Side letters: close enough for your comfort?

What’s a “side letter”?

Side letters, or comfort letters as they’re also called, often pop up in commercial transactions and have a wide variety of uses. For example, they can confirm details which couldn’t be known when the original contract was finalised or clarify certain points, e.g. the steps or conditions that a party must fulfil in order to satisfy an obligation. You may also see them used if contractual changes are needed, i.e. a side letter will be quicker - not to mention cheaper - than redrafting the actual agreement.

Are they binding or not?

But as these documents are usually drawn up informally, what’s their legal status and how will the courts approach them if there’s a dispute later? As you know, there can only be a binding contract if four basic elements exist, namely:

1. Offer and acceptance.
2. An “intention to create legal relations”. These are words, or conduct, that show the parties intended to be bound by their agreement.
3. Certainty. This includes using clear language and documentation (where relevant), i.e. is the agreement sufficiently complete, or really just an “agreement to agree”?
4. Consideration. This part is about showing that both parties derived a “benefit” from the contract - usually, goods or services changing hands in return for payment.

Risk. The problem is that in many side letters the last three are hard to find or missing altogether.

A case of (un)enforcibility

In the recent case of Barbudev v Eurocom 2011, the High Court was asked to consider the enforceability of a side letter. It concerned the sale of a company in which it had been agreed that the seller, Mr Burbudev, would hold a stake in the buyer’s newly merged company, Eurocom. As negotiations progressed, the parties couldn’t agree on the value of the merged company - so they prepared this document which described his “anticipated” shareholding.

It lacked clarity

However, the side letter was vague. Not only was there insufficient detail about the proposed shareholding, the four essential contractual ingredients were also missing. Therefore, the court had no choice but to rule the document was no more than an “agreement to agree”.

Tip 1. Just because a document is titled a “side letter”, or “comfort letter”, doesn’t mean it’s going to be binding. If any details, or one or more of the four elements, are missing it can’t be a contract.

Tip 2. To ensure that a side letter is enforceable, use explicit and specific language. Vague phrases, such as “not less than”, could cause you problems. Also, nothing further should be needed to perform the agreement - the court won’t enforce a side letter if it thinks key commercial terms are missing or still being negotiated.

Tip 3. There may be times when you won’t want to be held to a side letter. If you’re ever in this position, head the document with “subject to contract” - it’s not foolproof, but it can help.