The trouble with letters of intent and the law

It is interesting to see that the problems the construction industry encounters with letters of intent are replicated in the corporate world. In commercial contracts, side letters are used to clarify, supplement or vary the terms of the underlying contract. This may be because there are last minute points, or because certain obligations are only binding between two of the parties to a multi-party transaction, or perhaps because the original parties want to vary the terms of the contract. These side letters are often drafted and negotiated without the same care and attention as is applied to the underlying contract - whether it is one of the JCT Standard Forms or, as in the recent case of Georgi Velichkov Barbudev vs Eurocom Cable Management Bulgaria EOOD and others, a complex share purchase agreement (SPA).

As with letters of intent, the courts looked at the basic contractual tests as to whether a contract has been formed. Specifically they focused on ‘intention to create legal relations’ and ‘certainty of terms’

In this case, Barbudev was a significant shareholder in the target company and, in exchange for signing the SPA, he wanted to invest in the purchaser. The separate contract under which this investment would be made had not been negotiated at the time the SPA was to be signed. Accordingly, in order to protect Mr Barbudev’s position, the solicitor acting for other parties on the transaction drafted what he described as a “comfort letter”, setting out some key terms that had been agreed and containing some general legal boilerplate. It also stated that Barbudev would be offered the opportunity to invest “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. Such terms shall include, without limitation …” The agreed headline terms were then set out in a couple of paragraphs. Inevitably, the investment agreement was not agreed and the question arose as to whether this side letter constituted a legally enforceable contract. As with letters of intent, the courts looked at the basic contractual tests as to whether a contract has been formed. Specifically they focused on “intention to create legal relations” and “certainty of terms”. The other key question of “consideration” did not arise since Mr Barbudev then went on to sign the SPA.

Just as the “extrinsic evidence” rule baffles employers and contractors under letters of intent, Barbudev wanted to rely on evidence of discussions around the side letter and argued that the agreement was partly oral and partly in writing. He failed - the court found that the side letter was amended during negotiations. It reflected the parties’ agreement and had to be interpreted as written.

In determining whether the side letter was intended to be legally enforceable, the court dismissed the fact that it was described as a “letter of comfort” and the fact that it contained a lot of legal boilerplate and looked at what was meant by the obligation to negotiate in good faith - was it just an agreement to agree or did it create an enforceable obligation? The court reiterated that under English law, unlike in some continental jurisdictions, no enforceable obligation was created. It drew on an earlier authority to justify this. The court in the previous case had indicated that it is difficult, if not impossible, to say in an individual case whether the end of negotiations is brought about in good or in bad faith. And, since it would never be known whether good faith negotiations would have produced an agreement at all or what the terms of any agreement would have been if it had been reached, it is impossible to assess any loss caused by breach of the obligation. So, sensible commercial rationales to justify what seems initially a harsh conclusion.

The court also looked at the issue of the certainty of the terms and pointed out that mere agreement of the amount of the investment and the shareholding to be delivered was not enough. Agreements under which a party acquires a shareholding are long and complex not just two short paragraphs.

So the court concluded that Barbudev had no enforceable legal rights under the side letter. He had surrendered his shareholding for an unenforceable promise to negotiate.
Just as with the letter of intent, the court will not enforce a side letter if the commercial terms are still being negotiated. Even if the key terms are agreed, those are not enforceable unless a contract has arisen. Where more detailed terms are required to create a legally enforceable contract - and those terms are never agreed - there is no contract at all.

So, beware of relying on simple letters incorporating just key terms. Even if they look “legal” the court will not enforce them.

Ann Minogue is a partner in Ashurst. To read more articles by Ann, click here