The New Year normally brings with it the enthusiasm and drive to succeed and win business.
Prior to the establishment of a business relationship many deals start with a letter of intent, heads of agreement, term sheet or heads of terms (“Pre-Contract Document“). Such documents are normally used to outline the general key commercial terms or principles of a proposed deal or project and may often be negotiated or drafted without consideration as to the legal effect and / or without legal assistance. But the event of a dispute, how legally binding are such documents on the parties?
Under English and Welsh law it is well established that in order for there to be a legally enforceable contract, one which creates rights and duties, there must be the following:
- Intention to create legal relations, and
- Certainty of Terms.
For business, the use of a Pre-Contract Document or similar document can raise 2 issues:
- A contract cannot be made without a mutual intention to create a legally binding arrangement, however, there is a presumption in commercial situations that the parties intend their agreements to be legally binding; and
- Does the Pre-Contract Document contain sufficient certain terms?
So how can a business ensure their Pre-Contract Document doesn’t unintentionally create a legal relationship?
Document Title: The common factor in most Pre-Contract Documents are that their titles imply there may not be an “intention to create legal relations” at the time they are signed, rather their purpose is to state the “intent” or “understanding” of the parties. They are usually intended as a non-binding record of the terms that may have been agreed in principle prior to finalising the contract.
Document Content: There is no rule that a Pre-Contract Document’s title prevents it from being a legally enforceable contract. Therefore the interpretation of the wording in the body of the Pre-Contract Document will also be a key factor in determining whether it is intended to have legal effect. Consideration would need to be made as to whether all elements of a legally enforceable contract are present, i.e. offer, acceptance, consideration, etc. If all elements are present the Pre-Contract Document may be considered legally binding despite its title suggesting otherwise.
In order to rebut the presumption that a Pre-Contract Document is intended to create a legally binding effect the parties would need to produce clear evidence that the Pre-Contract Document is not intended to create a legal relationship. However, the parties may need or want some elements of a Pre-Contract Document to be binding, such as obligations of confidentiality, allocation of costs for negotiations/document preparation, etc. If this is the case, the Pre-Contract Document needs to be clear on what is and what is not intended to have legal effect. A carefully drafted Pre-Contract Document can achieve this as well as satisfying the need to clarify the position of the parties before a final contract is signed.
Finally, and on a more commercial note, where a carefully drafted Pre-Contract Document does not create legally binding obligations there is still a practical risk that once signed it may be difficult, practically or morally, to re-negotiate any terms if during final contract negotiations an issue arises that may not have been considered at the outset.
Contact our team of experts for advice on commercial contracts.
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