No comfort on side letters

July 12, 2011

The High Court has ruled that a side letter is not enforceable as a legally binding contract because - as a matter of its construction - it was an “agreement to agree”.

The judge considered that the provisions of the side letter were not sufficiently certain and could not be performed because they were dependent on the outcome of good faith negotiations between the parties to enter into a further agreement.

Background

A contract cannot be made without intention to create a legally binding arrangement. Where no such intention can be shown, there is no contract.

Also, for a binding contract to exist, the terms must be certain. An "agreement" to negotiate in good faith is nothing more than an “agreement to agree” because it lacks the necessary certainty, and is, therefore, normally unenforceable.

The case

The recent case (Barbudev v Eurocom Cable Management Bulgaria EOOD & Others [2011] EWHC 1560) concerned a company sale, where it was agreed that the seller would have shares in the buyer’s newly merged company.  As part of the closing, a side letter was signed which included the following provisions:

"In consideration for you [ the seller ] agreeing to enter into the Proposed Transaction and to sign the Transaction Documents [ for the sale of the company ], the Purchaser hereby agrees that, as soon as reasonably practicable after the signing of the Agreement by all Parties, we shall offer you the opportunity to invest in the Purchaser on the terms to be agreed between us which shall be set out in the Investment Agreement and we agree to negotiate the Investment Agreement in good faith with you"

The question was whether the Side Letter constituted a legally enforceable contract, or if it was no more than an agreement to agree.

Decision

The judge ruled that the Side Letter was not legally enforceable.

In coming to his decision, the judge had to answer three questions: whether there had been intention to create legal relations, whether there was an agreement to agree, and whether there was sufficient certainty of terms. Although in principle these were distinct questions, in practice they were interlinked.

As a matter of construction, the judge held that the Side Letter was an agreement to agree. In essence, it gave the seller the opportunity to invest on terms to be agreed, which the purchaser agreed to negotiate with the seller in good faith.  The agreement to negotiate in good faith extended to the price and the percentage.  On the construction of side letter, it was clear that there was no final agreement on these, because words such as "not less than" in the side letter allowed for negotiation of an amount above that threshold.

The judge also held that there was insufficient certainty of terms. The parties were seeking to reach agreement. The terms mentioned in the side letter were not comprehensive, given that the presence of the words "such terms shall include, without limitation, the following...".

On the basis of the conclusion that the Side Letter was an agreement to agree, with insufficient certainty of terms, the judge ruled that the parties did not intend to create legal relations.

Comment

Side letters can range from non-binding comfort letters to binding collateral contracts. Non-binding side letters are often used in transactions to "smooth-over" contentious areas, provide reassurance of the parties' intentions or as a "quick fix" when transactions are perhaps taking too long to complete.
However, as this case illustrates, users of a side letter must be very clear about its purpose. Is it really intended to simply convey the parties' good intentions at a difficult time, or is it meant to be an enforceable contract ? Do all parties to the side letter have the same expectations about objectives of the side letter?

When drafting binding side letters:

• Review each clause that is intended to be binding and enforceable to ensure that they are not in fact an agreement to agree. In this case, the construction of the clauses indicated that the terms included were not exhaustive, nor were they sufficiently certain.

• Ensure that such terms are clear and certain enough to be performed without reference to the results of any further negotiations (which may or may not be successful) or future events with unpredictable outcomes.

When drafting non-binding side letters:

• Expressly use the words "subject to contract" and "non-binding" in the document.

• Avoid sole reliance on phrases such as "letter of comfort", as this is not conclusive either way. 


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