Side letters: intention to create legal relations?
25 June 2012
The Side Letter
In 2005, Mr Barbudev began negotiations with the Warburg Pincus Group (WPG) to sell his company, Eurocom Plovdiv (Eurocom). WPG intended to merge Eurocom with Eurocom Cable Management Bulgaria (Eurocom Bulgaria), a company it had recently acquired through its subsidiary, Eurocom Cable Management Bulgaria EOOD (ECMB). It was envisaged that Mr Barbudev would have the right to purchase up to 10% of the newly merged entity.
WPG agreed to prepare an investment and shareholder’s agreement (ISA) that was to grant Mr Barbudev the right to purchase the 10% stake. The ISA was to be prepared after the share purchase agreement (SPA) for the acquisition of Eurocom had been agreed and signed by ECMB as purchaser and a newly incorporated company as seller. The closing of the SPA was conditional upon execution of the ISA but the SPA allowed either the seller or purchaser to waive this condition. WPG prepared a side letter addressed to Mr Barbudev on ECMB headed paper to give Mr Barbudev comfort that ECMB would not exercise the waiver. The side letter was signed by the parties. Subsequently ECMB did waive the ISA closing condition and so Mr Barbudev sued the WPG group companies involved in the deal to enforce the terms of the side letter. The issue in dispute was whether the side letter was a legally enforceable contract or no more than an agreement to agree.
The High Court held that the terms of the side letter were too uncertain to be enforceable. Blair J also found that an agreement could not be intended to create legal relations "if it is unenforceable in its entirety".
The Decision of the Court of Appeal
The Court of Appeal upheld the High Court’s decision that the side letter was an unenforceable agreement to agree. Of most interest, however, was its unanimous decision to overturn the first instance holding that the parties did not intend to create legal relations.
Aikens LJ found that, despite the parties’ failure to create an enforceable contract, it was clear from an examination of the side letter that they had intended to create legal relations. In particular, Aikens LJ pointed to the fact that the letter (a) was drafted by Freshfields, (b) contained the language of legal relations (eg it referred to the parties providing consideration), (c) contained boilerplate terms such as references to the Contracts (Rights of Third Parties) Act 1999, an English governing law clause, and an English jurisdiction clause, and (e) included binding confidentiality obligations.
To create a binding contract, however, it was not sufficient merely to establish an intention to create legal relations. The legal obligations that the parties intend to create must also be enforceable. Aikens LJ sought to demonstrate this with reference to contracts for the sale of land. Parties may intend to buy and sell land and may make an oral agreement to that effect. In such a situation there is sufficient intention to create legal relations but, absent an agreement in writing, there would be no enforceable contract.
Similarly, in spite of the intention of the parties, the side letter was held to be unenforceable as it was no more than an unenforceable "agreement to agree". The side letter made it clear that the terms of the investment had not been agreed but were to be negotiated. It offered Mr Barbudev "the opportunity to invest in the Purchaser on the terms to be agreed between us" which the court deemed not to be the language of a binding commitment. This lack of certainty was fatal to the existence of an enforceable contract.
While the side letter also contained terms more specific than a mere agreement to negotiate, the Court of Appeal considered that those terms also lacked the required certainty. For example, while Mr Barbudev had agreed to invest "not less than EUR 1,650,000", this left open the possibility that Mr Barbudev might invest more than that. This would require future negotiations and agreement. There also remained the possibility that the parties might negotiate to increase Mr Barbudev’s percentage stake or the consideration payable. Such uncertainty prevented the contract from being enforceable.
Consequently, the decision that the side letter evidenced the parties’ intention to create legal relations did not enable Mr Barbudev to enforce the contract.
Comment: Whilst in this dispute the uncertainty of the terms of the side letter prevented it from being a binding contract, the case is a warning to commercial parties intending to draft non-binding agreements. It demonstrates that the courts will readily find that a written agreement prepared by lawyers in a commercial context evidences an intention to create legal relations.
This can cause complications as there are many documents, such as heads of terms, where parties wish to record their intentions without being legally bound. These heads of terms will typically be drafted by lawyers and contain references to the parties’ consideration, boiler plate terms and confidentiality clauses. The presence of these factors will encourage the court to consider that the heads of terms contain an intention to create legal relations.
In light of this, extra care must be taken to rebut the presumption that the parties intended to create binding obligations. This case indicates that the person drafting the relevant document ought to specify that the terms set out in the document are "to be agreed" or "to be negotiated". Where there are specific terms within the document that are intended to be binding, such as a term obliging the parties to keep the negotiations confidential, the drafting must make it perfectly clear that it is only that term which is intended to be binding. Finally, while it may be commercially desirable for parties to record their intentions with precision, if they do not wish a document to be legally binding they are advised to keep its terms as vague as the circumstances allow.
This case summary is part of the Allen & Overy Litigation Review, a monthly update on interesting new cases and legislation in commercial dispute resolution. For more information please contact Sarah Garvey firstname.lastname@example.org, or tel +44 (0)20 3088 3710