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Incorporating terms from one contract to another

24 November 2014

In Northrop Gruman Mission Systems v BAE Systems (Al Diriyah C4I) Ltd [2014] EWHC 2955 (TCC), 8 September 2014, a software licence agreement between BAE and Northrop was "governed by" an enabling agreement between a related BAE entity and Northrop. This meant that the terms of the enabling agreement, including termination provisions, were incorporated into the licence agreement. The court was prepared to construe the terms of the enabling agreement so that they worked within the context of the licence agreement. This decision illustrates the way in which the courts will interpret the relationship between agreements, and highlights the difficulties that can arise.

The defendant (BAE) and another company in the BAE Systems plc group (Insyte) engaged the claimant (Northrop) to supply software products and computers as part of a system to be supplied by BAE to a customer. Insyte and Northop entered into an agreement (the Enabling Agreement) which governed purchase orders placed by Insyte with Northrop for these products. BAE also entered into an agreement with Northrop (the Licence Agreement) to obtain licences for deployment of the software.

BAE subsequently relied on the terms of both agreements to terminate the Licence Agreement with Northrop. Northrop commenced Part 8 proceedings against BAE, seeking (amongst other things) a declaration that BAE had not been entitled to terminate the Licence Agreement.

Relevant contractual terms

A term of the Licence Agreement provided that it "shall be governed by the terms contained within the Enabling Agreement". A term of the Enabling Agreement stated that "This entire Agreement and/or any or all Purchase Orders may be terminated for convenience at any time by the PURCHASER serving on the CONTRACTOR notice of twenty (20) calendar days of termination".

Meaning of "governed by"

One of the issues in dispute was the meaning of the phrase "governed by" in the Licence Agreement. Ramsey J held that where the terms of one agreement "govern" another agreement (the governing agreement), they are incorporated in that other agreement. Further, the terms of the governing agreement rule or regulate the other agreement and generally prevail over its terms.

In considering the incorporation of the terms of one contract into another related contract between different parties, Ramsay J referred to AIG Europe SA v QBE International Insurance Ltd [2001] 2 Lloyd's Rep 268, which states that the court must decide which terms of the governing contract the parties intended to incorporate and which terms they did not. In the absence of specific language, the Court will not be able to infer that the parties intended to incorporate any terms other than those which are relevant to their own contract.


Effect of the Enabling Agreement on the Licence Agreement

Northrop argued that there were a number of difficulties in determining which terms in the Enabling Agreement would apply to the Licence Agreement if the Licence Agreement was governed by the Enabling Agreement. There were some provisions which were specific to the Enabling Agreement which could not have any governing influence over the Licence Agreement. In particular, Northrop submitted that the right to terminate for convenience under the Enabling Agreement could not apply to the obligations under the Licence Agreement since the granting of licences and associated intellectual property rights over software on a perpetual and transferable basis was not consistent with a right to terminate for convenience. However, Ramsay J held that there was nothing in the admissible factual background which showed that the Licence Agreement could not be terminated for convenience, as the parties were free to agree the circumstances in which termination could occur.

Although BAE was not a party to the Enabling Agreement, Ramsay J considered that there was little difficulty in BAE, which was the Purchaser under the Licence Agreement, becoming the Purchaser under the Enabling Agreement. Northrop was the Contractor under both the Licence Agreement and the Enabling Agreement. This was necessary and appropriate to give effect to the clear intention of the Licence Agreement as being governed by the Enabling Agreement.

Ramsay J held that the reference to "Purchase Orders" in the Enabling Agreement should be construed as being a reference to the Licence Agreement. This was because in light of the admissible background evidence as to how the Licence Agreement came about, Ramsay J considered that the Licence Agreement was governed by the Enabling Agreement in the same way as a Purchase Order was governed by the Enabling Agreement.

Ramsay J concluded that the relevant term of the Enabling Agreement should be construed so as to give BAE the right to terminate the Licence Agreement for convenience on 20 calendar days' notice.

Comment: This decision illustrates the way in which the courts will interpret the relationship between one contract and another contract when there are a number of agreements in place between the parties, particularly the meaning of the phrase "governed by". It also demonstrates the difficulties which can arise in such situations when deciding which terms of the governing agreement are relevant to the secondary agreement and the extent to which those terms apply to and are consistent with the obligations under the secondary agreement. The same issues arise more generally when considering which terms of one agreement should be incorporated into another agreement and how the two agreements will work together. Ramsay J was largely able to avoid such issues in this case by focusing on a very small number of terms.

The courts will go to substantial lengths to give effect to the intention behind a contractual structure, even where that results in a change in the wording of one contract which it is not immediately apparent should be made. In this case, a party was able to rely on a contract to which it was not a party in order to terminate another contract to which it was a party. A further difficulty may arise if the governing agreement were modified after the secondary agreement was signed – there may be a question as to which version of the governing agreement applies and whether someone who is not a party to an agreement should be bound by it even after changes that they did not agree to and may not have been aware of. Contracting parties (and their advisers) should keep firmly in mind the relationship between each contract which forms part of the agreement between them and ensure that this is expressed clearly and consistently in those contracts.