Overview

Barristers are frequently asked to advise whether an informal agreement is binding. By informal agreement, I mean a consensus of sorts arrived at between parties which is not recorded in any elaborate formal document.

Informal agreements may be made by:

1) Oral agreement;

2) The exchange of correspondence;

3) Heads of agreement; or

4) A memorandum of understanding.

Following the making of an informal agreement, parties often continue to negotiate in the expectation that they will be able to incorporate further terms – yet to be agreed – in the formal document.

In the event that the formal document is not executed, a question arises: Is the agreement legally binding and enforcible? It’s a deceptively simple question but not always easy to answer.

In what circumstances have courts considered legally binding agreements to arise out of negotiations?

What causes of action are available to parties who have acted to their detriment upon the terms and conditions which have been informally agreed?

The test for contract formation

The test for a binding contract is a question of fact and involves a threefold test:

First, did the parties arrive at a consensus (ie did the parties agree on the terms of the bargain – in most cases did one party make an offer which was accepted without qualification by the other party);
Secondly, if so, id the parties objectively intend that the consensus should constitute a binding contract; and
Thirdly, if the first two questions are answered in the affirmative, was the consensus capable of forming a binding contract in the circumstances? In particular, were all essential terms of the bargain agreed, alternatively were any important terms so vague as to be uncertain: Charter Challenge Pty Ltd v Curtain Bros (Qld) Pty Ltd [2004] VSC 1 per Gillard J at paras [89] and [90].

In deciphering the intention of the parties, the Court is concerned with the objective intention of the parties manifested by their outward words and conduct, and not their subjective intentions: Ermogenous v Greek Orthodox Community of SA Inc (2002) 187 ALR 92 at 99-100.

Masters v Cameron

Where parties enter into an informal agreement in the expectation that a formal document is to be subsequently prepared and executed, the question of whether the informal agreement is legally binding gives rise to a Masters v Cameron dispute, named after the High Court case Masters v Cameron 91 CLR 353.

In Masters v Cameron the High Court considered whether the expressions ‘subject to contract’, ‘subject to the preparation of a formal contract’ and other similar terms created an overriding condition so that what was agreed upon must be regarded as the intended basis for a future contract and not constituting the contract itself.

In Masters the parties agreed to the sale of farming land on terms and conditions. The document containing the terms and conditions provided that they were ‘subject to the preparation of a formal contract of sale which shall be acceptable to my solicitors (Cameron’s) on the above terms and conditions.’

The High Court said that where parties who have been in negotiation and reach agreement on terms, but agree that the subject of their negotiation be dealt with by a formal contract, the case may belong to three of the following categories:

First, the parties have reached finality in arranging all terms of their bargain and intend to be immediately bound to the performance of those terms, but at the same time propose to have the terms restated in a form which will be fuller and more precise but not different in effect;
Second, the parties have completely agreed on all the terms of their bargain and intend no departure from or addition to that which their agreed terms express or imply, but nevertheless have made performance of one or more of the terms conditional on the execution of a formal contract;
Third, the intention of the parties is not to make a concluded bargain at all, unless and until they execute a formal contract: 91 CLR 353 at page 362.

If the case falls into categories (a) or (b) then there is an immediately binding agreement. If it falls into category (c) the informal agreement is not binding.

The question depends on the intention disclosed by the language of the parties. No special form of words is required to ensure that no binding contract will exist prior to the execution of an agreement in final form.

The fourth category: where the parties envisage agreement on further terms

Often parties negotiate the core terms of an agreement, leaving subsidiary matters and contingencies to one side to be agreed later. If agreed, they will be incorporated into a comprehensive formal agreement: Fletcher Challenge Energy Ltd v Electricity Corporation of New Zealand [2000] 2 NZLR 433 at [131] and [132].

An informal agreement which contemplates the possibility of negotiation on further terms (yet to be agreed) does not fit neatly within the three categories contemplated in Masters v Cameron.

In Baulkham Hills Private Hospital Pty Ltd v GR Securities Pty Ltd (1996) 40 NSWLR 622 (affirmed on appeal at (1996) 40 NSWLR 631) McLelland J considered whether the informal contract between the purchaser and seller of the assets and business known as the ‘Hughlings Private Hospital’ was binding. There was an exchange of a letter in which the sale was agreed but conditional upon certain matters occurring including the execution of a formal contract of sale.

