At the outset of a transaction, parties often use a commitment letter, letter of intent or memorandum of understanding to set out the principal terms on which the parties wish to establish their commercial relationship. The terms of these documents are often non-binding in nature and usually explicitly state that this is the case, carving out certain exceptions such as the confidentiality provisions and any terms governing the payment of any fees or deposits due prior to signing the final transaction documentation. Naturally with a commitment letter, certain elements of the commitment itself are more likely to be binding, and in the case of Novus Aviation Ltd v Alubaf Arab International Bank BSC(c),1 the position was explored in light of the absence of any statement that any of its terms were non-binding.
Facts of the Case
In May 2013, the Bahraini bank Alubaf Arab International Bank BSC(c) (Alubaf) signed a commitment letter addressed to aircraft lessor and finance arranger Novus Aviation Ltd (Novus) to provide approximately US$40m equity financing to assist with the purchase of an Airbus A330-300 aircraft to be leased to Malaysian Airlines (MAS).
In June 2013, before the principal documents were executed, Alubaf informed Novus that it did not wish to proceed with the equity financing, as it had been advised that the special purpose companies being incorporated as part of the ownership structure for the aircraft would need to be consolidated into Alubaf’s financial statements. With delivery of the aircraft to MAS scheduled to occur in July 2013, Novus was unable to arrange alternative equity funding, and MAS purchased the aircraft itself using debt financing.
If Alubaf had not withdrawn from the transaction, Novus (through a special purpose company) would, as the court found, most likely have purchased the aircraft and Novus would have received management fees from Alubaf through a management agreement (which had already been signed by Alubaf at the time of its withdrawal but awaited Novus’ signature). These fees were the damages claimed by Novus as a result of Alubaf’s anticipatory repudiatory breach of the terms of the commitment letter and the management agreement.
The Claim and the Defences
Before the High Court in England, Novus claimed the following:
1. the management agreement and the commitment letter were binding contracts; 2. these were both repudiated by Alubaf; and 3. as a result, Novus lost the opportunity to earn fees under the management agreement (damages claimed were over US$8m).2
Alubaf denied the claims on the following grounds:
1. the commitment letter was not intended to be legally binding and/or is void for uncertainty; 2. the signatory to the commitment letter and management agreement did not have authority to bind Alubaf to provide funding for the transaction; and 3. in any event, there was no binding contract, as neither document was countersigned by Novus and returned to Alubaf before Alubaf decided not to proceed with the transaction.3
Analysis of the High Court
Intention of the Parties
The judgment focused on the inclusion of a governing law clause in the commitment letter and discussed other language in the letter which sought to impose legal obligations on the parties with the inclusion of words such as “shall” and “covenants.” The judge found that the wording of the governing law clause in particular was a clear objective measure of the parties’ intention to create legal relations. This was a result of applying the objective test established by the Supreme Court where Lord Clarke stated the applicable principle:
“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 a 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.”4
Alubaf argued that there is a practice in the aviation finance industry that parties are not bound to participate until “definitive documentation is executed at the closing of the transaction”5. However, the judge believed that there was no ambiguity in the wording of the commitment letter and that if Alubaf had intended the commitment letter to be non-binding or only certain provisions to be binding, then that should have been expressed explicitly in the document. Furthermore, the court found that there was no objective evidence in the conduct of the parties that suggested the letter was non-binding and/or to be treated as a letter of intent. In fact, Novus took action to proceed with the transaction with MAS as a result of the commitment letter being signed by Alubaf as, from Novus’ perspective, Alubaf was “locked in” as an equity investor. Expert evidence presented in the case showed that while an equity investor may elect not to commit itself unconditionally until the documentation has been finalised, the terms of the commitment letter did not do this.
The commitment letter contained two conditions:
- satisfactory review and completion of documentation for the purchase, lease and financing; and
- the transaction realising a minimum net expected average cash on cash return of around 9.5% per annum.
Alubaf’s counsel argued that the first condition should be read as two conditions: (i) satisfactory review and (ii) completion of documentation for the purchase, lease and financing. Further, counsel submitted that there is little difference between a review of the documentation for the transaction and a review of the transaction as represented by the documentation, and that therefore a commitment which is conditional upon such review is too uncertain to be enforceable.
