In August 2004, Graham Allen mentioned to his friend and neighbour, Kim Wallace, that he was interested in selling his business. Wallace in turn expressed interest in purchasing the business. The two of them discussed and negotiated for weeks and, finally, after Allen refused to sign two earlier versions that “left too much up in the air”, the two of them signed a letter of intent (LOI) for the share purchase and sale of four companies of which Allen was a major shareholder. The parties were to reach a final share purchase agreement at a later date.

Four months later, after Wallace missed a closing meeting with Allen’s knowledge and approval, Allen declared that the transaction was at an end and refused to close the deal. Wallace sued for breach of the LOI. At trial, the judge held that the LOI was not a binding agreement. However, on appeal, the Ontario Court of Appeal overturned the decision and held that the LOI was a binding agreement that Allen had breached by refusing to close the deal.

Why was the LOI legally binding?

The Court’s decision that the LOI was legally binding was based on a number of facts:

  • The LOI drafts: Allen refused to sign the initial drafts because they left too much information uncertain. The Court found that his willingness to sign the final draft suggested that all the necessary information was now decided.
  • Allen announced to his employees that he was retiring and that the business had been sold.
  • Wallace began working at the business regularly in order to learn the day-to-day requirements.
  • The critical clauses of the LOI were clear and unambiguous, evidencing an intention of the parties to be bound.
  • The parties used words of contract like “this agreement”, “upon acceptance”, and “it is agreed”.

The wording of the LOI combined with the conduct of the parties made the contract legally binding. Even though the LOI said that there would be “much legal work to be done” in order to come to a final sale, the parties both admitted to having reached an agreement with respect to all essential terms and were already acting like the deal had closed.

How can a LOI be drafted to avoid making it legally binding?

First, the more explicit that the LOI is not intended to be legally binding the better. Use clear, unambiguous language to communicate that the LOI, or where desired, that parts of the LOI, are not legally binding. Avoid using contractual language like “this agreement” or “upon acceptance”.

Second, make clear that the LOI is not the entire agreement and that a final agreement will be reached down the line with new substantive terms.

Finally, ensure that conduct before, during, and after signing the LOI does not imply that the agreement was binding. In Wallace, both parties acted as if the agreement was final. Allen announced that he was retiring and told staff that Wallace was the new owner. Wallace began working at the business full time and brought in a friend to run the business with him. The Court took this conduct as significant evidence that the LOI was intended to be binding. Until a sale is closed, parties should take care to ensure that their conduct does not contradict their intentions.

The author would like to thank Kevin Schoenfeldt, Summer Student, for his assistance in preparing this legal update.

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