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A Pressing Commitment

03/08/2016

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United Kingdom

A recent High Court decision illustrates the potential perils for parties entering into what might be assumed (or at least appear) to be documents that are not legally binding.

A recent High Court decision illustrates the potential perils for parties entering into what might be assumed (or at least appear) to be documents that are not legally binding.  In Novus Aviation Limited v. Alubaf Arab International Bank BSC(c) [2016] EWHC 1575 (Comm) it was held that a commitment letter signed by one party but not the other party was an enforceable contract such that the defendant's withdrawal from its terms constituted an anticipatory – and costly – breach of contract.  This note summarises the facts of the case, the outcome and practical steps that can be taken to reduce the risk of documents expressed to be not legally binding being found to be so.

Facts

In March 2013, Alubaf Arab International Bank BSC(c) (the "Bank") contacted Novus Aviation Limited ("Novus").  Novus's business consists of arranging finance for the acquisition and subsequent leasing of commercial aircraft.  Novus and the Bank entered discussions and the Bank expressed interest in an upcoming transaction for the purchase of new Airbus 330-300 aircraft to be delivered to Malaysia Airlines.  The purchase was to be funded by way of equity and debt finance such that the Bank would provide the majority of the equity financing (approximately USD 40,000,000) and Novus would arrange the debt financing (approximately USD 70,000,000) (the "Transaction").  On 5 May 2013 the investment committee of the Bank approved the Bank's entry into the Transaction.  Later the same day, Novus sent a draft commitment letter to the Bank.  Following discussions between Novus and the Bank, some minor amendments were made to the letter and the Bank sent Novus a scanned copy of the executed commitment letter.  Given the structure of the Transaction, further steps were taken, including the incorporation of various special purpose companies, the opening of bank accounts, nomination of directors and the like.  By 19 May 2013, law firms had been instructed to produce draft Transaction documentation.  By early June, however, the Bank became aware that the structure of the Transaction was likely to prove problematic. Under international accounting rules the accounts of the special purpose companies would be consolidated with the accounts of the Bank such that USD 70,000,000 of debt finance would be a liability of the Bank whilst the acquired aircraft would be regarded as an asset of the Bank.  For various other reasons, from the Bank's perspective, this was an insuperable barrier.  By 17 June 2013 the Bank's board resolved to reject a proposal to continue with the Transaction.  On 25 June 2013 – following conversations from 18 June 2013 when Novus was told of the board's decision – Novus's solicitors wrote to the Bank requesting an undertaking that the Bank would abide by the terms of the commitment letter (failing which proceedings would be initiated).  Solicitors for the Bank responded three days later stating that there was no binding agreement between the Bank and Novus and that the Bank did not intend to proceed with the Transaction.  Consequently, the Transaction aborted and Malaysia Airlines purchased the aircraft themselves.  Novus sued the Bank for breach of contract.  One of the questions for the court (the others are not discussed here) was whether the commitment letter was intended to be legally binding.  Importantly, although the Bank had signed and returned the commitment letter, there was no evidence that Novus had signed the commitment letter.

The outcome

Mr Justice Leggatt held that the commitment letter was legally binding.  In particular, whilst there was no evidence that Novus had signed the commitment letter, binding legal relations had arisen between it and the Bank viewing both the conduct between the parties and the terms in which the letter was expressed.  In other words, when determining the existence or non-existence of enforceable contractual relations the court will not, in the absence of clear language to the contrary, limit itself to communication in words only to the exclusion of the parties' conduct.  As to the words used in the letter, the judge thought that the language employed in the letter (and the jurisdiction provision in particular) dispelled any doubt about intention to create legal relations: the use of the formulation "the agreement constituted by acceptance of its terms", mandatory language such as "shall" and the 'quintessential' language of legal obligation, "covenant".  The judge acknowledged that in principle it is possible to create a document some parts of which are to be legally enforceable and others which are not.   Nonetheless, as an aside, he added that one would expect to see the "distinction between the two qualitatively different types of provision clearly signalled".

Practical steps

If a party wishes to enter a document to signal intent but not to be legally bound by that document (including, for example, term sheets, memorandum of understanding, commitment letters and the like) it will have to demonstrate that intention not to be legally bound very clearly as this case demonstrates.  From a practical perspective, documents ought:

  • to state that they are not intended to create legal relations (and/or they are subject to contract) if that is what the parties seek;
  • to be drafted so that they prescribe that the only mode of acceptance is by signature and countersignature to avoid the situation in this case;  and
  • to state, if adopting the approach in the above bullet, that such prescribed mode of acceptance can only be waived in writing to avoid that requirement being waived by words or conduct.

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