It’s not uncommon for documents which have been prepared without legal advice to result in disputes about their interpretation, or even disputes as to whether the parties intended them to be legally binding. The Court of Appeal recently confirmed that a “skimpy” document called a “Heads of Agreement” prepared without legal advice was legally binding and enforceable.
Heads of Agreement
“Heads of Agreement” are one example of a document that may or may not be legally enforceable. Other names for these documents are a “Letter of Intent”, “Memorandum of understanding”, “Heads of Terms” or “Term sheet”. These documents are often used so the parties have something in place without the time and expense of a more comprehensive document. They are also sometimes used as a preliminary document which is to be followed by a more comprehensive document. The test for whether these documents are legally binding depends on:
- Whether the parties have intended them to be legally binding; and
- All the essential terms being agreed upon.
Tower Insurance Ltd v Nicon Ltd
The recent case arose after the 2010 Christchurch earthquake. There was unprecedented demand for contractors and the insurer wished to secure the services of a demolition contractor. The contractor wanted a firm commitment that it would be given work. A Heads of Agreement was therefore prepared providing that the insurer was obliged to offer the contractor the demolition work (with two exceptions). Things changed when the insurer’s agent had a new project manager who referred work to cheaper contractors because he was unaware of the Heads of Agreement. The contractor issued proceedings claiming damages for the lost contracts.
The insurer argued the Heads of Agreement did not meet the requirements of a legally binding contract, the insurer was not legally bound to offer the work to the contractor and therefore could not be liable for any damages.
The Court stated that the test as to whether or not the parties intended to enter a legally binding document is an objective assessment which can take into account the context or purpose of the document, its wording and the conduct of the parties both before and after the document is signed. On the evidence before the Court, and taking all these factors into account, the Court held the Heads of Agreement was legally binding. The Court also held that, although all the terms of the agreement were not included in the Heads of Agreement, sufficient terms were included to show the parties intended to be bound.
The takeaway from this case
Deciding whether “Heads of Agreement” or similar types of documents are legally binding is not always clear. This uncertainty may lead to disputes and ultimately to litigation – an extremely costly and time consuming process which any business would do best to avoid. If you want to be confident that the document you intend to sign expresses your intentions fully and accurately, then legal advice is necessary.
Barbara McDermott is part of our Private Client team at Norris Ward McKinnon.