The judge did not agree with these submissions and found the first condition to be sufficiently certain (and that it ought not to be construed as two separate conditions) and that Alubaf’s right to reject documentation as unsatisfactory should not be unqualified—in the absence of other language, the contractual discretion should be “exercised in good faith for the purpose for which it was conferred, and must not be exercised arbitrarily, capriciously or unreasonably (in the sense of irrationally)”.6
Authority: Actual vs. Apparent
The court held that Novus had no reason to believe that the Head of Treasury and Investments (who signed both the commitment letter and the management agreement on behalf of Alubaf) did not have the authority to bind Alubaf, based principally on the communication between the parties, and that, accordingly, the commitment letter bound Alubaf.
As with many large institutions, Alubaf had an authorised signatory list, but the judge found that any constraints set out in the list were not relevant in this circumstance given that this transaction had been formally approved by the bank’s investment committee, which had authorised the individual “to proceed with executing the necessary documentation to fund and close the [MAS] transaction”.7 The court found that whether the Head of Treasury and Investments had actual authority to bind Alubaf or not was not relevant, as it was plain that he had apparent authority, which is sufficient in law to bind Alubaf. Apparent authority arises where a principal represents to a third party that it is authorised to act on that party’s behalf and the third party relies on such representation. In these circumstances, the principal is bound by the agent’s act whether or not the agent was actually authorised to act.
The evidence showed that Novus had been told that Alubaf had “formally fully approved” the transaction, and accordingly the judge held that Novus was able to rely on the Head of Treasury and Investments’ authority to bind Alubaf unless it was specifically informed otherwise.
Acceptance and Agreement
Both the commitment letter and the management agreement anticipated a countersignature by Novus. In relation to the commitment letter, the delivery of a countersignature by Novus to Alubaf (which would only indicate acceptance of the terms) was deemed unnecessary, as Novus’ conduct clearly demonstrated that it accepted the terms of the commitment by Alubaf and was proceeding with the transaction on that basis.
The management agreement was distinguished by a provision which stipulated that the obligations of the parties were to take effect when the agreement had been executed by both parties. Thus, countersignature was the required mode of acceptance, unless waived by the other party.8 The facts did not indicate there having been any waiver, and the document was only partially executed (i.e., by Alubaf only). However, the court concluded that the management agreement formed part of the documents which would be signed prior to closing, and evidence indicated that it was in agreed form and that (as a matter of course, as a closing formality) Novus would ultimately provide its signature. Accordingly, the court found that the arrangements under the management agreement would have formed part of the transaction had it proceeded to close; and the fees thereunder would have been due from Alubaf to Novus.
As detailed in a follow-on case before the court relating to the quantum of damages,9 Novus had made a Part 36 offer10 which was more advantageous for Alubaf than the value of the judgment in Novus’ favour when calculated at the time the judgment was issued. However, this advantage arose solely as a result of exchange rate fluctuation—Novus’ Part 36 offer was provided in pounds, while the amounts being claimed were in dollars. Following a broad weakening in the pound against the dollar since the result of the referendum on leaving the European Union, the dollar value of the Part 36 offer was inflated as against its value in dollars both at the time the Part 36 offer was made and at the start of the trial.
Given the inflated dollar value of the Part 36 offer which followed the referendum result, the judge found that the fluctuation, and resulting discrepancy, was just “happenstance” and, accordingly, the judge determined it “unjust” to apply the usual rule, which would allow the court to apply interest on the original damages amount at a rate of up to 10% above base rate and to grant costs on an indemnity basis11 along with interest on those costs at a rate of up to 10% above base rate.
Parties entering into a transaction should always seek to ensure that their intentions are accurately reflected in the documentation, and an objective view of conduct and communications between the parties may be used to assess the true purpose and intent of the parties.
In this case, the commitment letter was a binding commitment which should be distinguished from a non-binding letter of intent. Parties should be clear on the purpose of the initial documentation even though commitment letters, letters of intent and memoranda of understanding are often very short form agreements setting out only the high-level agreed points. Transaction parties should take particular care to clearly draft any conditions to each party’s obligation to proceed with the transaction, as well as to clearly identify provisions that are intended to be non-binding understandings as opposed to binding agreements. In addition, institutions should also be clear on the authority granted to employees and the manner in which this authority is communicated to counterparties.
It should be noted that the judge did not give leave to appeal in this case, but it appears that Alubaf has applied to the Court of Appeal for permission to appeal.