Introduction
In commercial transactions, parties often begin with a Letter of Intent (LOI) before entering a final, binding agreement. But does the duty of good faith apply to these preliminary documents?
A recent Ontario case, Dr. Michael Emon Dentistry Professional Corp. v. Alexander Sevo Dentistry Professional Corp., provides useful guidance. It confirms that even if good faith principles were considered, courts will not use them to rewrite a non-binding business arrangement.
The Background
The case involved an LOI for the sale of an endodontics practice. The LOI clearly stated that it was “not contractual or binding”, except for certain limited provisions.
The purchaser was given broad discretion to terminate the LOI “for any reason” if not satisfied with the results of his due diligence.
After more than a year of discussions, the purchaser could not finalize a lease with the landlord and discovered other “red flags” in his investigation. He terminated the LOI.
The seller sued, claiming that the purchaser acted in bad faith and breached contractual obligations.
The Court’s Decision
The Ontario Superior Court dismissed the claim in its entirety.
The Court found that:
- The LOI was primarily an “agreement to agree”, not a binding contract.
- Even if a duty of good faith applied, the purchaser’s conduct was reasonable and honest.
- The purchaser had an express contractual right to terminate and used it within the terms of the LOI.
Key Points from the Decision
1. Good Faith Only Applies to Contracts
The duty of good faith governs how parties perform binding agreements.
Where an LOI is expressly non-binding, that duty does not apply. Courts will not impose good faith on purely pre-contractual negotiations.
2. Freedom of Contract Prevails
The LOI gave the purchaser discretion to end the process “for any reason.”
The Court respected that bargain and refused to interfere, emphasizing that good faith cannot be used to limit or rewrite contractual rights.
3. Legitimate Business Decisions Are Not Bad Faith
The purchaser’s failure to secure a lease and his concern about a key employee’s resignation were legitimate commercial reasons to walk away.
His conduct was diligent, not deceptive.
Good Faith Has Its Limits
This decision reinforces that good faith does not equal moral fairness.
Courts will not impose a sense of “judicial moralism” on sophisticated parties who have clearly defined their own risks and discretion in writing.
As long as a party exercises its contractual rights honestly and within the agreedterms, it will not be found to have breached good faith, even if the outcome disappoints the other side.
Practical Takeaway
When drafting a Letter of Intent:
- State clearly whether it is binding or non-binding.
- If you want the parties to negotiate in good faith, say so expressly.
- Recognize that broad discretion clauses (e.g., “sole and absolute discretion”) will be upheld by the courts.
Bottom line:
An LOI that is not intended to be binding creates no obligation to complete a deal. Good faith cannot be used to rewrite the parties’ bargain or restrict their right to walk away.
Brian Madigan LL.B., Broker
www.OntarioRealEstateSource.com