When is a letter of intent binding?

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Letters of intent and other similar documents are commonly used tools in construction and commercial settings to ensure the expedient and efficient commencement of the parties' obligations.  A question that often arises when dealing with letters of intent is whether or not they are binding on the parties, or whether they serve as a guide and record for further negotiation and agreement.  The case of Factory 5 Pty Ltd v State of Victoria [2010] FCA 1229 considers these issues and clarifies the requirements of a binding letter of intent.

Facts

Factory 5 entered into negotiations with M2006 (a statutory corporation formed to manage the Commonwealth Games in Melbourne) to become the sole retail concessionaire of licensed souvenirs, memorabilia and apparel for the Commonwealth Games in Melbourne.

On 16 December 2004, M2006 sent a letter to Factory 5 detailing the proposed terms and structure of the agreement. 

On 23 December 2004, M2006 wrote to Factory 5 and relevantly stated:

We confirm that the parties have agreed that F5 is to be appointed as Concessionaire subject to reaching agreement on a legally binding Long Form Concessionaire Agreement to be provided by M2006 and subject to M2006 Board Approval.

The 23 December letter incorporated into what it called 'this agreement' the commercial terms and conditions that were set out in the correspondence specified, including the letter of 16 December 2004.

Factory 5 claimed that on 23 December 2004 it made a fourth class Masters v Cameron agreement with M2006.  That is an agreement in which the parties were content to be bound immediately and exclusively by the terms which they had agreed upon, whilst expecting to make a further more formal contract in substitution for the first contract containing, by consent, additional terms.

M2006 denied that a contract of any kind was made on 23 December 2004. It contended that what occurred on 23 December 2004 resulted in a class three Masters v Cameron situation (that is, a situation where the intention of the parties was not to make a concluded bargain at all, unless and until they executed a formal contract).

In the alternative, M2006 contended that if it and Factory 5 did make an agreement on 23 December 2004, the terms of that agreement were that Factory 5 was to be appointed as concessionaire subject to reaching agreement on a legally binding Long Form Concessionaire Agreement (LFA) approved by the Board of M2006. This was said to be in the nature of a class two Masters v Cameron agreement where the parties have completely agreed upon all of the terms of their bargain and intend no departure from or addition to that which their agreed terms express or imply, but nevertheless have made performance of one or more of the terms conditional upon the execution of a formal document.

The decision

The court held that on 23 December 2004, Factory 5 and M2006 did make a legally binding contract. That contract was a fourth class Masters v Cameron contract and its legally binding effect was not subject to the parties making an LFA. 

The terms of M2006’s letter of 16 December 2004 were of central importance to the ultimate conclusion reached about whether a legally binding contract was concluded on 23 December 2004. Firstly, the letter identified 37 subject matters and set out the proposed terms in relation to each. The list of matters dealt with appeared comprehensive. It was not apparent that any term of importance to a contract was not dealt with by the terms specified.  Secondly, those terms identified a plan by which M2006 and Factory 5 would negotiate and thereafter arrange their agreement.  The objective of the plan was clear – there would be a legally binding Deal Memo on or before 23 December 2004, followed by a further agreement.

The court held that upon reading the 23 December 2004 letter, Factory 5 had no basis for believing that the letter was anything other than the legally binding Deal Memo foreshadowed in the letter of 16 December. The foreshadowed negotiating period was about to expire. No extension of it was sought by M2006. There were no outstanding issues to be resolved in the negotiations. All matters on the table had been resolved. There were no suggestion, not even the slightest of hints, that M2006 had cause to or had changed its mind about the legally binding nature of the intended Deal Memo. A reasonable person in the position of Factory 5 was entitled to expect and must have expected that a volte face in terms of contractual intent would be the subject of a clear and unambiguous communication.

Furthermore, by reason of the plan laid out in the 16 December letter, the reasonable person would have understood that beyond the Deal Memo stage there was a second stage – the making of a binding LFA and an intended contractual commencement of 31 January 2005. 

M2006 asserted that the parties continued to negotiate the terms of the agreement after 23 December 2004, thus negating the idea of an existing concluded contract.  The court held that this argument could not be accepted as the agreement expressly contemplated that their agreement should be further detailed in a formal contract. That course necessarily entailed the need for further communications and negotiations as to the form of the formal contract. Accordingly, that further negotiations occurred as to the form of the LFA is apt to be regarded as consistent with what was agreed, rather than being an acknowledgement of no agreement having being made earlier.

The court stated that there was an obvious distinction to be drawn between negotiations held for the purpose of reaching an agreement and negotiations held for the purpose of reflecting and properly expressing an agreement already reached. In the context of a fourth class Masters v Cameron agreement, evidence of the negotiation of the form of a formal contract and evidence of the negotiation of additional terms was not ordinarily to be regarded as evidence of no prior concluded agreement.

Furthermore, a review of the evidence of the post-23 December 2004 communications between Factory 5 and M2006 shows that a draft of the LFA was prepared by M2006 and provided to Factory 5 for consideration and comment. A number of communications occurred in relation to the first draft, and further drafts were exchanged. Those exchanges, other than for the drafting of the concessionaire as manufacturer clause, showed that in relation to clauses dealing with subject matters that were canvassed in the 23 December letter, there was little or no controversy as to how the LFA should be expressed.

Accordingly, it was held that there was a binding contract of the fourth class made between M2006 and Factory 5 on 23 December 2004.

Implications

A common problem when using letters of intent, heads of agreement and memorandums of understand is that parties do not state the extent to which they wish to be bound by the document.  If they wish to record the state of the negotiations in a document but wish it to have no binding effect, they can do so and clearly state this fact in the document at the outset.

It is critical that both parties when using such documents are aware of the implications of such agreement, and furthermore, that such agreements are clearly drafted to reflect the precise intentions of the parties.