16 Aug 2012

Subject to board approval - must the board approve the contract?

by Ian Bloemendal, Sarah Frost

The organisation, the other party and the Board all have particular responsibilities when a contract is subject to Board approval.

Organisations often try to protect themselves by inserting a clause into the contract that its performance is subject to Board approval. What does this involve, and does each party – and the Board – need to do?

There is little guidance from the courts on the concept of "Board approval", particularly where contracts are made "subject to Board approval", but some general principles are clear.

What is the effect of a "subject to clause"?

Contracts that contain "subject to" clauses are conditional contracts. A "subject to" clause has the effect of postponing the performance of the binding contract. This means that neither party can withdraw from the contract until the time for fulfilment of that clause has passed.

Contracts that are "subject to finance" are a good example. A "subject to finance" clause is inserted into a contract to benefit the purchaser, who is not bound to complete the contract if the purchaser cannot obtain finance. It follows that until finance has been approved, the purchaser is not bound to pay the contract price but, will be required to act honestly and reasonably in their efforts to obtain finance.

What if you don't try to get Board approval?

A general rule in contract law is that each party impliedly agrees to do all things that are necessary to enable the other party to have the benefit of the contract.

Failure to take reasonable steps to seek Board approval may constitute a breach of contract (subject to the particular circumstances of the case).

Does the Board have an unfettered right to approve or reject the contract?

The Board does have an unfettered right to approve or reject a contract that contains a clause that it is "subject to Board approval".

That said, the Board must exercise that right by:

  • considering the approval or otherwise of the contract by reference to its general obligations to the company (for example to act in the best interests of the company); and
  • ensuring that it acts in good faith as required, either expressly under the terms of the contract or by acting consistently with the general rule that each party to a contract has an obligation to ensure the other party may have the benefit of the contract.

What if the Board rejects the contract?

If the Board rejects a contract, the other party would need to consider the facts, matters and circumstances of each individual case (including the contract's terms) to determine whether the rejection is actionable.

For example, the other party might have an expectation that Board approval will be given. This will depend largely on the representations and negotiations that have occurred at or around the time the contract was executed. It might be, for example, that representations were made before the contract was executed that the Board approval process is simply a rubber stamp. The other party might be able to sue on that basis.

What should the Board consider?

A Board that is considering rejecting a contract that is 'subject to Board approval' should ensure that they understand the manner in which the contract was negotiated and any representations that may have been made.

It ought to also seriously consider keeping a detailed record of the reasons for the refusal of the contract.

What should each party consider when making a contract subject to Board approval?

Representatives of the company should be careful about what representations are made about Board approval (and indeed, about anything material to the contract!), to avoid giving rise to an expectation that it will be given as a matter of course.

They should also be sure to take reasonable steps to obtain that approval.

Likewise, the other party should think about the consequences of this condition for its own business. Is Board approval likely, given what the company's representatives have said during the negotiations? How long can you afford to wait for it? If Board approval is needed by a certain date, it's worth specifying the date, and that time is of the essence. This will start the clock ticking and help concentrate the mind of the company.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.