💡 Key insights
- A collateral contract is a secondary agreement that exists alongside a main contract and can create additional legal obligations even if it is not included in the main written contract.
- For a collateral contract to be enforceable there must be a clear promise, consideration provided by the promisee and intention to create legal relations separate from the primary agreement.
- Collateral contracts often arise when pre-contract representations, assurances or guarantees induce a party to enter the main contract and those representations are relied upon.
- Understanding collateral contracts helps prevent disputes by ensuring that important promises made before signing a contract are documented and legally binding.
Collateral contracts are contracts that are additional to, or build on top of an original, main contract. A plaintiff will often argue that a collateral contract exists where they have relied on a statement or document not part of the legally binding contract and wish to enforce it. This article will describe the steps involved in creating a collateral contract.
Parol evidence rule
The first threshold concept in understanding collateral contracts is the parol evidence rule. This rule effectively says: ‘Where a contract is entirely in writing, extrinsic evidence cannot be used to change the terms of that written contract. This means that oral statements, written documents, and the context or circumstances of the contract being made, all cannot be taken into account in construing a contract or changing it in any way.
Here’s a fictional scenario for an example. Adam agrees to enter into a completely written contract with Brian. The contract includes provisions for the sale of goods to Brian. Prior to signing the agreement, Adam says that the goods will be delivered within two weeks (but this was not a binding clause in the contract). Brian cannot rely on the oral evidence as it is extrinsic to the main contract and therefore, there is no requirement for Adam to deliver the goods within two weeks. Remember, this rule only applies where a contract is completely in writing.
Contract wholly in writing
But when is a contract entirely in writing? NSW case law provides some insight:
- If a document looks like it’s complete and fully in writing, then it probably is a contract wholly in writing.
- Even though a document looks like its meant to be completely written, it is still open to the parties of the contract to argue that oral agreements were also meant to be included in the contract;
- The parol evidence rule applies to contracts that are entirely written;
- The circumstances and context of the contract and its creation can be taken into account.
Collateral contracts
Importantly, collateral documents are in connection to, but separate from the main contract. The statement or document does not form a clause of the main contract. Whatever is collateral to the contract is in effect a separate contract. Therefore, breaching a collateral contract will allow a person to sue for damages, however the main contract will still stand.
In summary so far, collateral contracts exist only when it is proved that the contract is found in other places, other than the main written document. This means that the parol evidence rule cannot apply. Furthermore, you would need to show that the contract never intended to be fully in writing, and in one main document. There are further requirements in proving a collateral contract.
The nature of the extrinsic agreement
To prove an oral statement is collateral to the main contract, it must be promissory, and not a mere representation. This means that the person must have intended to promise something, and not just make an opinion or passing comment.
Intention and reliance
The statement or document must intend to induce a person to enter into the main contract. Also, the other party needs to have relied on that extrinsic agreement.
Time of conclusion
The extrinsic agreement, whether that be an oral statement or external written document, must be finalised before the main contract is completed.
Consistency
A collateral contract must be able to stand together with the main contract, independently. The collateral agreement cannot alter the main contract. It can only add to it.
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