Variations by side letter are very uncertain

Many people think that a side letter is a simple and effective way of varying a contract or deed.

The case of ACN 151 368 124 v Pro-Pac Packaging (Aust) Pty Limited¹ shows that this is not the case – variations of contract  or deeds by side letter are, in fact, quite uncertain and problematic.

Facts

Pursuant to a written agreement between ACN 151 368 124 formerly Eco Food Pack Australia Pty Ltd (Seller) and Pro-Pac Packaging (Aust) Pty Limited (Buyer) the Seller agreed to sell the Buyer its meat-tray supply business (Sale Agreement).

The consideration payable by the Buyer under the Sale Agreement was payable by way of:

• a “Completion Payment” of $1.2 million (subject to adjustment);
• a “Deferred Payment” of $250,000 payable in four half yearly instalments (Deferred Payment); and
• incentive payments if earnings and gross profits targets were met in the years following completion.

In addition, there was to be an inventory of goods and saleable stock and the Buyer was to pay the value of that stock.

The Buyer and the Seller also entered into a number of other documents at the same time as entering into the Sale Agreement including, but not limited to, a document entitled “Side Letter – Refund of Deferred Payment” (Side Letter).

Side Letter

One of the matters in dispute was whether the parties reached an agreement with terms contained in the Side Letter.

“(a)   in consideration of the Seller granting the Buyer a licence to occupy Premises for a period until 31 July 2015 under the BPSA, the Buyer will pay the Seller the Deferred Payment (which comprises of four half-yearly instalments of $62,500.00 each, the first of which is to be paid by the Buyer 5 days post Completion date and the last instalment is to be paid on the second anniversary of the Completion Date); and

(b) if and to the extent that the Premises is sublet, assigned or otherwise disposed of by the Seller prior to 31 July 2015, which the Seller will undertake to do at the direction of and in cooperation with the Buyer, the Seller:

(i) will refund any instalments of the Deferred Payment already paid by the Buyer to the Seller on a pro rata basis; and

(ii) waives any future instalments of the Deferred Payment to be paid by the Buyer to the Seller”.

Issues

The Seller sued the Buyer for (among other things) the balance of the Deferred Payment.  In particular, the Seller:

• argued that the Side Letter had no contractual effect.  It  could not be relied upon as a collateral contract because it was inconsistent with a term of the Sale Agreement; and
• alternatively, the relevant promises in the Side Letter were unenforceable because no consideration had been given for them.

The Buyer denied that it was liable for the Deferred Payment.  The Buyer appeared to accept the Seller’s position that paragraph (a) of the Side Letter was unenforceable.  However, the Buyer submitted that paragraph (b) could stand by itself.

Decision

In Justice McDougall’s view:

• as the Sale Agreement granted the Buyer a license to occupy the premises, a further promise to grant the same licence could not be good consideration to support paragraph (a) of the Side Letter; and
• it is not legitimate to read the two paragraphs separately.  Paragraph (b) follows on from, and is inseverable from, the first.  The defect of want of consideration affected paragraph (b) also.

In reaching his Honour’s decision, McDougall J cited the following principles set out by Isaacs J in Hoyt's Pty Ltd v Spencer:²

1. where entry into the main contract is the consideration for the collateral contract, the former “must be taken exactly as it is” and the parties must “have and be subject to all (not some only) of the respective benefits and burdens of the main contract”; and
2. “a collateral contract…, being supplementary only to the main contract, cannot impinge on it, or alter its provisions or the rights created by it”.  Thus, where entry into the main contract is the consideration for the collateral contract, “it is a wholly inconsistent and impossible contention that the other party is not to have the full benefit of the main contract as made”.

Ultimately, McDougall J found that the Buyer’s reliance on the specified provisions in the Side Letter failed both for a lack of consideration and their unacceptable variation of the terms of the Sale Agreement, being the main contract between the parties.

The Buyer was liable to pay the Seller the Deferred Payment.

Lavan comment

If parties choose to supplement, or flesh out, the terms of a contract by entering into a side agreement, they should be aware that any terms in the side agreement that alter the parties’ respective rights and benefits under the contract may render the side agreement unenforceable.

This is why documents often specify that a variation can only be effected by a deed.

A deed is a more formal document considered under the law to represent the most solemn indication by the parties that they wish to be bound by the terms of the deed.  A deed does not require consideration to be effective.  A deed must be executed by a person in the presence of an independent adult person.  A company must execute a deed in accordance with the Corporations Act 2001 (Cth).  Each party must receive a copy of the document.  If all these things are met, there is a deed.

We do not recommend the variation of contract by side letter.

Simple For a side agreement to be effective in altering the party’s rights and benefits under a contract, there must be separate consideration in respect of the side deed.  Consideration is the concept of legal value in connection with contracts.  It is anything of value promised to another when making a contract.