When entering into contracts on behalf of your business, you may occasionally need to change or add to the contract terms. The most effective way to do this is through a side letter. However, there are a few essential things to remember to ensure your side letter is effective and legally enforceable. This article will explain a side letter, provide examples of how it can be used, and outline the key risks of using a side letter.
What is a Side Letter?
A side letter, or a side agreement, is used in various commercial transactions. The main purpose of a side letter is to clarify the main contract terms. However, a side letter can also add details or change the main contract terms.
When Can I Use a Side Letter?
Suppose Company X is purchasing goods from a supplier, Company Y, on an ongoing basis. They have a master supply agreement that outlines the general terms and conditions of their business relationship, such as pricing, delivery schedules and quality standards. Here, the parties can use a side letter in three different ways.
1. Clarifying Terms of a Master Agreement
A side letter can clarify specific details of the master supply agreement. For example, the master supply agreement could include an obligation on Company Y to use “all reasonable endeavours” to deliver the goods on time. The parties may use a side letter to confirm what “all reasonable endeavours” means in the context of their agreement.
2. Vary a Master Agreement
A side letter can vary the master supply agreement. For example, the ordering process outlined in the master supply agreement could be the standard process used by the supplier, Company Y. However, the parties may use a side letter to change this ordering process.
3. Supplement a Master Agreement
A side letter can supplement the master supply agreement. Side letters are often used to supplement a main agreement where multiple parties are involved in a transaction. For example, Company Z may be a logistics and repair service provider that Company X uses to handle product shipments and manage customer returns. A side letter could be drafted between Company X, Company Y and Company Z to cover additional transaction terms, such as warranties, returns and logistics support involving the third-party service provider, Company Z.
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Risks of Using a Side Letter
Side letters can often be a ‘quick fix’ to get around the primary contract, but it is not without risk. There is often a question of whether a side letter is enforceable under the law. Two significant issues often arise in the context of a side letter:
- contract formation; and
- whether the side letter is inconsistent with the main agreement.
A side letter must contain the basic contract formation principles to be enforceable as an agreement. These are:
- offer;
- acceptance;
- intention to create legal relations;
- certainty; and
- consideration.
Often a side letter lacks consideration, which means ‘value’. Consideration requires the passing of value between the parties to a contract. If no consideration can be passed, you should consider executing your side agreement as a deed rather than an agreement.
A side letter must also be consistent with the main agreement. This means that the terms of the main agreement and the side letter should not contradict each other. For example, the main agreement and side letter can both include clauses about the delivery schedule of goods. An inconsistency may arise if it is unclear whether the side letter intends to amend the delivery schedule clause in the main agreement. Inconsistency can lead to confusion and potential disputes.
Key Takeaways
Before drafting, reviewing or signing a side letter, make sure that you consult with a lawyer to ensure that the side letter will have legal effect and give effect to the intentions mutually understood by you and the other party. It is important that your side letter will be enforceable if a dispute arises. We also recommend that your side letters be executed as a deed rather than an agreement to ensure it is enforceable. Even though side letters are a convenient way to vary, clarify or supplement a contract, you should resist the urge to plug in any gaps in your arrangement with variations unless you carefully consider them.
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Frequently Asked Questions
A side letter is a separate agreement that covers specific issues not fully covered in the main contract between parties involved in a commercial transaction.
The main difference between a contract and a deed is that a contract requires consideration (value) to be transferred between the parties for the contract to be legally binding. A deed does not require consideration for the deed to be legally binding.
A side letter can be used in various commercial transactions to clarify, vary or supplement the terms of a main agreement.
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