Canada: The Superior Court Of Québec Enforces The Terms Of A Non-Binding Letter Of Intent Despite The Existence Of A Definitive Agreement

Last Updated: January 21 2010
Article by Maxime Cloutier and Rachael D. Golem

A recent judgment of the Superior Court of Québec, Ihag-Holding, a.g. v. Intrawest Corporation1 enforced the terms of a letter of intent which contradicted the terms of the definitive agreement executed by the parties. By rendering this decision, despite there being a "Complete Agreement" clause in the definitive agreement, the Court emphasizes the limitations of such clauses and the important role of the "non-binding" letter of intent in the context of a transaction. Although this judgment is on appeal, legal advisors and business people should have this decision in mind when they draft and execute a non-binding letter of intent or when they subsequently draft or execute an agreement containing a Complete Agreement clause.

Facts

IHAG-Holding AG ("IHAG"), a Swiss based holding company, sought to sell a Québec resort owned by its wholly-owned subsidiary. Following a failed attempt by IHAG to select a purchaser through an auction process, Intrawest Corporation ("Intrawest") emerged as the only interested potential purchaser. The parties proceeded to negotiate the structure of the acquisition, and settled on a potential earn-out payment pursuant to which the purchase price would be raised should the resort be particularly profitable (Intrawest would pay IHAG an amount equal to 4.8 times the average earnings before interest, taxes, depreciation and amortization (EBITDA) exceeding $2M over the four-year period following the transaction (the "ROPA Payment")). A letter of intent (the "LOI") was drafted by Intrawest and sent for review by IHAG, its financial advisor and its Québec counsel. The parties exchanged comments and signed the LOI a month later.

Intrawest then mandated an experienced commercial lawyer to draft the share purchase agreement and loan agreement (the "Agreement") based on the LOI. The provisions relating to the ROPA Payment were quite complex. In the second of three drafts circulated, the drafting lawyer attempted to clear up the ROPA Payment provisions but instead such provisions were inadvertently changed in such a way that they no longer reflected the terms of the LOI. Neither of the parties, including their respective experienced legal and financial representatives, noticed the change, and the Agreement was signed with the modified provisions. Over the next four years, the resort generated an EBIDTA inferior to $2M. Under the LOI, that meant that Intrawest owed IHAG nothing. However, under the terms of the Agreement, Intrawest owed a total of approximately $6M. IHAG appealed to the Superior Court to order Intrawest to pay, notably, the $6M ROPA Payment.

Judgment

At trial, IHAG sought to exclude the LOI from evidence presented by Intrawest, citing the "Complete Agreement" clause contained in the Agreement which stipulated that there was no other agreement between the parties. Such a clause, IHAG claimed, was agreed to by sophisticated parties and was meant to avoid problems such as those raised at trial. The judge, however, noted that in certain cases, such a clause can be set aside. In the case at hand, the judge set aside the Complete Agreement clause, first, in the interest of finding the common intention of the parties, and second, because he found that IHAG was not acting in good faith by misinterpreting the Agreement and that it was abusive for IHAG to rely on the Complete Agreement clause to prevent the introduction of evidence showing the drafting error.

The judge then continued his analysis in order to determine whether a material drafting error had occurred in the Agreement. The judge concluded that there had in fact been such an error for two reasons. First, the error was clearly overlooked by all the parties. There was a substantial difference in the ROPA Payment formula provided in the LOI and that provided in the Agreement. There was no evidence, however, attesting to any discussions regarding modifications to be made thereto. Second, the judge noted that reliance on the ROPA Payment formula in the Agreement would result in an unreasonable commercial transaction. This conclusion was based on expert evidence that the resort was worth approximately $2.5M at the time of the sale and that Intrawest had already paid a purchase price of $3.2M. In the circumstances, the judge found the error to be excusable. The judge noted that many experienced professionals failed to detect the drafting error which was part of a complex series of definitions.

Finally, the judge refused IHAG's request that the transaction be declared null and that there be restitution of the prestations of the parties on the grounds that such a remedy would not be equitable. Instead the judge chose to enforce the common intention of the parties, as reflected in the relevant provision of the LOI. While the judge noted that the LOI was not a binding agreement, he found that it evidenced a meeting of the minds which reflected the business terms agreed to by the parties.

Discussion

(a) The Stability of the Contract

With regards to the setting aside of the Complete Agreement clause, both lawyers and business people are likely to be taken aback by the judge's decision in this regard. This clause is routinely included in agreements in order to bring an element certainty to the contractual relationship by providing that the parties shall be bound solely by the obligations contained in the "final" agreement. This judgment, however, emphasizes that a Complete Agreement clause should neither prevent a judge from seeking the common intention of the parties, nor should it allow a party to circumvent its obligation to act in good faith. A judge will not simply note the Complete Agreement and accept to enforce the agreement as drafted. Even when the terms of an agreement are unambiguous, if a judge has reason to believe that the agreement as drafted does not reflect the common intention of the parties, he or she will look to precontractual documents and agreements to decipher it. While this approach may at first appear to be a threat to the stability of a contract, it may rather, as in the case at hand, ensure that the common intention of the parties is in fact enforced.

(b) Correcting Drafting Errors

The possibility that a judge could remedy a drafting error in a definitive agreement is also relevant to lawyers and business people. The definitive agreement of a transaction is generally reviewed, commented and negotiated by all parties and their respective advisors. However, regardless of how sophisticated the parties or how thorough the process, drafting errors have been found to slip through. Not all such errors are material, but in some cases, as in the case at hand, they are. While in this case materiality was hardly at issue, the judge spoke to the excusable nature of the drafting lawyer's error. Under Québec civil law, an error may constitute a defect to consent only if it is excusable. In the circumstances, the error was hidden in a complex series of definitions and was not detected by of the experienced business people and professionals who reviewed the Agreement. The drafting error was thus determined to be excusable. While those drafting and reviewing agreements will not be off the hook for any drafting error, a material and excusable error is susceptible to be remedied by the courts.

(c) Minimizing Uncertainty

Above all, this case brings to light the importance of agreements signed, and other documents exchanged between parties, prior to the signing of a definitive agreement. The letter of intent is often taken lightly, especially when the parties agree that it is non-binding, as is most frequently the case. However, this case serves as a reminder to lawyers and business people alike that the letter of intent need not be considered a mere starting point for negotiations. Therefore, the letter of intent should be carefully drafted. The goal is not to negotiate the letter of intent as one would a definitive agreement, but rather to recognize that non-binding does not equate to without consequence. In addition, it is recommended that parties document any major deviation from the terms of the letter of intent by amending the letter of intent itself or by a written instrument clearly evidencing each party's consent to deviate from its terms. In this case, the terms of the deal between the parties did not change leading up to the signing of the Agreement and the LOI was thus used to interpret the common intention of the parties. However, deals can change significantly between the signing of a letter of intent and that of a definitive agreement. The failure by a party to properly document amendments to terms of a letter of intent could leave it open to a challenge from the other party.

Conclusion

This judgment serves as a reminder to lawyers and business people that they should not be careless in their handling of agreements signed and documents exchanged prior to the signing of a definitive agreement, only to rely on a Complete Agreement clause to eliminate any uncertainty. Such agreements and documents can prove to be detrimental if not given sufficient attention.

Footnote

1.2009 QCCS 2699 (CanLII). This judgment is currently on appeal before the Québec Court of Appeal (500-09-019848-092).

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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