The sides that bind: Be wary of informal arrangements amending existing formal agreements

Ordinarily, when two parties wish to clarify or alter the terms of an existing formal written agreement, they will execute an amending agreement. Since an amending agreement is typically itself a contract, separate from the original agreement, the parties are well-advised to draft the amending agreement with the proper contractual language - including the acknowledgement of the exchange of consideration.^[1] However, parties should bear in mind recent jurisprudence from the Ontario Court of Appeal suggesting that existing formal agreements may also be validly (and in some cases, inadvertently) modified by fairly informal arrangements.

In Richcraft Homes Ltd. v Urbandale Corp^[2], the two parties - Urbandale Corporation ("Urbandale"), and Richcraft Homes ("Richcraft") - had entered into a limited partnership agreement (the "LPA") that provided for the sale by developers of residential building lots to homebuilders. Sometime after the LPA was executed, the principals of Urbandale and Richcraft signed a second document (the "2005 Agreement"). The 2005 Agreement was essentially a "side agreement", setting out very briefly (in three short paragraphs) a process for the sale of lots that differed from that outlined in the LPA. The document was silent with respect to consideration, and in general lacked other traditional formal characteristics of an amending agreement. For years after executing the LPA and the 2005 Agreement, the parties had no issues - until it came time to deal with the lots.

The sale process described in the 2005 Agreement was more favourable to Richcraft than the provisions of the LPA as it gave Richcraft the right to acquire additional lots for homebuilding at a preferential price compared to other homebuilders. Richcraft successfully argued at trial before the Ontario Superior Court of Justice that the 2005 Agreement amended the LPA and was enforceable.^[3] Urbandale appealed the judgement.

In its analysis, the Ontario Court of Appeal considered three principal issues:

1. whether the 2005 Agreement was unenforceable because Richcraft did not give consideration;
2. whether the 2005 Agreement was simply an option agreement; and
3. whether the 2005 Agreement was "fatally uncertain".

The Court of Appeal undertook a thorough review of the jurisprudence on consideration in amending agreements. Notably, the Court appeared willing to accept authority from outside of Ontario standing for the proposition that consideration is not an essential requirement for the validity of contractual variations. However, the Court of Appeal did not ultimately have to rule on this particular point, since it went on to find that Richcraft actually had provided consideration for the 2005 Agreement. In particular, the Court stated:

"Clarifying an unclear term in a long-term contract, in order to create certainty and to avoid future costly disputes, enures to the parties' mutual benefit, and is something of value that flows from and to each contracting party. It thus serves as a functional form of consideration."^[4]

On the second point, the Court determined that the 2005 Agreement was not in fact an option agreement, a specific kind of contract with unique characteristics, and therefore not required to include more specific terms as to the details of the option. Finally, the Court reasoned that the 2005 Agreement contained enough certainty in its terms to be enforceable, and served to clarify the issue of quantum in terms of the number of lots Richcraft could purchase at the preferential price. In doing so, the 2005 Agreement filled a void left by the original LPA which was unclear.^[5] The fact that other details (like time frames) were not specified in the 2005 Agreement was not problematic as those details could be sorted out through mechanisms within the LPA. Key to the Court's finding here was that the 2005 Agreement was not a stand-alone agreement, but merely clarified some of the terms of the LPA.

In light of the Court of Appeal's decision in Richcraft, lenders should be mindful of the potential hazards of offering informal reassurances or clarifications of the interpretation of terms within their formal credit agreements and commitment letters -- they may find themselves inadvertently bound by these informal arrangements. Informal amendments or side agreements can also be problematic from a purely practical perspective, as they can easily be forgotten and left out of reporting letters and record books. When looking to amend the terms of formal credit documents, lenders should be as formal as possible.