THE RECENT CASE OF CASDAR PTY LTD V JOSEPH FANOUS[1] reminds us of the hazards of non-binding and informal agreements. In that case, a Landlord, relying on a signed Heads of Agreement as the source of his rights, sought damages against a tenant. The court dismissed the claim on the basis that the Heads of Agreement did not amount to a formal lease and did not bind the parties. We use this case to review the key differences between a legally binding contract and a non-binding agreement.
THERE ARE TWO SPECIES OF AGREEMENTS; those which are formal, contractual and legally enforceable, and those which are informal, unbinding and have no legal bearing whatsoever. A question that frequently arises in contractual disputes is whether an agreement is of the legally binding variety, or the informal and legally toothless kind; in essence, whether there exists a contract at all.
SOMETIMES, PARTIES SIGN A DOCUMENT WHICH RESEMBLES A BINDING CONTRACT, but that document indicates that the parties plan to execute a formal contract at a later date (e.g., a subject to contract clause). Is that document binding? The law here is concerned with the element of intention; would a reasonable person deduce from the totality of dealings between the parties that they intended to form a contract? Casdar sheds light on the kinds of factors which a court may consider when ascertaining the nature of an agreement.
Case Summary
IN CASDAR, the landlord and tenant had signed a document containing various essential terms of a lease. This included the rent and deposit amounts, the term of the lease and a number of special conditions. The tenant subsequently obtained finance approval, payed the first month’s rent and collected the keys to the premises.
Following a dispute regarding planning permissions and the quality of building works, the tenant requested to execute a Deed of Settlement and Release. The landlord objected, asserting that the Heads of Agreement was legally binding. The dispute was heard in VCAT and upheld on appeal in the Supreme Court. The tribunal held that document did not amount to a binding lease, noting the following deficiencies in the document.
1. The document was titled a ‘Heads of Agreement’, which is not normally binding. However, the tribunal recognized that ‘simply because a document is titled “heads of agreement” is not determinative of the question whether an agreement is legally binding or not.’
2. The document contained a clause titled ‘commencement date for lease’. Per that clause, the lease was to commence ‘7 days from signing the Heads of Agreement’. The tribunal inferred from this clause that the commencement of the lease was dependent on the execution of a separate contract.
3. The document specified that the lease was subject to the ‘lessee’s lawyer’s approval within 7 days of the lessor providing the Heads of Agreement’. Consistent with point 2, this suggested that additional documents were required for approval before parties were to become bound.
IN ADDITION TO THE AFOREMENTIONED DEFICIENCIES, the Tribunal noted various failures of the landlord to comply with the Retail Leases Act 2003 (the Act). For example, the landlord did not provide a disclosure statement pursuant to section 17 of the Act. Furthermore, the Tribunal observed that the parties did not conduct themselves in a manner consistent with them having entered into a binding agreement. Following the signing of the Heads of Agreement, both parties had made representations to the effect that a lease had not yet been signed and had not yet commenced. These points militated against there being a formal lease.
Broader discussion; when is a contract legally binding?
AS CASDAR DEMONSTRATES, the court will assess the totality of the circumstances in deciding whether or not the parties intended to enter into a binding contract. As Croft J remarked, this process ‘does not lend itself to formulaic or prescriptive rules’. Rather, ‘regard must be had to any written agreement between the parties and [their] pre- and post-contractual conduct’.
THE CASE OF MASTERS V CAMERON IS THE LEADING AUTHORITY ON ‘SUBJECT TO CONTRACT’ CLAUSES. Per Masters, where two parties who are in negotiation reach an agreement upon contractual terms, and also agree that their negotiation shall be dealt with by a formal contract, the case may belong to any of three following classes:
1. The parties have settled all the 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. In this case the parties are bound to the agreement, regardless of whether or not they execute a formal contract.
2. The parties have agreed on all terms of their bargain but nevertheless have made performance of one or more of those terms conditional upon the execution of a formal contract. In this case the parties are bound to prepare and execute a formal contract.
3. Parties do not intent to conclude a bargain at all, unless and until they execute a formal contract. The parties may not necessarily want to vary the terms but may simply want the flexibility to withdraw at a later date. In this case, the parties are not bound to their agreement. Generally, the phrases ‘subject to contract’ are indicative of an agreement of this kind.
Three lessons for businesses
HEADS OF AGREEMENT, GENTLEMAN’S AGREEMENT, PRELIMINARY AGREEMENTS and the like do have their place in business. But a note of caution; confuse a legally binding contract with a non-binding agreement and you may find yourself the victim of a broken promise with no recourse for its consequences, however devastating they may be. Alternatively, a promise you once dismissed as legally toothless may come back to bite you. Follow these preliminary steps to avoid potential disputes:
1. Decide whether a non-binding agreement is appropriate
Your decision should be the corollary of business and legal reasoning. It is commonplace for business operators to make non-binding agreements so as to bypass the formalities and legal obligations of a contract. However, if you view the subject of the agreement as important, or if the failing of the agreement will harm you, then a formal contract is almost always the wiser choice.
2. Clearly express your intention
It is on this point that we must broach some basic legalese. One feature of a contract is that it is intended to create a legal relationship. Courts will often assume that commercial transactions are intended to create legal relations. Thus, if you have opted to make a non-binding agreement then let it be known. State that you do not intend to form a legal contract. Make that statement explicit and clear so that anyone privy to the agreement will know of your intention. Words such as ‘this agreement is binding only in honour and does not constitute a legal contract’ will typically oust the jurisdiction of the courts. However, given the idiosyncrasies of contract law, it is prudent to take an additional protective step.
3. Avoid confusion
If you have opted to make a non-binding agreement then avoid contaminating it with contractual characteristics. A written agreement, a signature and words such as ‘promise’ and ‘guarantee’ belong to the stream of contracts are likely to cause confusion.
[1] Casdar Pty Ltd v Joseph Fanous [2017] VSC 616
The content of this article is intended for general interest purposes only and does not constitute legal advice. Contact the commercial lawyers at Rankin & Co. for specialised advice.
