Is your side letter at risk of being non-binding?

Is your side letter at risk of being non-binding?


Author: Emma Deane

The key component of a legally binding document is certainty of the drafted terms.

The courts will always attempt to give legal effect to an agreement based on the intention of the contracting parties, and there can be no legally binding contract where that intention is absent.

Side letters are used in various commercial scenarios. However, the parties must be aware that a side letter may not constitute a legally enforceable contract. If its provisions are uncertain and have been drafted subject to further good faith negotiations, it will be no more than an unenforceable agreement to agree.

The recent case of Barbudev v Eurocom Cable Management Bulgaria EOOD and others provides useful guidance on the application of general contractual principles, and more specifically on the construction of side letters.

In Barbudev, the Court of Appeal confirmed on appeal that a side letter relating to the terms of a future investment was no more than an agreement to agree and was legally unenforceable.

The side letter provided for the parties to later negotiate an investment and shareholders' agreement in which Barbudev would purchase shares in a company. The agreement to negotiate the terms in the future was held not to be final as it left several factors dependent on further negotiations.

It was held that the terms of the side letter were insufficiently certain as essential terms of the investment had not been addressed. The parties were not seeking to agree a simple share sale for a set price. Instead, they were seeking to reach an agreement of all the terms that would govern the relationship between the shareholders at some point in the future.

The complexity of the proposed shareholder agreement meant that the side letter, which failed to set out the comprehensive specific terms required for there to be certainty, could not be legally binding. The position may have been different had the parties made provision for these essential terms within the side letter.

However, unlike the judge at first instance, the Court of Appeal did find that the side letter demonstrated an intention to create legal relations. This was due to the fact that the letter was drafted by lawyers; it contained boilerplate provisions and the language of legal relations, such as 'in consideration of'; and it made reference to specific statutes.

However, despite the demonstrated intention to create legal relations, the side letter was still unenforceable due to the lack of certainty.

Barbudev also contended that the side letter was partly oral and partly written and that oral representations and assurances that he had been given formed an enforceable agreement. This argument was rejected.

What does this mean?

In complex transactions where matters can be delayed, side letters are often used to provide reassurance of the parties' intentions. However, it is paramount that they are appropriately drafted to minimise the risk of costly disputes and misunderstandings.

Just because the parties may have the intention to create legal relations, that alone does not necessarily mean that an enforceable agreement will exist.

What should you do?

This case illustrates that parties wishing to use a side letter should be absolutely clear as to the legal effect of each provision.

If the parties want a provision to be legally enforceable then they should expressly state this in the side letter. Similarly, if there are matters and terms which are still to be agreed, then the parties should specify these provisions are not intended to be binding.