Backdoor Bargains: The Enforceability or Otherwise of Side Letters

Ijeoma Rita Ezeagwu

In the corporate world, there are various types of agreements, each serving distinct purposes. A few examples include non-disclosure agreements, memoranda of understanding, service level agreements, facility agreements, lease agreements, employment contracts, tenancy agreements, production sharing contracts, concession agreements, statements of work, data protection agreements, award contracts, master services agreements, etc. Some agreements are ancillary to the aforementioned agreements, such as waiver letters, amendment letters, side letters, order forms, addenda, etc. The nomenclature of a document and how it is drafted is determined by the mutual understanding of the parties, applicable industry standards or business practices in connection with the transaction dynamics contained in the document (this mostly applies where a party to the agreement belongs to a highly regulated industry) and whether the transaction is governed by specific regulations.

Sometimes, parties may decide to modify the provisions of a signed contract or introduce fresh terms with respect to the same contract. To achieve this, they have to enter into another agreement called an addendum or an amendment agreement. There are also instances where an agreement has not been finalised or is nearing execution stage, but the parties agree to put into writing, sensitive information or change certain terms of the agreement to grant special considerations to a party or both parties outside what was agreed in the main contract. In this case, they may decide to either amend the unsigned agreement or use a side letter.

What is a Side Letter?

Imagine you order a meal at a restaurant and the waiter tells you that the meal you ordered comes with a side like french fries, rice or mashed potatoes. This means that your order is the main dish, which is complemented and enhanced through its pairing with the side. This is exactly how a side letter operates; it does not exist alone, and for every side letter, there is an underlying contract.

A side letter is a written confidential understanding between parties to an agreement which introduces special concessions to the agreement or addresses specific issues with respect to the transaction envisaged in the agreement. It is drafted in the form of a letter written by a party to the main contract and addressed to the other party. Like a formal letter, a side letter must have a subject which references the main contract; for instance, Side Letter to the Share Purchase Agreement. It must be signed by the sender and contain an acceptance section to be executed by the addressee. Some common examples of side letters are letters of comfort and waiver letters.

Side letters are mostly used for commercial transactions such as facility agreements, limited partnership agreements, mergers and acquisitions documentation, and venture capital fundraising agreements. They generally offer favourable terms to a party or the parties to the agreement, which the parties prefer to reduce visibility on. Where they exist, side letters operate as a shadow behind the corners of the main contract, containing sensitive information or carve-outs that aid the finalisation of the transaction and preserve the relationship of the contracting parties.

The primary attraction of a side letter is its confidential nature, which makes it parties’ most preferred form of documentation as opposed to an addendum. The trade-off to this is that by their very hush-hush nature, side letters not only raise concerns around the risk of unenforceability, but their existence may pose challenges to the certainty of the terms in the main agreement.

Contractual Certainty Versus Side Letters

The inevitable implication of a side letter to an agreement is that the agreement does not contain the full details of the understanding reached by the parties. This is because the terms in the side letter will be different from those of the main contract, thus giving it a whole new meaning.

The question then is which document will prevail in the event of a conflict between the side letter and the main contract? The answer to this is largely dependent on the language of the main contract and the side letter. Let us analyse it based on the perspective of an “entire agreement clause” being present in the main contract. It is customary for contracts to contain an “entire agreement” clause, which can be drafted in different forms. Drafts 1 & 2 below are standard wordings of an “entire agreement” clause:

1. This agreement contains the entire agreement of the parties with respect to the subject matter hereof and supersedes all other prior agreements or understanding, whether express or implied, oral or written, of any nature whatsoever with respect to the subject matter.

2. This agreement constitutes the entire agreement of the parties with respect to the subject matter hereof.

A cursory look at draft 1 & 2 may give the impression that they are different, however, they have the same interpretation and implication. Where an entire agreement clause is present in the main contract, and the provisions are similar to those in the drafts above, it means that in the event of a conflict between the side letter and the main contract, both documents will be reviewed concurrently to decipher the intentions of the parties. This interpretation will also apply where there is no entire agreement clause in the primary agreement except there is an express provision in the side letter that gives it prevalence over the main contract and vice versa.

It is worthy to mention that the presence of an entire agreement clause in a contract does not automatically render subsequent agreements on the same transaction entered into by parties invalid.

Enforcement Limitations of Side Letters

There is no gainsaying parties enter into a side letter to provide some comfort for either themselves or for the party that requested it. Consequently, this poses some concerns in determining the kind of obligation the parties intend to create with the side letter. It is an established principle of law that a side letter will operate as a gentleman’s understanding, giving rise to a moral obligation and nothing more between the parties, except where the language used in the side letter shows an intention to create legal obligations. The court in Kleinwort Benson Ltd v Malaysia Mining Corporation (1989) 1 WLR 379 held that the context of the comfort letter did not evidence an intention to create a legal obligation and the words were merely of a moral responsibility without creating a legally-binding effect. In the case of Systems Floors Ltd v Ruralpride Ltd 1 EGLR 48 CA, the Court of Appeal ruled that a landlord’s successors were bound by the terms of a side letter that amended the commercial lease because the language of the letter showed an intent for the successors to be bound even though they were not aware of the existence of the side letter.

The enforceability of a side letter is also tied to the language used in drafting it and whether other requirements of a valid contract are present in the letter. Thus, it is imperative that caution is exercised when drafting a side letter. If the terms of a side letter refer to a prospective agreement or subjects the performance of the terms in the letter to a future event, the side letter is not enforceable under the law. In Barbudev v Eurocom Cable Management Bulgaria 2011 EWHC 1560, the court held that the side letter was unenforceable because it deferred essential terms to an un-negotiated agreement and as a result was declared uncertain with insufficient intention to create legal relations.

In the same vein, where the essence of a side letter is for the performance of an act prohibited by law, it will not be binding, irrespective of the language used. In President of the Federal Republic of Nigeria and 3 Ors v Korea National Oil Corporation & 6 Ors SC 114/2013, the side letter issued by the President granting Korea National Oil Corporation a discount on the signature bonus in consideration for their commitment to invest in strategic downstream projects was declared invalid by the Court of Appeal because it was contrary to the procedures for awarding an oil prospecting license under the Petroleum Act 1969. In Vivienne Westwood Ltd v Conduit Street Development Ltd 2017 EWHC 350 (Ch), a side letter was declared unenforceable because the terms gave the landlord the right to terminate concessions and impose a higher rent different from the main lease. The court held that the side letter violated the law on penalties and was designed to punish the tenant rather than protect a legitimate interest.

Conclusion

It is axiomatic that a side letter will only have the full force of law where it contains the features of a valid contract. The decision of a court on the enforceability or otherwise of a side letter will be determined by the terms, the peculiarities of the transaction and the position of the law with respect to the transaction in the side letter.

Given that they are usually brief, side letters must be straight to the point, couched concisely and conclusively with no reference to future events or non-existent agreements. Imprecise terms that can make a side letter appear as “an agreement to agree” or “subject to a definitive agreement” only evince inconclusiveness and should be strongly avoided.