The recent decision of the Commercial Court in Novus Aviation Limited v Alubaf Arab International Bank BSC(c) [2016] EWHC 1575 (Comm), serves as a cautionary tale to any financial institutions that regularly use letters of commitment.

The Court found that a letter of commitment, which was expressed to be "conditional upon satisfactory review and completion of documentation", was nevertheless legally binding. Further, although it was intended that the commitment letter would become contractually binding once executed by both parties, this did not prevent it from having legal effect when executed by only one party. There was no term of the commitment letter that stipulated that the only means of acceptance was by countersignature, such that acceptance could be communicated by conduct.

Background

In March 2013, the Claimant ("Novus"), a company that arranges finance for the acquisition and leasing of commercial aircraft, was contacted by the Defendant (the "Bank"), who expressed an interest in investing with Novus in the acquisition/ financing of passenger aircraft. Around this time, Novus was in discussions with Malaysia Airlines to finance the purchase of two Airbus A330-300 aircraft.

Novus and the Bank discussed an investment structure whereby the Bank would provide the majority of the US$40m equity funding for the purchase, and Novus would arrange the remaining US$70m debt funding. The Bank's investment committee approved the deal in early May 2013 and, following some discussion over terms, the Bank subsequently provided Novus with executed copies of a commitment letter and management agreement.

Throughout May 2013, work was undertaken to progress the transaction. However, in June 2013 the Bank's board of directors decided not to proceed with the transaction. Novus claimed that the commitment letter and management agreement constituted binding contracts and that the Bank's withdrawal was a repudiatory breach of contract. The Bank argued that there was no agreement on three principal grounds:

  1. the commitment letter was not intended to be legally binding and/or was void for uncertainty;
  2. the individual that signed the commitment letter and management agreement on behalf of the Bank did not have authority to bind the Bank to provide funding for the transaction; and
  3. there was, in any event, no binding contract made because neither the commitment letter nor the management agreement was countersigned by Novus and returned to the Bank before the Bank withdrew from the transaction.

Decision

The Court held that the commitment letter was a legally binding document and that the Bank's decision to withdraw from the transaction was a repudiatory breach of contract. Novus was accordingly entitled to damages in respect of the lost opportunity to earn fees that would have been payable under the management agreement had the transaction been completed.

(i) Intention to create legal relations

The Bank accepted that the management agreement was intended, when executed, to be legally binding. However, the Bank argued that the commitment letter was not intended to be legally binding or to bind the Bank to proceed with the transaction.

The leading case on the test of whether parties intend to create legal relations is the decision of the Supreme Court in RTS Flexible Systems Ltd v Molkerei Alois Muller GmbH & Co KG [2010] UKSC 14:

"Whether there is a binding contract between the parties and, if so, upon what terms depends upon what they have agreed. It depends not upon their subjective state of mind, but upon consideration of what was communicated between them by words or conduct, and whether that leads, objectively to a conclusion that they intended to create legal relations and had agreed upon all the terms which they regarded or the law requires as essential for the formation of legally binding relations."

Applying this test, the Court held that it was plain from the terms of the commitment letter that it was intended to create legally binding relations. In particular, the Court found that "any possible doubt" was removed by the 'Governing Law' clause which provided that:

"This Commitment Letter Agreement (including the agreement constituted by your acceptance of its terms) and any non-contractual obligations arising out of or in connection with it, (including any non-contractual obligations arising out of the negotiation of the Transaction) shall be governed by, and construed in accordance with, English law…" (emphasis added).

The Court accepted that it is possible, in principle, for parties to create a document of which only part is intended to be legally binding (for example recitals are common place but not legally binding). However, where that is intended, the Court indicated that it would expect to see the distinction between the two qualitatively different types of provision clearly signalled. In this case, the language of obligation was used throughout the commitment letter, with various provisions including the mandatory word "shall".

(ii) Uncertainty

The commitment letter stated that the Bank's obligation to provide the equity funding was "conditional upon satisfactory review and completion of documentation for the purchase, lease and financing". The Bank argued that as there was no objective criteria by which to judge whether the documentation was "satisfactory", the commitment letter was void for uncertainty.

