Letter of Intent-How Binding?

The Ontario Court of Appeal in Wallace v. Allen, 2009 ONCA 36, recently held that if a letter of intent clearly expresses that the parties intend to be bound by it, and the parties conduct themselves as if they are bound, then neither side will be able to back out of the transaction before closing.

The defendant, Allen was looking at selling his business interests, and the plaintiff, Wallace, expressed a desire to acquire them. The parties executed a letter of intent for the share purchase and the sale of four companies. Both parties acknowledged that all the terms that were essential to the transaction were agreed upon and included in the letter of intent.

It is not uncommon for a Letter of Intent to contain a clause stating that there is no binding contract until a formal agreement is signed. The Court of Appeal did not have to deal with this type of clause in this case, but rather they found that the Letter of Intent contained clauses which contemplated a further agreement. Those clauses read:

IT IS ALSO AGREED BY THE PARTIES 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

THIS LETTER OF INTENT MUST BE REDUCED INTO A BINDING AGREEMENT OF PURCHASE AND SALE BY THE PARTIES WITHIN THE NEXT 40 DAYS

These clauses were critical in evidencing both parties intention to be bound by the Letter of Intent, as they were clear and unambiguous that further negotiations would take place, and a deadline was provided to turn the deal into a binding Agreement of Purchase and Sale.

After much negotiation, a final draft of a share purchase agreement was exchanged between the parties’ lawyers, and shortly before the closing date they met to finalize the terms. On the closing date, Wallace was not present, as he had gone to Florida with the defendant’s knowledge and approval. Wallace had not signed the necessary closing documentation, and so Allen refused to close and elected to terminate the transaction. The trial judge determined that the parties had no intention to create legal relations until the agreed upon share purchase agreement was executed.

The Court of Appeal did not agree and held that the letter of intent plainly expressed the intention of the parties to be bound by its terms. This intention was evidenced by the conduct of the parties after the letter of intent was signed, which clearly demonstrated that both sides considered themselves legally bound by its terms. After signing the letter of intent, Allen held a special employee meeting, announcing his retirement and the fact that he had sold his company. Wallace began working at the business every day to learn how the business operated and to ensure the change of ownership went as smooth as possible. Allen also introduced Wallace to all of the employees as the “new owner”.

What should be taken away from this decision? If an individual or company wants a letter of intent to be binding on other parties involved, the letter of intent should clearly express the intention of the parties to be bound. All the essential or necessary terms of the transaction should be included in the letter of intent. It would also be prudent to insert clauses similar to the ones found in Wallace, providing a timeline for the deal, and stating that it is understood that much more work needs to be done. Finally, they should conduct themselves as if they are legally bound by the terms.