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14 December 2016
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 they 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 before signing the final transaction documentation. Naturally, with a commitment letter, certain elements of the commitment are more likely to be binding. In 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.
In May 2013 Bahraini bank Alubaf Arab International Bank BSC(c) signed a commitment letter addressed to aircraft lessor and finance arranger Novus Aviation Ltd to provide approximately $40 million equity financing to assist with the purchase of an Airbus A330-300 aircraft to be leased to Malaysian Airlines.
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 the delivery of the aircraft to Malaysian Airlines scheduled to occur in July 2013, Novus was unable to arrange alternative equity funding and Malaysian Airlines 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If Alubaf had not withdrawn from the transaction, Novus (through a special purpose company) would, as the court found, most likely have purchased the aircraft and Novus would have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's 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.
Before the High Court, Novus claimed that:
Alubaf denied the claims on the following grounds:
Intention of the parties
The High Court 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, including words such as 'shall' and 'covenants'. The court 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 based on the objective test established by the Supreme Court where Lord Clarke had 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 it is common 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 court held 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 this should have been expressed explicitly in the document. Furthermore, the court found that no objective evidence in the conduct of the parties 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 Malaysian Airlines as a result of the commitment letter being signed by Alubaf as, from Novus's perspective, Alubaf was "locked in" as an equity investor. Expert evidence presented in Novus v Alubaf 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:
Alubaf's counsel argued that the first condition should be read as two conditions:
Counsel further 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 a review is too uncertain to be enforceable.
The court disagreed with these submissions and found the first condition 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)
Actual versus apparent authority
The court held that Novus had no reason to believe that the head of treasury and investments (who had signed both the commitment letter and the management agreement on behalf of Alubaf) lacked 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 court found that any constraints set out in the list were irrelevant because 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 [Malaysian Airlines] transaction".(7)
The court found that whether the head of treasury and investments had actual authority to bind Alubaf was irrelevant 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, regardless of whether the agent is actually authorised to act.
The evidence showed that Novus had been told that Alubaf had "formally fully approved" the transaction and, accordingly, the court held that Novus could 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. Regarding the commitment letter, the delivery of a countersignature by Novus to Alubaf (which would indicate only acceptance of the terms) was deemed unnecessary, as Novus's conduct clearly demonstrated that it had 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 would 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 (ie, by Alubaf). However, the court concluded that:
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 relating to the quantum of damages,(9) Novus had made a Part 36 offer,(10) which was more advantageous for Alubaf than the value of the judgment in Novus's favour when calculated at the time the judgment was issued. However, this advantage arose solely as a result of exchange rate fluctuation: Novus's 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 after the UK 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 of the Part 36 offer and at the start of the trial.
Given the inflated dollar value of the Part 36 offer , the court found that the fluctuation and resulting discrepancy were just "happenstance" and, accordingly, determined it "unjust" to apply the usual rule, which would have allowed 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 basis(11) along with interest on those costs at a rate of up to 10% above base rate.
Parties entering into a transaction should seek to ensure that their intentions are accurately reflected in the documentation ‒ an objective view of conduct and communications between them may be used to assess their true purpose and intent.
In Novus v Alubaf 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 which set out only the high-level agreed points. Transaction parties should clearly draft any conditions to each party's obligation to proceed with the transaction, as well as clearly identifying provisions that are intended to be non-binding understandings as opposed to binding agreements. In addition, institutions should be clear on the authority granted to employees and the manner in which this authority is communicated to counterparties.
While the High Court denied leave to appeal in this case, it appears that Alubaf has sought permission to appeal from the Court of Appeal.
For further information on this topic please contact Joshua Alexander at Vedder Price LLP by telephone (+44 20 3667 2900) or email (email@example.com). The Vedder Price website can be accessed at www.vedderprice.com.
(10) A Part 36 offer is an offer to settle under the UK Civil Procedure Rules which may result in severe cost consequences if a party loses, having failed to accept a 'better' offer ahead of the applicable hearing; it is designed to encourage parties to settle cases before going to trial.
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