Court provides guiding principles on interpreting a Memorandum of Understanding

In Da Shing Group Ltd v Rich Promise Limited [2020] HKCFI 588[1], the Hong Kong Court of First Instance provided guiding principles in the interpretation of a memorandum of understanding (MOU) and considered whether pre-contractual exchanges could be admitted as evidence.

The MOU in Chinese related to the acquisition of about 50.46% of the shareholding (Shares) in a listed company, Crocodile Garments Limited (Crocodile). However, the MOU did not specify whether the sum of HK$30 million (Sum) deposited into the prospective vendor’s designated bank account, was refundable or not if negotiations for the acquisition fell through.

The Court had to determine whether the prospective vendor was liable to return the Sum.

Having considered the MOU and relevant commercial background, the Court held that the nature of the Sum was no more than earnest money to demonstrate the prospective purchaser’s sincerity in entering into negotiations with the prospective vendor. On the true construction of the MOU, the prospective vendor was liable to return the Sum to the prospective purchaser after the negotiations for the formal agreement for sale and purchase of the Shares failed.

Guiding principles on interpreting the MOU

The Court set out the following guidelines:

1. 

In interpreting a contract, the Court should take account of both its language and background. Between the language and background, the Court must be careful in striking a balance between the indications given by the language and implications of the competing constructions.

2. 

The MOU was not drafted by lawyers, and was an adaptation from an in-house standard form of the Plaintiff’s financial consultant. Both the text (language) and context (commercial background) should be considered.

3. 

The Court should be astute to possibilities such as one side having agreed to something which with hindsight did not serve his interest, or that a provision may be a negotiated compromise, or that the negotiators were not able to agree more precise terms.

4. 

Against the parties’ rival constructions, the Court shall go through the iterative process by which each suggested interpretation is checked against the provisions of the contract and its commercial consequences are investigated.

5. 

Textual Analysis:The central plank of the prospective vendor’s case was that the Sum served as the monetary consideration of the Defendant’s legally binding obligations in the MOU. It was fraught with the difficulty that there was no provision in the MOU which suggested so.

6. 

Contextual Analysis: After examining the commercial background and context at the time of the MOU, it is unlikely that the Sum was intended by both parties to be monetary consideration.

Exclusion of pre-contractual exchanges as evidence

The prospective vendor produced 3 drafts of the MOU and sought to rely on them. In particular, the words “可退回” (literally translated as “may be refunded”) and the proviso concerning the mechanism and timing for the Sum to be repaid were deleted in the draft by way of track changes.

However, the court excluded pre-MOU drafts and exchanges as evidence because:

1. 

They are irrelevant to the question to be decided by the court, namely, what the parties would reasonably be taken to have meant by the language which they finally adopted to express their agreement. Even if they are admitted in exceptional cases, they are admitted not as evidence of what the clause in question means, but as “background known to the parties” that may assist the interpretation. 

2. 

On some occasions, the difference between evidence of what the contract means and evidence as background could be subtle or imprecise and the line is hard to draw. In most cases, evidence on pre-contractual negotiation only reflects one party’s subjective intention and hence is inadmissible. 

3. 

If it is capable of becoming evidence of the meaning of the contract subsequently agreed, it must be capable of showing that it, albeit at that time the contract had not yet been concluded, had already reflected the parties’ mutual or common intention on what they both wanted the contract to mean. But such cases would be exceptional.

4. 

Moreover, even if such prior negotiations, whether orally, in writing or by conduct, do reflect the parties’ mutual intention on what the contract means, the value of such evidence may be very limited. Such prior negotiations have likely been “superseded by, and merged in, the contract itself”.   

As to subsequent conduct and statements of the parties after the contract has been entered into, the Court held that they are generally not relevant and not admissible. There must be a proper basis for enabling the Court to take consideration of the facts and conduct subsequent to the MOU in aid of the construction of the MOU. “Commerciality and fairness” is no such basis.

Comments

When parties negotiate an M&A deal, they wish to have a successful transaction. However, when the transaction does not proceed as expected or, as in the Da Shing case, the negotiations for the formal agreement for sale and purchase fail, it will be important for the parties to have a properly drafted and unambiguous  agreement (especially on those critical provisions), which should not be compromised by a desire to conclude a deal quickly.

 


[1] Deacons act for Da Shing Group Limited