Signing a preliminary agreement, such as an offer to lease a property, can result in a binding commitment even if the parties do not then agree on all terms of the formal lease.

Lessors, and lessees keen to put their stamp on new premises, need to understand the extent to which they are committing themselves by signing preliminary agreement documents presented to them.

The potential lessee in the case of Activ Foundation v WBHO-Carr [2014] in Western Australia found out the hard way.

Background

WBHO, the potential lessee, signed an ‘Offer to Lease’ (Offer) with Activ as lessor, for 650 sq metres of office space for a term of 5 years at an initial annual rental of ~$250,000 ex GST, and outgoings, with a 5 year option.

The lessor’s agent, Savills, made it clear that there was competition from other parties for the space. WBHO was under time pressure to secure premises.

When signing the Offer, WBHO’s Managing Director added a note stating – ‘Offer subject to Board (WBHO) approval at scheduled meeting 9/5/11’. Activ’s CEO then signed the Offer on behalf of the lessor on the same day. On 20 May 2011, about one month later, WBHO’s Managing Director advised that all approvals had been obtained. He also stated that if the space was still available, the process of formal lease preparation could commence.

The Offer contained brief clauses providing for:

  • The lessor’s standard form of lease to be used
  • Both parties to sign their respective approval/acceptance of the terms
  • The key terms of a lease including rent, rent review, term and option, identification of the premises, parties, possession to fit out, lease incentive, outgoings, car parking, approvals/permits, building alterations, signage, manner of payment of rent, bank guarantee security, public liability and other insurances, and a deposit of 2 months gross rent

About 10 days later, the draft formal lease documents were submitted to the lessee. One week later, WBHO’s CEO emailed Savill’s to the effect that the WBHO Board had reviewed financial performance and decided not to approve the lease.

The Issues

The central issue was whether the parties intended to be bound by the terms of the signed Offer once the 20 May 2011 communication of the WBHO Board approval had been conveyed to Savills.

The law recognises 4 categories in the situation where negotiating parties reach some form of preliminary agreement with a view to then finalising a formal contract.

  1. All terms are agreed and the parties intend to be immediately bound to perform, but wish to restate them in a formal contract – this agreement is binding.
  2. All terms have been agreed, and performance of all or part of the agreement is conditional on signing a formal contract – this agreement is binding.
  3. Parties do not intend to make a concluded agreement, until a formal contract is signed – there is no binding agreement.
  4. Parties have agreed key terms, to be performed immediately, pending negotiation in good faith of a formal contract containing the remaining terms.

This agreement is binding, and replaced by the detailed, formal terms once signed. If the detailed terms cannot be agreed, a Court may determine the remaining terms.

WBHO argued that this was a Category 3 situation and that the parties failed to agree on a formal lease. It also argued that the Offer was simply an agreement to negotiate a lease, and was not binding.

Unfortunately for WBHO, the Court decided this was a Category 4 situation. Sufficient key terms had been agreed in the Offer. The lead up negotiations, and circumstances following signing the Offer, showed that both parties considered they were making a binding commitment.

The Court decided there was a binding 5 year lease agreement, and WBHO was ordered to pay damages including loss of rental of circa $650,000 to Activ. This well exceeded the 2 month deposit.

Key lessons

  • If the Offer had stated it was ‘made subject to the parties entering into a formal lease to their mutual satisfaction’, it was more likely to be a Category 3 (non-binding) situation
  • Preliminary agreements made ‘subject to Board approval’ are likely to be non-binding until the approval is communicated
  • Detailed offers to lease are capable of imposing binding obligations which do not allow a party (lessor or lessee) to withdraw, so the wording needs close consideration
  • Emails and other communications of the negotiating parties, and their agents, will be considered to determine if they intended to be bound by the terms in the preliminary document

Preliminary agreements in commercial transactions are common for property leasing, sale of land, sale of business, joint ventures, franchises, supply agreements and many other everyday commercial arrangements. They take all sorts of forms such as Offer to Lease, Heads of Agreement, Term Sheet or Memorandum of Understanding (MOU).

The Activ WBHO case shows that there can be a significant outcome for the enforcing, or withdrawing, party.

At CIE Legal, we see many commercial transactions, both before and after, an offer to lease or other preliminary agreement is entered into. There is certainly opportunity to assist, manage commitment risk, and add value to clients before a preliminary document is signed by all parties.


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