If you enter into email negotiations in respect of a proposal documents (such as a heads of agreement, term sheet, memorandum of understanding or letter of intent) and indicate that it is “subject to contract”, you haven’t entered into a binding contract, have you?
Case law illustrates that no document needs to be signed for the prospective parties to have formed a binding contract. Email exchanges often result in the parties reaching agreement in a casual or informal way about essential contractual terms. Depending on the wording in the correspondence and any related discussions or actions, if the essential terms have been agreed between the parties, a binding agreement may be formed.
We look at some of the ways in which parties might unintentionally form a binding agreement without any understanding that you were doing so.
The High Court in the case of Masters v Cameron  HCA 72; (1954) 91 CLR 353 separated preliminary agreements expressed as being “subject to contract” into three categories:
- The parties intend to be immediately bound to perform, but also propose formalising or restating terms, but not changing their effect.
- The parties have agreed on all the terms of their bargain and do not intend to change them, but have also made performance of one or more of those terms conditional on the execution of the later formal document.
- The parties have an informal agreement but do not intend to make a final and binding contract until and unless a later formal document is executed.
Circumstances in the first two categories result in a contract that is binding on the parties, but not the third. Which category any given case fits within ‘depends upon the intention disclosed by the language the parties have employed, and no special form of words is essential to be used in order that there shall be no contract binding upon the parties before the execution of their agreement in its ultimate shape.’ (page 363 of the judgement).
However, the ‘natural’ meaning imported to the words ‘subject to contract’ or ‘subject to the preparation of a formal contract’ is that there is no intention to be immediately bound unless and until executing a formal contract.
Determining ‘intention’ to form an immediately binding contract
Courts assess the intention to enter into an immediately binding contract on an objective basis – what each party by their words and conduct would lead a reasonable person in the position of the other party to believe. This will apply even though a party may have never actually intended to form a binding contract.
In doing so, the court will look:
- at the construction of the agreement, including whether there are any terms that would not have a purpose unless a further agreement was to be signed;
- whether there is agreement on the essential terms (not all terms need to be agreed);
- use of the words “offer” and “acceptance;” and referring to the agreement in the present tense instead of the future tense;
- At whether the parties have performed any obligations as if the agreement were on foot and binding.
Cases in which binding obligations have been created
In Vantage Systems Pty Ltd v Priolo Corporation Pty Ltd  WASCA 21 a binding obligation was created between a landlord and a tenant following the tenant’s approval of the landlord’s proposal for a new lease, “subject to formal lease documents being signed“. Amendments to the proposal were negotiated by email and the essential terms were agreed upon. The tenant then asked the landlord to prepare the lease documents and negotiation commenced in respect of some minor terms. The tenant subsequently refused to sign the lease.
The Court found that when the tenant accepted the revised proposal, the parties intended to be bound immediately by an agreement to lease, which would in due course be superseded by formal lease documents. The following were factors:
- the tenant had been in occupation of the premises for a number of years and was familiar with the premises and their suitability
- the revised proposal embodied all terms that were legally necessary to form a contract;
- the tenant’s communications indicated approval of the terms of that contract; and
- the terms of the proposed written form of lease prepared to formalise that contract were not materially different from those contained in the existing lease.
In Stellard Pty Ltd v North Queensland Fuel Pty Ltd  QSC 119 the Supreme Court of Queensland found that a seller of a service station business had intended to be immediately bound by its initial offer, despite:
- the seller’s email accepting the buyer’s offer stating that it was “subject to execution of the contract provided“;
- the fact that the seller was continuing to negotiate with another party; and
- some terms of the contract, namely the length of the due diligence period and whether personal guarantees of the directors were required, had not been agreed (but key details such as price, deposit, settlement date and other conditions had been).
The court considered that the wider context of the emails between the parties, in particular (i) a statement in the buyer’s email that it wanted its offer to be accepted immediately so that its due diligence investigations could commence and (ii) urgently seeking confirmation of acceptance on the basis that “both parties are now going to start incurring significant expenses”), strongly suggested that the parties were to be bound immediately and exclusively by the terms they had agreed upon.
In The Edge Development Group Pty Ltd v Jack Road Investments Pty Ltd   VSCA 91 the Victorian Court of Appeal considered whether an Offer to Purchase documents signed by a seller and a buyer resulted in binding contractual relations.
The Offer to Purchase contained a clause stating that the offer was ‘subject to the contract being executed’.
The Court decided that this was a matter falling within the non-binding third category identified in Masters v Cameron, as:
- the scope of possible further negotiation was significant, with outstanding issues such as the licence agreement, GST and disclosures under section 32 of the Sale of Land Act 1962 (Vic);
- upon the signing of a formal contract the balance of the deposit would became payable, the buyer would gain immediate access to the office/warehouse and the confidentiality obligations on the buyer would cease.
The Court found that these matters suggested that the execution of the Contract of Sale was intended to mark a significant transition in the relations between the parties and there was no binding contract until that stage was reached.
Learnings from the case law
- To avoid being bound by a contract which you thought you could still walk away from, you need to clearly and consistently communicate the intention not to be bound unless and until a formal agreement is entered into.
- Solicitors will use statements such as the following to communicate this position “We reserve our client’s rights to require changes and confirm that our client does not intend to be bound until and unless a final contract is signed by the parties.” Note that this alone may not be effective where the parties act in ways that indicate that a binding contract has been created.
- The closer you come to reaching agreement on fundamental terms, the more caution may need to be exercised with restricting further negotiations.
- Consider whether any urgency is being communicated with regard to finalising terms and any expectation that the parties will solely deal with each other upon finalising such terms
- Refrain from using the words “offer” and “acceptance”.
If you’d like to discuss this article in more detail, please contact Chris Lillie
Individual liability limited by a scheme approved under professional standards legislation (personal injury work exempted).