His Honour said that the intention of the parties to be legally bound by their consensus was sufficiently clearly expressed to take the case out of the categories expressed in Masters v Cameron.

McLelland J in Baulkham Hills said at 628 that there is a fourth category comprising cases where:

…the parties were content to be bound immediately and exclusively by the terms which they had agreed upon whilst expecting to make a further contract in substitution for the first contract, containing, by consent, additional terms.

The same sentiment was expressed in Sinclair, Scott & Co v Naughton (1929) 43 CLR 310 per Knox, Rich and Dixon JJ at 317.

In Love & Stewart v S Insone & Co (1917) 33 TLR 475 at 476, Lord Loreburn said:

It was quite lawful to make a bargain containing certain terms which one was content with, dealing with what one regarded as essentials and at the same time to say that one would have a formal document drawn up with the full expectation that one would by consent insert in it a number of further terms. If that were the intention of the parties then a bargain had been made none the less that both parties felt quite sure that the formal document could comprise more than was contained in the preliminary bargain…

In LMI v Baulderstone [2001] NSWSC 886 (upheld on appeal at [2003] NSWCA 74) Barrett J considered the enforceability of a Heads of Agreement entered into by the parties in which it was agreed that LMI would be appointed as manager of the Docklands Stadium (now known as ‘Etihad Stadium’) in the event that Baulderstone was successful in its bid to construct the stadium. Barrett J said at [35]:

There is, in other words, a point beyond which “agreement to agree” elements (of themselves unenforceable) cause the totality to fail. The central question, it seems to me, is whether the elements not affected by that problem of unenforceability are sufficiently cohesive and coherent to stand as a contract in their own right…

His Honour said that the description of the head of agreement as ‘The agreement’ in a sentence also referring to a ‘draft’ of some other agreement may be taken to demonstrate the acceptance of their contractual nature (at [23]).

However, he noted that the document was entitled ‘heads of agreement’ and to that extent may be taken to indicate that it was preliminary in nature only. In the Baulkham Hills case Mc Hugh J said that the words ‘in principle’ cannot prevail against the conclusion to be drawn from the express words ‘a legally binding agreement.’

In LMI, the express words were ‘heads of agreement’ rather than ‘agreement in principle’. Barrett J was of the view that the use of the words ‘heads of agreement’ did not detract from the force of the statements in the recital of the agreement that pending the making of a formal agreement the parties intended the document to be legally binding. He said that it focussed attention on the aspect of the recital showing that the heads of agreement do not represent the parties’ last contractual word (at [23]). That is, the parties contemplated a subsequent binding agreement.

Factors that indicated the parties contemplated a subsequent binding agreement included:

A number of matters between the parties were left to be determined and agreed in subsequent agreements.
Core provisions and dealing with operating expenses and revenues that were required to be defined.
Acknowledgements by LMI of its awareness of other agreements and agreed that in providing the management series it would comply with the other agreements and that the provisions of the ‘heads of agreement’ would be read down accordingly.

However Barrett J concluded that the indications in favour of a present contractual force prevailed despite the number of ‘uncertainties and gaps’. That is, they were not sufficient as to deprive the whole coherent contractual meaning.

Collieres Pty Ltd v Sijehama Pty Ltd (1991) 24 NSWLR 1 also involved a document entitled ‘Heads of Agreement’. Kirby J considered the capacity of the other matters to deny the legal force to a compact otherwise apparently intended to have such force. By its terms the document was to be superseded by a detailed agreement to be negotiated but so that the negotiation ‘shall not in the meantime in any way prejudice the full and binding effect of what is not agreed.’ His Honour went through the heads of agreement clause by clause identifying features for and against a conclusion of present contractual force despite the clear contemplation of a future and superseding contract.

In Pagnan SpA v Feed Products Ltd [1987] 2 Lloyds Rep 601, Loyd LJ said:

But there is no legal obstacle which stands in the way of the parties agreeing to be bound now while deferring important matters to be agreed later. It happens every day when the parties enter into so-called ‘heads of agreement.

Therefore it appears there is no obstacle to parties arriving at an interim agreement with the expectation of negotiating further terms to be incorporated into a formal contract.

