A recent decision of the High Court has found that a side letter used in relation with a commercial transaction did not constitute a legally enforceable contract. The court applied established principles of contract formation to determine enforceability and the side letter was ruled to be an agreement to agree.
 
The case involved the acquisition of a Bulgarian cable television and internet company. The claimant was the CEO of such company and a principal shareholder. During negotiations it was discussed that the claimant would be offered an opportunity to invest in up to 10% of the shareholding of the newly acquired cable company, after completion of the sale. The investment was set out in a side letter. 
  
Under the heading of “Investment Agreement”, the side letter contained the following:

“In consideration for you agreeing to enter into the Proposed Transaction and to sign the Transaction Documents, 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 proposed investment also specified “an aggregate amount of not less than €1,650,000”. 
  
The main issue in the dispute was whether the side letter constituted a legally enforceable contract. The court considered three distinct but interconnected questions: (a) whether the side letter was intended to create legal relations; (b) whether it was an agreement to agree; and (c) whether there was sufficient certainty of terms.
 
As you may know and as we have explained in our training sessions, and previous articles on letters of intent a contract is a legally enforceable agreement giving rise to obligations for the parties to it. The formation of a contract is complete when the basic principles of offer, acceptance, consideration and intention to create legal relations are satisfied.

Often the formation of an enforceable contract will be preceded by a protracted negotiation process. As a result, it can be difficult to pinpoint the precise moment at which the parties made the contract. Identifying this precise moment is crucial as it is the point at which the terms of the contract are finalised and each party takes on contractual obligations which can only be reneged upon by breaching the terms of the contract and incurring liability as a result.

Traditionally, the law considers that an agreement is formed through offer by one party with acceptance of that offer by another party. This involves a matching of the two communications of offer and acceptance.

The parties involved in the negotiation process should always have the four basic elements in the back of their minds. They should be careful not to bind themselves inadvertently to a contract at a time when they only intend to reach an understanding on the scope of the negotiations by agreeing preliminary matters.

The same applies also in the event the parties are negotiating heads of terms or letters of intent or side letters.

The legal effect of heads of terms, letters of intent and side letters can be either binding or non-binding heads of terms and this is a key concern of the parties. If they do not want the statement of the terms of the commercial transaction to be legally binding; but if, as is often the case, they include provisions in the heads of terms document dealing with issues such as confidentiality, exclusivity (lock-out), or costs, they will want those provisions to have legal effect. Where the parties do intend the heads of terms, or certain provisions in the heads of terms, to be legally binding, the legal requirements relating to the creation of a valid contract must be satisfied. Third party rights may also become an issue at this point.

Heads of terms can give rise to liability for misrepresentation or negligent misstatement, whether or not they are contractually binding.

The main issue in the dispute was whether the side letter constituted a legally enforceable contract. The court considered three distinct but interconnected questions: (a) whether the side letter was intended to create legal relations; (b) whether it was an agreement to agree; and (c) whether there was sufficient certainty of terms.

Firstly, it was ruled that there was no intention to create legal relations. In applying the objective test, the court could not consider the subjective state of mind of the parties but rather only what was communicated by their words and conduct. The language used (extracted above) indicated that only a subsequently executed “Investment Agreement” would be legally enforceable.
 
Secondly, the side letter was ruled to be an agreement to agree, which is unenforceable. The court also noted that an agreement to negotiate in good faith is unenforceable under English law. The side letter, in effect, set out the claimant’s opportunity to invest on terms that were yet to be agreed and the proposed investment amount of “not less than €1,650,000” also allowed further room for negotiation.
 
Finally, it was ruled that the terms were not sufficiently certain. While the side letter contained some terms, they were not comprehensive and did not cover the requisite provisions for an agreement of this type.
  
To avoid disputes over enforceability, parties should clearly convey their intentions to be bound, ensure that all essential terms are agreed, and avoid using language that leaves essential terms open to negotiation.
 
Similarly, if a side letter is intended to be non-binding the parties should include express language to that effect, such as “subject to contract”. Simply referring to the document as a “letter of comfort” will not negate its enforceability if it contains the all elements of an enforceable agreement.


All articles are for general purposes and guidance only and do not constitute legal or professional advice.

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