Are Side Letters Legally Binding?

Side letters are legally binding and just as enforceable as normal contracts, so long as they follow the requirements of creating a binding contract. So far as the requirements of consideration, offer, and acceptance as a present are concerned, the enforceability of a side letter should not be an issue. The same applies to judicial interpretation.

During transactions, several agreements and contracts are usually drafted. But if you wanted to make changes to the contract or agreement before or after it is finalized, you would have to redraft the specific clause and, in some cases, other clauses to ensure consistency.

As a result, the parties may find that some clauses and terms have to be redrafted, which could be cumbersome and expensive. This is where a side letter comes in. This short article details a side letter’s functions and enforceability under the law.

 What are Side Letters?

Side letters set out terms that supplement or, in some cases, modify the existing terms of an agreement or a legally binding contract between parties and are typically memorialized in a letter acknowledged and executed by the parties.

In start-up advisory, Side letters are often used to grant special rights and privileges to important investors (e.g., seed investors, strategic investors, those with large commitments, and employees, friends, and family) or to those subject to government regulation.

Side letters should be used to provide reassurance of the party’s intentions. Even if the intention to establish legal relations exists, it may not be legally enforceable. To prevent this, one must be clear in what they are trying to achieve, and if it is required to be legally enforceable, this must be clearly stated in the side letter.

Are Side Letters Binding?

A side letter’s judicial interpretation will be done the same way as it would for an ordinary agreement or contract.

There are many good things about changing contracts and agreements with side letters, but there are also some bad things. The only major downside is that the effectiveness and viability of a side letter depend on how it is drafted. A side letter that isn’t written well can have unintended effects and even create contractual relationships and effects where there weren’t any before.

 Why use a side letter? A side letter might be useful for setting out changes that need to be made in the agreement instead of amending multiple clauses. With a side letter, you can itemize the changes that need to be made. It will be just as binding as the original reference agreement if it has the basic parts of a contract.

Conclusion

Using side letters by venture capital and private equity funds has become common. Side letters are also a good way for investors and founders to make last-minute changes or requests before the fund’s first closing and to negotiate more without changing the agreements already in place.

When negotiating or drafting side letters, it is important for all parties to be very clear on the letter’s contents. Even though some risks or unintended effects could happen, the benefits of using one outweigh the risks that seem obvious when a side letter is not written correctly.