Commitment letter: Acceptance by conduct

Executive summary

This Commercial Court decision, which concerns a bank commitment letter, serves as a reminder that a contractual “offer” can be accepted by conduct so as to create a binding agreement, even where it is contemplated that counter signature would ordinarily be provided. Where negotiating parties wish to avoid that outcome they should ensure that documentation clearly states that acceptance can only be by signature and/or clarify that they do not intend to be bound to the terms under discussion.

This judgment will be of interest to financial institutions that use commitment letters as part of their business operations. More generally, it highlights the risk in signing a document which could be construed as a contract unless one intends to be bound.

Case facts

Novus Aviation Limited (Novus), an aircraft finance company, engaged Alubaf Arab International Bank BSC(c) (the Bank) regarding the purchase of a new Airbus 330-300 aircraft to be delivered to Malaysia Airlines. The purchase would be funded by approximately $40m equity provided by the Bank and approximately $70m debt arranged by Novus. Novus sent a draft management agreement and a draft commitment letter to the Bank. The Bank executed and returned the commitment letter and management agreement to Novus in due course. The signed commitment letter stated that it was “conditional upon satisfactory review and completion of documentation”. Novus did not countersign the commitment letter but instead proceeded to carry out work for the successful completion of the transaction. This work included incorporating special purpose companies, nominating directors and setting up bank accounts.

Shortly afterwards, the Bank sought to withdraw from the transaction. The Bank alleged that no binding legal agreement had been created due to the lack of a countersignature, and by reason of uncertainty.

Intention to be bound by the commitment letter

No term within the commitment letter stated that Novus could only signal acceptance by counter-signature. The Court held that Novus was able to and had communicated its acceptance of the contract via its conduct. This was evidenced by Novus proceeding with the transaction in the way that it had. The Court found no evidence that Novus was unhappy with the terms of the commitment letter or that the Bank was only willing to treat the commitment letter as binding if counter-signed and returned. For these reasons the commitment letter was understood to be agreed and binding.

The Court further relied on the language used throughout the body of the contract, which denoted contractual obligations. Words such as “shall” were interpreted as creating mandatory actions for Novus. Likewise, the Bank’s covenant to pay was highlighted as “quintessentially the language of legal obligation.”

The Bank alleged that the commitment letter was not intended to be a legally binding document. The Court applied the test set down in the leading case of RTS Flexible Systems Ltd v Molkerei Alois Muller GmbH & Co KG [2010] UKSC 14. The focus of that test is on whether the words and conduct by which the parties communicated leads objectively to the conclusion that they intended to create legal relations, and had agreed upon all of the terms which are necessary for that purpose. Applying this test, the Court found that the parties did intend, via the commitment letter, to create binding legal relations. In reaching this conclusion the Court noted in particular that the use of a governing law clause, which dispelled any doubt of the parties’ intention to be bound (since, if there were no agreement, there would be no purpose stating which law was to govern it).

Arguments regarding uncertainty

The Bank further alleged that even where a document is intended to be legally binding, it may be too uncertain to be legally enforceable, and that was the case here. The Bank cited in particular the language that the obligation to provide equity funding was “conditional upon satisfactory review and completion of documentation”. The Judge held that English law aims to uphold and give effect to the intentions of the parties, not to defeat them. Therefore, as the parties did intend to be bound by the agreement the Court gave effect to that intention by construing words in a way which gave them a practical meaning. On that basis it held that whether documentation was “satisfactory” was a question of fact, and any contractual discretion thereby conferred (as to whether the documentation was, in fact, satisfactory) was to be exercised like any other contractual discretion (in good faith, for the purpose conferred, and not arbitrarily, capriciously or unreasonably). The Judge therefore held that the agreement did not fail for want of certainty.

Comment

In certain situations parties may seek to explore a prospective commercial arrangement through "heads of terms", or some other form of summary. Sometimes, as here, that results in a party stating its intention to proceed with the deal, without necessarily intending, subjectively, to be bound contractually to those summary terms. In such circumstances, care should be taken to ensure that any document recording such terms does not, of itself, constitute an offer that is capable of acceptance by the other party’s conduct.

This can be achieved by including language to expressly state that the terms are subject to contract, and that the party has no intention to be bound to the summary of terms. The documentation might also state that a contract can only be reached via signature and countersignature, and that this requirement can only be waived in writing.

However, as this case demonstrates, even if there is an express requirement for countersignature this does not (in the absence of provisions to the contrary) preclude the waiver of that requirement by subsequent words or conduct. To avoid uncertainty, countersignature should therefore be obtained, so that the parties each know that they are bound to the agreement they have made.