Letters of Intent: When are they legally binding?

11 August 2011
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The Federal Court has clarified the requirements of a binding letter of intent in the recent case of Factory 5 Pty Ltd v State of Victoria [2010] FCA 1229. In this case, Factory 5 Pty Ltd (“F5”) entered into negotiations with M2006 (a statutory corporation formed to manage the Commonwealth Games in Melbourne) for a contract to become the sole retailer of licensed souvenirs, memorabilia and apparel for the Games.

On 16 December 2004, M2006 sent a letter to F5 containing the structure and terms of the agreement. The letter relevantly stated that “these terms will be further detailed in a legally binding Deal Memo and Long Form Agreement.”

On 23 December 2004, M2006 wrote to F5 confirming that the parties had agreed to appoint F5 as the sole retailer “subject to reaching agreement on a legally binding Long Form Concessionaire Agreement”. This letter also incorporated commercial terms and conditions set out in specified correspondence, including the 16 December letter, into what it called “this agreement”. The parties never executed a long form agreement.

Despite the wording of the 23 December letter, which stated that the agreement was “subject to” the making of a formal contract, the court found that the parties did make a legally binding contract on 23 December 2004. In reaching this decision, the court placed great emphasis on the conduct of the parties and the circumstances surrounding the 23 December letter, including:

1. that there were no outstanding issues of importance to be resolved in the negotiations;
2. that there had been subsequent conduct and communication between the parties that evidenced a common view that the letter amounted to a binding contract; and
3. that M2006 had not indicated any change in its intention to enter into a legally binding Deal Demo.

Letters of intent must be clearly drafted to reflect the precise intention of the parties, including the extent to which they wish to be bound by the letter. It is critical for both parties to be aware of the implications of letters of intent and ensure that their conduct, both before and after the date of the letter of intent, is consistent with their respective intentions. Otherwise, as demonstrated in this case, the courts may find that a letter of intent is contractually binding despite the language of the letter itself.

Simon Williams
Principal
Spruson & Ferguson
E: Simon.Williams@sprusons.com.au

Reyahaneh Saadati
Solicitor
Spruson & Ferguson
E: Reyahnaeh.Saadati@sprusons.com.au