How to Avoid Accidental Contracts that Almost Killed 3 Startups
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David Willbe | 2015-09-15T19:30:00+00:00
The word "contract" makes us think of long and complicated documents that parties spend lots of time agreeing. Most legal systems, though, will enforce an agreement between two parties if it can be proved to exist - no matter how it's made.
It's therefore possible to make contracts accidentally, getting legally bound when you don't want to be. It's also possible to enter into a contract when you haven't given full thought to all the terms, because you haven't had to go through the full process of drafting a long document. One area that often causes these accidental contracts is adverts.
Mrs Carlill and the Flu Remedy
We'll start as so many other startup articles: with a Victorian era flu remedy. In the 1890s in London, a company started marketing "The Carbolic Smoke Ball". This was an inhalant which was intended to prevent the user from catching flu. The company placed newspaper ads saying they were so confident in their product that they'd give £100 (equivalent to around £11,000 today) to anyone who used the smoke ball three times a day but still caught flu.
Enter Mrs. Carlill, who played the odds and bought multiple smoke balls. Sure enough, she caught the flu despite using one, and wrote to the company for her £100. The company refused to pay. How could a woman with whom the company had never had any previous contact have a binding contract with the company? Mrs. Carlill thought she did, and sued for the money.
The court ruled that it wasn't necessary to have a signed document with the parties' names on, only an offer of an agreement and acceptance of it. The newspaper ad was an offer of a contract to "all the world", which any person could accept by using the smoke ball as directed in the ad. Once that contract existed, it only had one term, again as written in the ad, if the person catches flu then the company will pay them £100.
What was apparently meant to be a marketing effort became an accidental contract, and the company had to make a significant payment. Ouch.
Hoover and the Free Flights
That was an expensive mistake, but a hundred years later a vacuum cleaner company made a far more costly one. In 1992, stuck with significant stock and falling market share, Hoover decided to place ads offering two free round trip flights with any purchase of Hoover products over £100.
As we know from the Carbolic Smoke Ball, these newspaper ads were offers to "all the world" which anyone could accept by spending £100 on Hoover products. Hoover knew this, and expected around 5,000 contracts to be formed. Unfortunately they did not include in the ads, which formed the terms of those contracts, a limit on how many people could accept. Oops.
The offer was very popular, especially once Hoover expanded the destinations to include the USA – those flights cost about £600 at the time. Stories include couples whose wedding gifts included four or five of the same Hoover appliance. By the end of the promotion over 200,000 people had formed contracts with Hoover through those ads.
This was a disaster for Hoover, which could not make products quickly enough nor buy flights cheaply enough to keep up with this level of demand. Without a limit in the ad, every customer had a contractual right to demand their flights. Many of them sued.
The cost of this promotion to Hoover, between the flights and the legal costs, has been estimated at £48 million. Even with an estimated £30 million of sales generated (before costs), this is a significant price to pay for not putting enough thought into the terms of a contract.
Pepsico and the Jump Jet
Although these cases show that it's important to take care over adverts, the law won't generally allow someone to rely on a contract formed by an ad that's clearly a joke.
In the mid 1990s Pepsico ran a TV ad campaign where consumers could acquire "Pepsi Points" by purchasing Pepsi products, and exchange them for branded merchandise. The ads featured the wide variety of merchandise available, and the number of Pepsi Points each cost.
The punchline is a Top Gun-styled teenage boy landing a Harrier VTOL jet on his school lawn, with a caption listing the jet at 7,000,000 Pepsi Points – collection of which would require the consumption of a truly heroic 190 Pepsis per day for at least one hundred years.
Mr Leonard believed that he had found a loophole. The order form required at least fifteen original Pepsi Points, but allowed additional Pepsi Points to be bought in cash for ten cents each. Mr Leonard sent in an order form for one Harrier, accompanied by 15 original Pepsi Points and a cheque for $700,008.50 to cover the remaining 6,999,985 Pepsi Points plus shipping. This represented a substantial discount to the $23 million pricetag of a Harrier.
Pepsico rejected the submission and returned the cheque with a letter making it clear that the Harrier's appearance in the advert was meant to be a joke. Mr Leonard took Pepsico to court, but the judge ruled that it was simply not reasonable for anyone to believe this was a serious offer. Unlike with the Smoke Ball or the free flights, there was no contract offer available for him to accept – just a joke.
Making a joke offer in an advert remains a risky strategy. As the Pepsi case demonstrates, it's possible that someone will think they're onto a winner by trying to hold you to your terms. A given judge on a given day may not get the joke you were making. Even if they do, defending a claim requires time, energy and cost that would be better spent elsewhere in a growing business.
Don't make offers in ads unless you'd be happy to be bound by them. They can become contracts.
If you're deliberately offering a contract in your ad, think through the terms as thoroughly as you would if it was a paper document.
Think twice about making joke offers - and if you do, make sure it's clearly a joke.
David Willbe
David is a lawyer based in London. He advises tech companies, founders and investors at all points in the corporate lifecycle - from seed to IPO.