Canada: To Bind Or Not To Bind: A Recent Case On A Binding Letter Of Intent

When acquiring a privately held company, purchasers will often enter into the term sheet or letter of intent (LOI) without involving their legal counsel. Generally, the LOI sets forth certain broad terms of the business deal between the parties. The intention of the parties is usually that the LOI not be binding other than with respect to a limited range of matters. These typically include exclusivity (if it applies), a deposit (if one is to be paid), confidentiality, an outside date for negotiation of a purchase and sale agreement, rights of access for due diligence, the fact that each party bears its own expenses and other similar matters.

Canadian jurisprudence includes a number of examples of cases in which a so-called letter of intent has been held to be binding in its entirety, even though at least one of the parties had arguably not intended to be bound. The latest is the case of Wallace v. Allen, decided on January 16, 2009 by the Court of Appeal for Ontario.

Allen, the seller, owned an environmental services company and was planning to retire. Wallace, an entrepreneur, expressed an interest in buying the business. They entered into a letter of intent naming December 29, 2004 as the closing date. A number of contentious issues were settled in the LOI, such as whether certain property was owned by the company or by Allen personally. Wallace missed the December 29 meeting at which the closing was to take place (he was on vacation, which the seller knew about and had apparently encouraged him to take) and Allen subsequently refused to sign the share purchase agreement that had been negotiated. Wallace sued for breach of the agreement.

The trial judge held that the parties had not intended to be bound. She relied specifically on a clause in the LOI stating that "there will be much legal work to be done upon acceptance by both sides and that the wording of this agreement may alter somewhat" and on another clause providing that "this letter of intent must be reduced into a binding agreement of purchase and sale by the parties within the next 40 days".

The Court of Appeal, however, overturned the trial judge's decision. In holding that the letter of intent was binding, the court focused on the following factors:

  • While the clauses noted by the trial judge stated that the agreement was not final, each referred to "this agreement", suggesting that an agreement did, in fact, exist.
  • Wallace had testified that he understood the clauses as referring to the legal work required to turn the relatively informal expression of the parties' intent in the LOI into more legalistic language.
  • The LOI used legal language such as "it is agreed", "upon acceptance" and "this agreement", suggesting that the parties had recognized that their arrangement had legal consequences and, therefore, that a contract existed.
  • Allen had refused to sign earlier drafts of the LOI because they left "too much up in the air", but agreed to sign the final version.

The Court of Appeal also focused on the subsequent conduct of the parties, notably (i) that Allen introduced Wallace to the employees of the company, (ii) that Allen announced his retirement to friends and family, (iii) that Wallace began working full time in the business and took steps to bring his two sons into the operations, (iv) that the parties met on December 9 and resolved the final issues in the draft share purchase agreement, and (v) that Allen attended the scheduled December 29 meeting fully expecting to sign the agreement. The Court of Appeal did not order a remedy of completion of the purchase and sale, however, partly because it had been four years since the closing date and partly because the court reasoned that since Wallace was a serial entrepreneur who acquired numerous businesses, the requirement for the remedy of specific performance that the object of the contract be unique may not have been entirely met. Rather, the Court of Appeal ordered Allen to pay Wallace seven months of damages, on the basis that this was a reasonable time for Wallace to find a replacement investment. The Court of Appeal also overturned the trial judge's finding that another business purchase by Wallace within three months of the aborted deal had mitigated his damages, accepting Wallace's testimony that he would have completed both transactions if the Allen deal had closed.

Given that most parties do not intend their letters of intent to be legally binding agreements, there are some important lessons to be learned from Wallace v. Allen. One such lesson is that the insertion of language making the LOI "subject to the execution and delivery by the parties of a definitive purchase and sale agreement" may not suffice to ensure that the LOI is non-binding. The conduct of the parties - in particular, the type of conduct that occurred in Wallace v. Allen subsequent to the signing of the LOI - might convince a court that a binding agreement has been entered into in spite of such a clause. Furthermore, in light of Wallace v. Allen, such language could be taken by a court as asserting that all that remains to be done is to have counsel "reduce" the agreement set out in the LOI into a longer, more detailed legal agreement. Therefore, it is always helpful to ensure that the LOI clearly and specifically identifies the provisions that are to bind the parties, while expressly stating that the remaining provisions are not binding. It is also important to use terms that suggest intention ("would" rather than "will" and "letter of intent" instead of "agreement") and to insert specific conditions within one party's control, such as requiring either the board or the shareholders (or both) to approve the transaction, or providing that the purchaser must be satisfied with the results of due diligence investigations.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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