The Court found that there was no uncertainty in applying this test; whether the documentation was satisfactory to the Bank was a question of fact. Further, the Bank's ability to reject the documentation as unsatisfactory was not completely unqualified, but in the nature of a contractual discretion. In the absence of very clear language to the contrary, such discretion must be exercised in good faith for the purpose which it was conferred, and must not be exercised arbitrarily or capriciously or unreasonably (Braganza v BP Shipping Ltd [2015] 1 WLR 1661).

(iii) Authority to bind the Bank

The commitment letter and management agreement were each signed on behalf of the Bank by Mr Abdullah, Head of Treasury and Investments. The Bank raised a number of arguments as to why Mr Abdullah did not have authority to bind the Bank by his sole signature. The Court rejected these arguments holding that it should be slow to find that the Bank's own Head of Treasury was mistaken as to his own authority to sign documents on the Bank's behalf.

Further, and in any event, it was "academic" whether Mr Abdullah had actual authority to bind the Bank because he had apparent authority to do so. Where one party (the principal) represents to a third party that an agent is authorised to act on its behalf, and the third party relies on the representation, the principal is bound by the agent's act whether or not the agent was actually authorised to do the act. In this case, it was reasonable for Novus to assume, unless specifically informed otherwise, that Mr Abdullah was duly authorised to sign the commitment letter and management agreement (as sole signatory) on the Bank's behalf.

(iv) Execution by Novus

The commitment letter provided for a signature on behalf of Novus to indicate that the terms were 'accepted'. However, there was no term of the commitment letter that stipulated that the only way in which Novus could signal acceptance was by counter-signing the letter.

In the absence of such a stipulation, acceptance of an offer can be communicated by conduct which objectively shows an intention to accept the offer (Reveille Independent LLC v Anotech International (UK) Ltd [2016] EWCA Civ 443). Here, Novus proceeded with the steps required to progress the transaction and gave no indication that it did not consent to the terms of the commitment letter. Equally, nothing was said on the part of the Bank to suggest that it was waiting for Novus to return a countersigned copy of the commitment letter or that it did not regard the commitment letter as binding until countersigned.

Notably, the position was different for the management agreement. In that case, the drafting made clear that the obligations of the parties were to take effect when the agreement was executed by both parties, and not until then.

The Court recognised that it is possible, as a matter of law, for the requirement that a document be signed in order to become binding to be waived by clear words or conduct. If the requirement is solely for the benefit of one party, it may be waived by that party. However, where, as here, the requirement for a signature is for the benefit of both parties, it must be clear that both parties have waived it (Reveille Independent LLC v Anotech International (UK) Ltd).

This is not an easy burden to discharge. The Court noted that it is one thing to infer acceptance of an offer from conduct in the absence of any stipulation that the document will only become binding upon signature, but it is another and harder thing to infer from conduct that such a stipulation has been waived. In this case, the parties did not treat the management agreement as binding before it had been signed by both parties, such that the Bank never became contractually bound by that agreement.

Comment

Commitment letters are frequently used by financial institutions. This case demonstrates that such letters are capable of creating binding contractual obligations. In order to reduce the risk of inadvertently creating binding obligations, financial institutions should be alive to the following points when drafting and issuing commitment letters:

  1. If a commitment letter (or certain provisions thereof) is not intended to create legal relations, this should be expressly stated in the letter.
  2. Where a transaction is conditional upon the exercise of discretion by a financial institution (for example that documentation be "satisfactory"), that discretion must be exercised in good faith for the purpose which it was conferred, and must not be exercised arbitrarily or capriciously or unreasonably.
  3. A financial institution may be unable to refuse to proceed with a transaction on the basis that it is no longer in its commercial interests, absent an express reservation of rights to this effect.
  4. If it is intended that a commitment letter should only become binding upon countersignature, that requirement must be expressly stated. Absent such express requirement, acceptance of an offer may be communicated by conduct or other communication between the parties.
  5. Even if there is an express requirement for countersignature, it is possible for that requirement to be waived by clear words or conduct. Accordingly, financial institutions should refrain from proceeding with the underlying transaction prior to countersignature.
  6. If the individual executing a commitment letter does not have authority to bind the financial institution, that must be expressly stated to the counterparty.