Are your Commitment Letters Binding?
On 18 October 2017, the Commercial Court in England refused appeal in the case of Novus Aviation Limited v Alubaf Arab International Bank BSC (the “Bank”) for breach of an agreement to provide equity funding for the purchase of aircrafts. This case serves as a reminder to many financial institutions of the potential consequences of signing documents, such as commitment letters or term sheets, which they may not have intended to be legally binding.
Facts behind the case:
- Novus and the Bank entered into negotiations to partially finance the purchase of a number of aircrafts for Novus.
- Novus then sent a commitment letter, which they intended to be legally binding, and a management agreement to the Bank for signing.
- The Bank returned the commitment letter to Novus with a signature.
- Following this, both parties undertook various steps to progress the transaction.
- After reviewing the transaction structure in more detail, it was decided that the Bank’s participation in the transaction was not viable; the bank then withdrew itself from the transaction.
- Novus went ahead and sued the Bank for breach of contract claiming that the commitment letter and management agreement constituted a binding agreement and that this was rejected by the Bank.
Case in favour of the Bank:
Although the management agreement was legally binding, the commitment letter was not and was void for uncertainty of its conditions. It was further argued that the person who signed the commitment letter had no authority to bind the letter on behalf of the Bank. Also, Novus did not countersign the letter or provide a written statement of their acceptance so, theoretically, the letter should not have been considered to be legally binding.
Case in favour of Novus:
Within the commitment letter it was stated that the Bank’s commitments were conditional upon “satisfactory review and completion of documentation”. Provisions also included that the Bank “shall” do certain things which were considered to clearly impose actual obligations upon them. A clause also stated the Bank “covenants to pay all transaction costs” and the language used, particularly “covenants”, was thought to show a binding legal obligation. The letter also included a governing law and jurisdiction provision, which of itself was considered sufficient information of a legally binding letter.
The Court held that the commitment letter intended to create legally binding relations to provide finance despite stating “conditional upon satisfactory review and completion of documentation”. The Court believed it was not merely a statement of intention and bound the Bank to provide equity funding. The Bank had signed the letter and despite that it was not countersigned by Novus, the Court found that they had instead communicated their acceptance to the Bank by email which was considered to be sufficient. The Bank argued that the person who signed the letter was not actually authorised to do so but it was objected that he had apparent authority which was sufficient enough by law to bind the Bank to the agreement. Upon the evidence and despite the uncertainty of the terms of the document, it was declared that the Bank had demonstrated its intentions to be legally bound by the document. Accordingly, Novus was entitled to receive a sum in respect of the fee that would have been payable on closing the transaction leading to damages totalling over $8million against the Bank.
This case highlighted that parties, particularly financial institutions, need to be extremely careful when drafting and executing commitment letters, especially when they do not consider themselves to be legally bound by it. Our advice to companies is as follows:
- Make it clear whether there is an intention to make legally binding obligations.
- If the letter is not intended to be legally binding it should explicitly state “subject to contract”.
- If the letter is to be legally binding, but subject to conditions, clearly define such conditions and consequences if these conditions are not met.
- Include a statement that the terms are only to be accepted with a countersignature from both parties.
- Clearly separate any particular provisions that are meant to be legally binding from those that are not.
- Include a presumption as to the authority of the signatures that bind the parties.
For further information and guidance on commitment letters, please contact Sean Halliwell, or you can give us a call on 0345 070 6000.