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Is your side letter legally binding?
The use of side letters in commercial transactions is common. Ancillary to a contract, a side letter is used to clarify, supplement or vary the original agreement. The key question is whether or not it is in fact a legally binding contract.
The recent case of Barbudev v Eurocom Cable Management Bulgaria EOOD & Others highlights the need to ensure that the side letter is not simply ‘an agreement to agree’.
The case concerned a company sale, where it was agreed that the seller, Mr Barbudev, would have shares in the buyer’s newly-merged company. Because the terms of Mr Barbudev's investment could not be agreed before the sale was completed, the parties entered into a side letter.
Several years on, the company was sold but Mr Barbudev's investment agreement had still not been signed. The court had to decide whether the side letter constituted a legally enforceable contract.
Intention to create legal relations
In Barbudev, 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’. Additionally, there has always been a strong presumption by the courts that parties to commercial transactions intend to create legal relations.
There are two components to this requirement: certainty of language; and whether the document is sufficiently complete. Where certainty of language is an issue, courts limit themselves to interpreting a contract and not making one.
It is important to remember that, to be binding, a side letter must, like all contracts, be supported by consideration (unless made by a deed). Two key principles have emerged from side letter case law. The first is that that consideration must move from the promise (that is, the person who seeks to enforce the promise), although it need not move to the promisor. Secondly, past consideration is no consideration, so completed obligations will not be regarded as consideration. This could be relevant when a side letter is used to vary an existing arrangement. However, the courts look at the entirety of a whole transaction which means that side letters can form part of a larger deal.
When drafting a side letter, care should be given to ensure that the document is legally binding. This can be done by explicit wording to that effect as well as including legal boiler plating and incorporating previous contractual terms. Where doubts exist as to consideration, the letter should be executed as a deed.