct collateral obligations, the rule accommodates commercial realities without eroding the preference for documentary evidence.

Notable Cases

English Cases

One of the foundational English cases establishing the doctrine of collateral contracts is De Lassalle v Guildford 2 KB 215. In this case, the plaintiff, De Lassalle, negotiated a lease for a house owned by the defendant, Guildford. Prior to signing the written lease agreement, De Lassalle inquired about the condition of the drains, and Guildford assured him that they were in good order to induce him to proceed with the lease. After execution, serious defects in the drains were discovered, leading De Lassalle to withhold rent and claim damages. The Court of Appeal held that Guildford's assurance constituted a separate collateral contract, independent of the main lease, with the consideration being De Lassalle's entry into the primary agreement; this collateral promise was enforceable despite the parol evidence rule, as it did not contradict the written lease terms. A significant post-war evolution in the doctrine is illustrated by Esso Petroleum Co Ltd v Mardon QB 801. , experienced in the petrol industry, provided Mardon with an estimate of 200,000 gallons annual throughput for a new service station site to encourage him to enter a three-year agreement. Due to Esso's failure to changes in site access, the actual throughput was far lower, causing Mardon's business to fail. The Court of Appeal, led by Lord Denning MR, ruled that Esso's estimate, given its superior knowledge, amounted to a contractual incorporated into a collateral contract alongside the main ; this was breached, entitling Mardon to , and alternatively supported liability for negligent . These cases underscore the doctrine's emphasis on objective intention to create enforceable promises and the requirement for consistency with the main contract, evolving from early 20th-century property disputes toward greater commercial fairness in business negotiations post-World War II. By recognizing collateral agreements as tools to uphold inducements without undermining primary terms, they solidified the doctrine's role in English contract law, particularly in addressing pre-contractual representations in complex transactions.

Cases from Other Jurisdictions

In Australia, the doctrine of collateral contracts has been applied to real property transactions, where oral or side assurances induce the execution of a main written agreement, provided they are supported by consideration and consistent with the primary terms. A key example is the High Court decision in Crown Melbourne Limited v Cosmopolitan Hotel (Vic) Pty Ltd HCA 26, which involved negotiations for a casino lease extension. The court held that vague oral comments by the lessor promising to "look after" the tenant at renewal time did not form a enforceable collateral contract, as they lacked sufficient certainty and separate consideration beyond the main lease agreement. This case underscores the emphasis on reliance and the need for the collateral promise to be a distinct inducement in property dealings. In the United States, collateral contracts are recognized alongside main agreements, particularly in sales of goods under the (UCC), where side warranties or oral representations can supplement written terms if consistent. For instance, UCC § 2-202 permits evidence of collateral agreements that do not contradict the writing, treating them as enforceable warranties under § 2-313. A representative case is Roto-Lith, Ltd. v. F.P. Bartlett & Co., 297 F.2d 497 (1st Cir. 1962), where oral assurances by a seller that an emulsifier was suitable for the buyer's manufacturing of bags were upheld as an express warranty under UCC § 2-313, despite a written no-warranty clause, as the representations formed part of the basis of the bargain inducing the purchase. This approach integrates statutory rules to protect reliance in commercial sales, differing from stricter evidentiary barriers. Canadian courts have applied the collateral contract doctrine to enforce oral agreements that induce entry into a main written , where consistent with its terms and not barred by the . In Hawrish v. , SCR 515, an oral assurance by a bank officer to a borrower that he would not be personally liable on a corporate was alleged to form a collateral contract. The held that no such collateral contract existed, as the oral assurance was inconsistent with the clear terms of the written guarantee that the borrower had signed after having the opportunity to review it, thus the applied to exclude it. This decision highlights the strict requirement for consistency between collateral promises and the primary agreement. In civil law jurisdictions within the , the concept of collateral contracts is adapted through broader principles of and , which impose obligations on pre-contractual representations without needing a separate "collateral" label. Under Article 1:201 of the Principles of International Commercial Contracts (reflecting EU harmonization efforts), parties must act honestly during negotiations, making inducing statements binding if relied upon, akin to collateral enforceability. This contrasts with English pure by integrating statutorily, as seen in directives like the Unfair Commercial Practices Directive 2005/29/EC, which protects against misleading inducements in consumer contracts. Recent trends in the 2020s show Australian courts extending collateral analysis to digital contexts, such as software inducements via online demos or terms, where representations form side obligations enforceable under reliance tests, though without a landmark ruling yet. Jurisdictions like the exhibit more statutory integration via the UCC for commercial deals, while civil law systems prioritize to achieve similar outcomes with less doctrinal fragmentation.

References

Add your contribution
Related Hubs
User Avatar
No comments yet.