Commitment letters are useful. They give some certainty to borrowers and investors about bank lending whilst documentation is negotiated. However, in a recent case, commitment letters have come under the spotlight where a lender was found to be contractually bound by one even though the other party hadn’t signed it.
In 2013, discussions were entered into between Novus Aviation, a company that arranges finance for the acquisition and leasing of commercial aircraft, and Alubaf bank. In May 2013, Novus sent a draft commitment letter to the Bank but invited the Bank to make any changes it thought necessary. The Bank made changes then sent Novus a signed copy of the letter. Crucial here was the fact that Novus did not countersign the letter. There was also a management agreement but for the purposes of this post we’ll just be looking at the commitment letter.
Work was undertaken to progress the transaction, with solicitors instructed and documents prepared, but in June 2013 the Bank’s board decided not to proceed with the transaction for accounting reasons. Novus made a claim against the Bank for breach of contract.
Was it binding?
The Bank argued that there was no contract under the commitment letter as:
Test for a contract
The court reminded the parties of the test for creating a binding contract and that, as well as documentation, it can depend on what passes between the parties both verbally and by their conduct and whether or not there was an intention to create legal relations.
The court had little problem in establishing that there was an intention to create legal relations. Amongst other things, the letter included a governing law clause that made this clear. Whilst it recognised that it is possible to create a document that is in part legally binding and in part not, if doing this the split would usually be made clear.
Subject to satisfaction with the documents
The fact that the letter made the commitment subject to the Bank being satisfied with the documentation did not act as a get out of jail free card. It is now well established in law that, unless clearly stated otherwise, such discretion must be “exercised in good faith for the purpose for which it was given, not arbitrarily, capriciously or unreasonably (in the sense of irrationality).” When the Bank decided not to proceed with the transaction, it was not based on any review of the documents.
The issue of the signatory’s authority was given short shrift given the authorisation from the board for the signatory to proceed with the transaction and execute necessary documentation. It did, however, place the Bank’s authorised signatory list and controls under scrutiny.
Conduct wins out
The commitment letter was held to be a legally binding document. Although Novus didn’t return a counter-signed copy of the letter the conduct of the parties communicated acceptance (such as instructing solicitors, establishing special purpose companies and taking the aircraft off the market). The Bank was liable to Novus for loss of opportunity as a result of the Bank’s breach of contract.
What does this mean in practice?
This case is a sobering reminder that parties need to be careful when negotiating commercial terms as to whether or not they intend to be bound. If they do not, then state clearly where there is no intention to create legal relations.
To ensure certainty of contract for both parties, it is worth including a provision that makes clear any commitment letter is only binding as and when accepted and signed on behalf of both parties and that any change to this requirement must be in writing. Whilst this is not entirely fail safe (conduct could still be a factor and the parties could waive the requirement) it does make the position much clearer to everyone involved.