Bound by intention? Novus Aviation Limited v Alubaf Arab International Bank BSC (c)

A recent decision of the Commercial Court in England serves as a reminder to financial institutions and other transaction parties of the potential consequences of entering into documents which they may not have intended to be legally binding. In Novus Aviation Limited v. Alubaf Arab International Bank BSC(c) [2016] EWHC 1575 (Comm), it was held that a commitment letter was legally binding despite the letter stating that it was “conditional upon satisfactory review and completion of documentation” and that the subsequent withdrawal by the defendant from its terms constituted an anticipatory breach of contract.

This note summarises the facts of the case, the outcome and practical steps which can be taken to lessen the risk of documents which are expressed not to be legally binding on the contrary being found to be so.

Significantly, it should be noted that the case is subject to an application to appeal.

• Novus Aviation Limited (Novus) and Alubaf Arab International Bank BSC (c) (the Bank) entered into negotiations for the Bank to finance in part the purchase by Novus of a number of aircraft to be delivered to Malaysia Airlines Systems Berhad.
• Following negotiations regarding the terms of the financing, Novus sent a commitment letter and a management agreement to the Bank for signing.
• The Bank returned the commitment letter to Novus executed by one signatory and later sent Novus the signed management agreement.
• The parties then each subsequently undertook steps to progress the transaction, including setting up bank accounts, nominating directors, incorporating a special purpose company, KYC and engaging legal counsel to complete the documentation.
• Upon more detailed review of the transaction structure, the Bank decided that due to international accounting principles its participation in the transaction was not viable and the board of the Bank resolved not to continue the Bank’s part in the transaction.
• Novus then sued for breach of contract claiming that the commitment letter and the management agreement were legally binding and repudiation of these documents by the Bank resulted in damages totalling over US$8 million.
• One of the questions for the court to consider was whether the commitment letter was intended to be legally binding. Importantly although the Bank had signed and returned the commitment letter, there was no evidence that Novus had signed the commitment letter.

• The Bank denied the commitment letter was legally binding.
• It contended:
  1. Although the management agreement was legally binding, the commitment letter was not and/or was void for uncertainty of its terms;
  2. The signatory that signed the commitment letter had no authority to bind the Bank to the terms of the letter; and
  3. As Novus did not countersign the commitment letter, it was not binding.

The Court rejected all three limbs of the Bank’s defence.

Intention to create legal relations

The commitment letter clearly stated that the Bank’s obligations were conditional upon its “satisfactory review and completion of documentation”. However, Mr Justice Leggatt decided that the Bank could not unilaterally reject the Transaction and the decision of its board of directors not to proceed with the transaction – when communicated to Novus - amounted to an anticipatory breach of the contract contained in the commitment letter which Novus accepted as putting an end to the contract.

In giving judgement, the court relied heavily on the nature of the language used and on the inclusion of particular provisions in the commitment letter which dispelled any doubt about whether there was an intention for it to be legally binding. For example:

• A number of provisions included the language – Party X “shall…” – which were considered clearly to impose actual obligations on the parties; and

• There was a clause which provided that the bank “covenants to pay all transaction costs” and the court found that “covenants” was quintessentially the language of a legal obligation.

The inclusion of a governing law and jurisdiction provision was of itself held to be sufficient evidence to conclude that the letter was legally binding.

In giving judgement it was acknowledged that it was, in principle, possible for an agreement to have some parts that were intended to be binding and other parts that were not. Nevertheless, the judgement concluded that there was an expectation that the “distinction between the two qualitatively different types of provision” should be clearly stated. In this case, that distinction was considered not to be clear.

As to the contention that the commitment letter was void on account of uncertainty, the Court held that since the intention of the parties to be legally bound by the document had been objectively demonstrated, the seeming lack of certainty in the terms of the document did not constitute sufficient grounds to render the agreement void.

Lack of authority

The Court found that Novus was entitled to rely on the signatory’s apparent authority to bind the Bank, even though the Bank had specific procedures in place that required two signatories.

Lack of countersignature

Turning to the lack of countersignature, the Court looked instead at the actions and conduct of the parties after the letter was agreed. The Court found that both parties had conducted themselves in a manner which was consistent with the conclusion that the commitment letter was legally binding. English courts are increasingly unimpressed with technical arguments raised by parties which are considered to fly in the face of commercial reality.

The decision in this case is an important signal that parties need to be extremely diligent when drafting, executing and relying on commitment letters (and other similar agreements such as term sheets, letters of intent and heads of terms) which they do not intend to be legally binding.

Some practical steps which can be taken to achieve this are:

• to include a clear and unambiguous statement in the document as to whether or not there is an intention to create legally binding obligations;
• to separate any particular provisions which the parties intend to be legally binding clearly from those which are not intended to create a legally binding obligation (for example, confidentiality provisions are typically stated to be binding even in documents which are generally intended to be non-binding);
• to state that its terms are only accepted upon receipt of written confirmation/countersignature from both parties;
• to state that such acceptance by signature/countersignature can only be waived in writing by the counterparty so as to reduce the risk of an implied waiver of that requirement through subsequent words or conduct; and
• to include a general presumption as to the authority of the signatories to bind the parties.