We have all heard the saying; it’s not worth the paper it’s written on, and while that can sometimes be true, in a legal context the answer is really determined by intent and proof.
People entering a commercial agreement will often attempt to document the basic points that they believe have been negotiated and agreed. The document can go under a number of names, including: “Heads of Agreement”, “Letter of Intent” and “Memorandum of Understanding”, and will usually note that formal agreements will be prepared subsequently.
Often, one of the parties assumes that other important matters can be added to the final agreement at a later point and that assumption can prove to be costly if the document which they have signed is held by a court to be a legally binding contract.
The relevant legal question is – When will informal correspondence give rise to a legally binding contract?
That question was answered over 50 years ago by the High Court of Australia in the case know as Masters v Cameron.
Since that time, failure by contracting parties to take note of the important decisions reached in that case has resulted in a great deal of litigation as people argue whether something was legally binding or not.
Masters v Cameron issues continue to involve a significant number of cases coming before the courts as ill-advised parties continue to incur substantial litigation costs that could, and should, have been avoided.
According to the Masters v Cameron, a binding contract may or may not emerge from informal written documents that contemplate a further formal contract. Whether it does depends on which of the following classes the informal document falls within:
Class 1: Where the parties have reached finality in arranging all the terms of their bargain and intend to be immediately bound to the performance of those terms, but at the same time propose to have the terms re-stated in a form which will be fuller or more precise but not different in effect.
Class 2: Where the parties have completely agreed upon all 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.
Class 3: Where the intention of the parties is not to make a concluded contract at all, unless and until they execute a formal contract.
The document will fit into one of these 3 classes and be binding or not binding, irrespective of what you call the document.
Masters v Cameron held that in each of the first and second classes there is a binding contract:
- In the first case, a contract binding the parties at once to perform the agreed terms whether the contemplated formal document comes into existence or not, and to join (if they have so agreed) in settling and executing the formal document;
- In the second case, a contract binding the parties to join in bringing the formal contract into existence and then to carry it into execution.
In many instances however, the parties may want some of the terms which they have negotiated at a given time to be contractually binding (example – an agreement that if a proposed joint venture does not proceed, any market information obtained by the parties in the investigation process will belong to one of them), while other terms may require precise definition and agreement before they become binding (example – requirements for any finance facilities which must be in place before the venture can proceed).In order to prove whether an informal agreement is immediately binding three matters arise for consideration: