When is an agreement legally binding?
One of the essential requirements for a legally binding agreement is that both parties must actually intend for the agreement to be legally binding. A court will look at the parties’ objective intentions at the time the agreement was made to determine whether or not this was the case. If both parties conducted themselves such that a reasonable person would think they intended to be legally bound, the agreement will be legally binding. Further, where an agreement is reached between two businesses, the courts will presume they intended to be bound by their agreement.
Use of the expression ‘subject to’
Disputes regarding intention often arise in relation to agreements that are expressed to be “subject to” the preparation of a further document – for example, a memorandum of understanding (MOU) or a heads of agreement might foreshadow the preparation of a more formal contract, or deed of settlement.
An example is the well-known case of Masters v Cameron (1954) 91 CLR 353. Here, ‘M’ was to purchase a farming property from ‘C’. An agreement was prepared, which included the following term:
‘This agreement is made subject to the preparation of a formal contract of sale which shall be acceptable to my solicitors on the above terms and conditions.’
Based on the facts presented before it, the High Court held ‘M’ did not intend to create a legal relationship with ‘C’ until such time as a formal contract was prepared and signed, such that the agreement they had made was not legally binding.
In Masters v Cameron the High Courtfound that where an agreement is expressed to be subject to the preparation of a further document, there are three possibilities:-
the parties intend to be legally bound immediately, although their agreement will be set out in a more comprehensive, formal, document which the parties will sign later on;
the parties intend to be legally bound immediately, but wish performance of one (or several) of the terms of the agreement to be delayed until, or conditional upon, the signing of a formal document later on; or,
the parties do not intend their agreement to be legally binding at all until the execution of a formal document later on.
More recently, the courts have found there to be a fourth category – where the parties intend to be legally bound immediately, but will later make a further agreement which will act in substitution of/replace the first.
When negotiating any agreement it is important to be clear about whether (and when) an agreement is intended to be legally binding. While the courts will generally interpret the expression ‘subject to contract’ (or other similar expressions) to mean the parties did not intend to be bound by their agreement until a formal contract is signed, this is not a hard and fast rule. It will always depend on the surrounding circumstances under which the agreement was entered into.
If you need assistance creating or enforcing a MOU, heads of agreement or contract, contact Jenkins Legal Services on 4929 2000.