Side letter not legally binding despite need for good faith
BARBUDEV v EUROCOM CABLE MANAGEMENT BULGARIA [2011]
Side letters are often signed in commercial transactions, sometimes when circumstances do not permit all the terms agreed to be incorporated into the formal contract. This case has highlighted that care must be taken to ensure that if a side letter is made with the intention to create a legally binding agreement, its terms must be sufficiently certain so that it is not treated as an unenforceable ‘agreement to agree’.
facts:
- B was the principal shareholder of a company which was in the course of being sold. It was provisionally agreed that B would be entitled to purchase shares in the buyer's newly merged entity. During the negotiations for the sale of the company, it became apparent that the terms of B's investment could not be agreed before the disposal of the company was completed. As a result, the parties entered into a side letter offering B the opportunity to invest in the new entity.
- The side letter referred to an investment “on terms to be agreed”. It went on to say “such terms shall include, without limitation, the following…”. Although the side letter specified how many shares would be the subject of the investment, the consideration was expressed to be “an aggregate amount of not less than £1.65million”.
- The parties agreed to negotiate the investment agreement “in good faith”.
- A few years later, the investment agreement envisaged by the side letter had still not been agreed or signed. B tried to enforce the terms of the side letter but E insisted its purpose was simply to provide comfort on a possible investment and that it was not intended to be binding.
decision:
- On the facts, the side letter was held to be unenforceable and no more than an agreement to agree as the terms were insufficiently certain and the parties could not have intended to create legal relations on that basis.
- There were three issues for the Court to consider:
- whether there had been an intention to create legal relations;
- whether there was an agreement to agree; and
- whether the terms were sufficiently certain.
- It was held that the terms of the side letter showed that it could not have been intended to be legally binding. While some key terms were notionally established, they were not finalised. Crucially, a commitment to pay a figure of 'not less than' was held to be too uncertain since it suggested that further negotiation on the final purchase price was envisaged. The terms in the side letter were not comprehensive. The use of the “such terms shall include, without limitation, …” wording demonstrated the anticipation of further negotiations.
points to note:
- An objective test is applied to ascertain whether a side letter constitutes a binding contract. It is the substance of the ‘agreement’ which matters not whether the parties thought they had a binding commitment.
- The same principles apply to a ‘Letter of Intent’. The ‘badge’ or ‘label’ given to a document is irrelevant. It is the substance of what has been agreed or remains to be agreed which is critical.
- A side letter should set out all essential terms if it is to be legally binding. No further negotiation or clarification on those essential terms should be necessary. A statement that it is the intention of the parties that the side letter is to be binding may not be conclusive if any of the required elements for a binding contract are missing.
- On the other hand, if a side letter contains imprecise provisions or clearly envisages agreement is necessary on additional terms even if accompanied by an obligation to negotiate in good faith, it is likely to be held to be unenforceable. If the document is not intended to be legally binding, this should be clearly stated within it. A ‘subject to contract’ statement, whilst helpful, is not always definitive.
- The addition of a ‘good faith’ requirement on the parties adds nothing and does not oblige them to reach agreement through negotiation. This has been long established.
- The inclusion of ‘boilerplate’ clauses such as a choice of law provision, is not definitive of whether there is a binding contract.
- The enforceability of any ‘agreement’ will, to a large degree, be affected by how complex the contract in question is. This was not the sale of a simple item for a specific price. This was, or would have been, a complex agreement between a minority and majority shareholder and the Courts are reluctant to get involved in specifying agreements of such complexity. They are also more likely to find a binding agreement where the ‘contract’ has been partly performed and the parties have acted as though a contract is in place.
- The case was an interesting contrast to the AstraZeneca case.
- This case was appealed in 2012 - see Barbudev v Eurocom Cable Management Bulgaria (CA).