The presence of elements amounting to an ‘agreement to agree’ is not fatal to the exercise of a contract. However, it is important not to lose sight of the comments of Gibbs CJ, Murphy and Wilson JJ in Brooker Industries Pty Ltd v Wilson Parking (QLD) Pty Ltd (1982) 149 CLR 60 in which they said:

It is established by authority, both ancient and modern, that the courts will not lend their aid to the enforcement of an incomplete agreement, being no more than an agreement of the parties to agree at some time in the future. Consequently, if the lease provided for a renewal ‘at a rental to be agreed’ there clearly would be no enforceable agreement.

Where at the time of entry into the informal agreement the parties contemplated future agreement on particular matters, in determining whether the consensus reached is capable at law of forming a binding contract, and assuming the parties have manifested an objective intention to be bound immediately, the question is whether the terms of the informal agreement are sufficiently cohesive to stand as a contract in their own right: LMI Australasia Pty Ltd v Baulderstone [2001] NSWSC 886 at [85].

Charter Challenge Pty Ltd v Curtain Bros (Qld) Pty Ltd

Further negotiation by the parties does not necessarily destroy the binding nature of an interim informal agreement, but it does pose risks.

In Charter Challenge Pty Ltd v Curtain Bros (Qld) Pty Ltd [2004] VSC 1 the plaintiff sued the defendant alleging that the parties had concluded an agreement for the sale of a ship by the plaintiff to the defendant. The plaintiff contended two versions of the agreement:

An agreement made during the course of a lengthy telephone conversation between the principals of the plaintiff and the defendant; and
An agreement constituted by heads of agreement forwarded by the plainiff’s solicitor to the defendant 10 days after the telephone conversation and which was allegedly accepted by the conduct of the defendant thereafter.
During the telephone conversation the parties agreed that the document would be prepared to record the terms of the sale. The later heads of agreement contained additional terms which had not been previously discussed or agreed.

Gillard J found that the plaintiff did not intend to be bound immediately at the time of the telephone conversation by reason of the addition of new substantive terms in the latter heads of agreement. It was held that the heads of agreement constituted a separate offer by the plaintiff, which was not accepted by the defendant.

Further, Gillard J found that even if the telephone conversation constituted a concluded agreement, it had been repudiated by the plaintiff on the basis that it was only prepared to proceed to settlement on the terms contained in the heads of agreement which were different from those previously agreed.

Determining the objective intention of the parties

In order to determine the objective intention of the parties the court will look to the best evidence being the actual communications that were exchanged giving rise to the informal agreement: ABC v XIV Cth Games Ltd (1998) 18 NSWLR 540 at 547-8. If the informal agreement is evidenced in writing then the words used in the written document must be construed: LMI v Baulderstone at [85]; Anaconda Nickel Ltd v Tarmoola Australia Pty Ltd [2000] WAR 101.

Similarly, if the informal agreement is constituted by oral discussion, it is necessary to identify the actual words used between the parties and determine whether those words manifested an objective intention to be legally bound immediately: Charter Challenge v Curtain Bros at [107] and [125].

Where the actual communications between the parties contain a clear and unambigious statement to the effect that the parties intend to be bound immediately, the court will give effect to that intention, notwithstanding the existence of other factors which might otherwise indicate that the parties do not intend to be bound immediately: Abigroup Contractors Pty Ltd v ABB Services Pty Ltd [2004] NSWCA 181 at [53].

In the absence of express words that clarify the parties’ objective intention as to the status of their informal agreement, the court will decipher the objective intention of the parties from all facts and circumstances. The usual factors which the court will have regard to include:

