Side letters: binding or not binding?

Practical Law UK Articles 6-508-4548 (Approx. 5 pages)

Side letters: binding or not binding?

by Patricia Wade and Sarah Stafford, Ashurst LLP

Why use a side letter?

The chief uses for side letters include:

Clarification. Side letters are often used to confirm additional details that are not known when the principal documents are finalised, or to clarify certain points; for example, setting out the steps that a party must take to satisfy an "all reasonable endeavours" obligation that is not defined in the main document.

Supplementation. They may also evidence a binding contract between two of the parties to a multi-party transaction, whether or not disclosed to all other parties. Side letters are often used in the formation of investment funds, creating various additional obligations or granting exemptions between the fund and a particular limited partner. Such side letters are disclosed to all limited partners in the fund.

Variation. When dealing with any last-minute changes, it is often easier to set out the relevant details in a side letter than to make manuscript changes and have them initialled. Side letters are also an efficient means of documenting any changes that have been agreed in relation to a party's standard terms and conditions. A side letter may be held to be a purported variation of a contract, even though it is expressed to be personal and not signed by all parties to the original contract.

Formation of contracts

Whether a side letter is binding or not will depend on an objective analysis of the principles of contract formation. There are four key elements to consider when establishing whether a contract has been formed: offer and acceptance; intention to create legal relations; certainty; and consideration. Of these, the final three are often the most difficult to establish in relation to side letters.

Intention to create legal relations. This element was dealt with in detail in Barbudev, where the High Court confirmed that whether the parties have decided to create legal relations depends not on their subjective opinions but on "a consideration of what was communicated between them by words or conduct, and whether that leads objectively [to the appropriate conclusion]" (following RTS Flexible Systems Ltd v Molkerei Alois Müller GmbH & Co KG [2010] 1 WLR 753; see News brief "Existence of contract: the importance of putting it in writing", www. practicallaw.com/3-502-1213). The title or description given to the document is inconclusive.

There is a strong presumption that parties to commercial transactions intend to create legal relations (Esso v Courts of Customs and Excise [1976] 1 WLR 1). In Barbudev, the fact that the side letter contained boilerplate clauses, dealing with topics such as third party rights, governing law, jurisdiction, and entire agreement, and was signed by both parties, supported the existence of the relevant intention, although it was not conclusive (see box "Barbudev and the uncertainty of good faith"). Conversely, in Cheverny Consulting Ltd v Whitehead Mann Ltd, the Court of Appeal gave effect to an oral contract based on a draft side letter that was never signed, although subsequent conduct suggested that the parties considered themselves bound by it ([2006] EWCA Civ 1303).

The courts will give effect to "honour clauses" (which have moral rather than legal force) provided that clear wording is used. One example is Rose & Frank Co v J R Crompton and Bros Ltd, in which the Court of Appeal upheld a statement that an arrangement was "not entered into as a formal or legal agreement, and shall not be subject to legal jurisdiction" ([1925] AC 445).

Certainty. There are two angles to this requirement: certainty of language; and whether the document is sufficiently complete or merely amounts to an "agreement to agree" (see box "Barbudev and the uncertainty of good faith"). Where certainty of language is an issue, the courts draw a clear distinction between "interpreting" and "making" a contract and the role of the court is limited to interpretation; it cannot make the contract for the parties (Scammell and Nephew Ltd v Ouston [1941] AC 251).

Only a reasonable degree of certainty is required. Where parties have failed to include certain details, legislation may intervene; for example, section 8(2) of the Sale of Goods Act 1979 provides for a "reasonable price" to be paid if the contract is silent. In general, the courts are reluctant to find that an agreement fails for uncertainty.

Consideration. Often, parties forget that, to be binding, a side letter must, like all other contracts, be supported by consideration (unless made as a deed). It is very difficult to settle on a precise definition of consideration, but it is usually expressed along the lines of reciprocity; that is, a promisee cannot enforce a promise unless it has promised something in return (Currie and Others v Misa (1875) LR 10 Exch 153). The concept is also sometimes expressed in terms of benefit and detriment. However, the courts are prepared to exercise discretion where they feel that justice is best served by upholding a contract. The key principles relevant to side letters are that:

Consideration must move from the promisee (that is, the person who seeks to enforce the promise), although it need not move to the promisor.
Past consideration is no consideration, so completed obligations will not constitute consideration. This could be relevant where parties wish to use a side letter to vary an existing arrangement. However, courts look at the entirety of a whole transaction, rather than splitting it into its component obligations, which is useful for those side letters entered into as part of a larger deal.
Consideration must be sufficient, but courts will not assess whether it is adequate or represents a fair bargain.

Judicial interpretation

Where a side letter constitutes a legally binding contract, normal rules of interpretation will apply, including the law of mistake and misrepresentation (British Nuclear Group Sellafield Ltd v Kernkraftwerk Brokdorf GmbH & Co [2007] EWHC 2245 (Ch)).

Where the language in a side letter is ambiguous, prior contracts, especially those that are drafted in similar terms and are related to the later side letter, are admissible in evidence for construing the later document (HIH Casualty and General Insurance Co Ltd v New Hampshire Co [2001] EWCA Civ 735). Indeed, if contracts are "inter-dependent" and must be read together (AG Securities v Vaughan [1988] 3 WLR 1205), then it may be open to disgruntled parties (that are signatories to the underlying contract but not the side letter) to argue that the underlying contract must be referred to for the purpose of deciding whether the side letter breaches its terms.

Patricia Wade is head of professional development, and Sarah Stafford is a corporate professional development lawyer, at Ashurst LLP.

Drafting advice

When drafting a side letter, the following should be considered:

The title of a document (for example "comfort letter" or "side letter") is not conclusive of its legal status. In Barbudev v Eurocom Cable Management Bulgaria EOOD and others, the first draft of the side letter was attached to an email headed "comfort letter" but this title, attributed solely by one of the parties, was not conclusive of its status ([2011] EWHC 1560).
If a side letter is intended to be legally binding, explicit wording to that effect, the inclusion of legal boilerplating and/or reference to incorporation of terms from a previous (legally binding) contract are all useful for evidential purposes. At the other end of the scale, "honour clauses" and "subject to contract" wording are useful evidence that a document has only moral force.
Whatever the language used, a court will not enforce a side letter if the key commercial terms are still being negotiated. It is not open to a court to make a contract, only to interpret one.
If doubts exist as to the validity of consideration, a legally binding side letter should be executed as a deed.

Barbudev and the uncertainty of good faith

Unlike many European jurisdictions, the English courts continue to deny specific performance of an agreement to negotiate in good faith (Walford v Miles [1992] 2 AC 128). In Barbudev v Eurocom Cable Management Bulgaria EOOD and others, the High Court held that a side letter was not enforceable as a legally binding contract because, as a matter of its construction, it was an agreement to agree ([2011] EWHC 1560). The side letter included the phrase "and we agree to negotiate the [agreement] in good faith with you". The court 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 negotiations between the parties to execute a further agreement and did not include terms essential to the performance of these provisions.

Although the side letter in Barbudev included some contractual boilerplate, including an English governing law clause, and was signed by the parties, the court considered that its uncertainty showed objectively that the parties cannot objectively have intended it to be legally binding (following Dhanani v Crasnianski [2011] EWHC 926 (Comm)).

End of Document

Also Found In

General contract and boilerplate

Resource ID 6-508-4548

Published on 28-Sep-2011

Resource Type Articles

Jurisdiction

United Kingdom