When is a letter of intent binding?

16 JUN 2011
By:

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.

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 The terms of M2006s 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.

DLA Piper is a global law firm operating through various separate and distinct legal entities. Further details of these entities can be found at www.dlapiper.com. This may qualify as
Attorney Advertising requiring notice in some jurisdictions. Prior results do not guarantee a similar outcome. Copyright 2016 DLA Piper. All rights reserved.