The use of the words ‘subject to contract’ in an informal agreement. Generally the use of such words creates a presumption that no contract was intended to be performed, although the use of the expression is not so intractable as to always produce that result.
The use of the words ‘in principle’ in negotiations often (but not always) conveys a message that there is a provisional acceptance of proposed terms as the basis for moving forward but without a final agreement.
The commercial context in which the communications were made and their commercial purpose is highly relevant in determining the objective intention of the parties.
The history of the negotiations leading up to the information agreement.
The size and complexity of the transaction will be taken into account. Where any informal agreement involves a significant and complex transaction it is less likely that the parties intended that they be bound by an informal agreement.
The Court may have regard to established or common practicesin certain industries or particular types of transactions. For example, conveyancing transactions require the formal exchange of contract before any binding contract is established.
Any uncertainty or vagueness in the language of any informal agreement is more likely to lead to the conclusion that it is not immediately binding.
The extent of any subsequent negotiations. The more extensive the negotiation between the parties after the informal agreement, the less likely it will be held to be immediately binding. That is the parties did not intend to be bound until the formal documentation was executed.
The subsequent conduct of the parties may be a factor in determining on an objective basis that the parties intended to be immediately bound to an informal agreement. However the subsequent conduct should be considered with some caution. Often statements made can be self-serving. Also statements by non-lawyers that there is a ‘contract’ will generally not hold any weight. Finally, the fact that the parties conduct themselves in a matter consistent with a binding contract, may be merely as a result of their belief that a formal contract will come into existence in the future.
Following an informal agreement, attention needs to be exercised in considering internal communication, and communications between one party and third parties. If at the time of entry into the informal agreement the parties contemplated that a third party would necessarily have to be involved as a party to a formal agreement this will tend to indicate that, objectively, there was an intention to be bound by the informal agreement.
Informal agreements made directly between business peoplewho deliberately exclude the involvement of lawyers tend to be given legal effect. It will depend on the circumstances of each case but evidence such as shaking hands and a celebratory drink are relevant factors that may indicate an intention to be immediately bound by the terms of the informal agreement.

Misleading and deceptive conduct

I mention this merely to ensure that a possible cause of action is considered. Claims for misleading and deceptive conduct pursuant to the Competition and Consumer Act 2010, section 18, may arise where representations were made in the course of commercial negotiations and/or pursuant to terms and conditions of an informal agreement. In particular, where a party has relied on a representation causing them to act upon it ot alter their position consistent with that representation.

In circumstances where the representations are made by an informal agreement, similar considerations as to whether the parties intended to be legally bound may be relevant as to whether reliance was fair and reasonable.

Asian litigants

Commercial litigators in Melbourne have been seeing a rise in litigants from mainland China in recent years. Disputes arise with frequency in a range of industries. A common theme is a lack of documentation because of relationship and ‘honour’ based cultural approaches to business. These differ substantially from the ‘western’ custom of ensuring that agreements are in writing.

Many asian litigants consider informal contracts to be enforceable but not strictly in accordance with any written terms they may have in any written document. For them, the depth of relationships are relevant. This often leads to conflicting views about whether a contract is the conclusion of a business deal, or merely the start of a business relationship. Likewise, there may be confusion about whether a contract is a conclusive statement of a static relationship or whether it is a tentative reflection of an evolving relationship.

Practical tips

The best evidence of the parties’ objective intentions is the actual communications that were exchanged that gave rise to the informal agreement: ABC v XIV Cth Games Ltd (1998) 18 NSWLR 540 at 547-8 per Gleeson CJ.
Front-end lawyers involved in client negotiations should ensure that any document signed for or on behalf of their clients reflects their client’s actual intention as to the binding nature of any informal document.
If not, it will ultimately be left to the court to decipher the parties’ objective intentions. This can be difficult and uncertain as deciphering the objective intention of the parties without a clear statement as to their intentions can give varying outcomes on any one set of facts.
It is possible that a court will decide that the objective intention was completely different from the actual intention of the parties: Geebung Investments Pty Ltd v Varga Group Investments No 8 Pty Ltd (1995) Australian Contract Reports 90-059; Anaconda Nickel; Fletcher Challenge.
A lesson from Challenge Charter: legal representatives of a party should be wary of proffering documents purporting to be an informal agreement that contains further terms of substance that have not been discussed or agreed with the other side. As Challenge Chartershows, a court in such circumstances is likely to decipher an intention on the part of the party proffering the document that it is no longer ready willing and able to comply with the earlier formal agreement.
There is no reason in principle why after making an informal agreement the parties may not only negotiate for the substantive terms, but also renegotiate the terms previously agreed, provided that they make it clear that in the event their further negotiations are unsuccessful, the earlier informal agreement remains binding: Fletcher Challenge at 230.
Beware of using vague language in any informal written agreement. Vagueness may support the view that there was no immediately binding agreement: Australian Hardboards Ltd v Hudson Investment Group Ltd [2006] NSWCA 146 at [124].
Advise your client to be cautious about its communications with the other party. Discovery orders or subpoenas issued in a proceeding may allow the other side to trawl through your client’s internal documents and communications with third parties during the period following the making of the alleged agreement. The other side may look for admissions or concessions or conduct which indicates understanding of a binding agreement (or the opposite, as the case may be).