The Commercial Reality of Oral Collateral Contracts

In the recent decision of Reid v AMRY Family Trust, 2026 ABKB 55, the Alberta Court of King’s Bench affirmed the five key elements necessary to form an oral collateral contract.

An oral collateral contract is an oral agreement ancillary to a written contract.[1] While not the same as the main contract, collateral contracts and main contracts are inextricably woven, where one does not exist without the other.[2] Courts have described oral collateral contracts as a distinct species of contract, though they ultimately require the same essential elements as any other contract.[3] Understanding whether an oral collateral contract exists with the main contract involves proving the same principles underlying contracts generally.[4]

Background

The case involved a contractual dispute between a sophisticated businessman (the “Debtor”) and a Trust represented and controlled by another sophisticated businessman. The two businessmen used to be friends, and engaged in various commercial ventures together. The Trust advanced a $1 million loan to the Debtor, secured by a promissory note and pledged shares.[5] When the Debtor could not pay the loan interest and principal, the Trust prepared to recover the loan and enforce the security.[6] However, the parties then entered into a written contract to settle the loan through a Debt Settlement Agreement (“DSA”).[7]  The primary consideration paid by the Debtor under the DSA was the transfer of the pledged shares.[8] The value of shares and other property transferred to settle the debt was less than the value of the debt.

The DSA included terms by which some shares or cash would be returned to the Debtor if 1) the Trust sold the shares for a value exceeding a certain threshold, net of all expenses, by a certain date; or 2) if the Trust received dividends from the shares exceeding a certain threshold, net of all expenses, by a certain date.

Subsequent to the DSA, the value of the shares increased in value, but the Trust did not sell the shares nor receive a dividend from them that would trigger a return to the Debtor in accordance with the DSA.

The Debtor alleged that, in addition to the DSA, he and the trustee had an oral collateral contract whereby the Trust agreed to return shares or cash for any amount of the future value of the shares exceeding a certain threshold, regardless of whether the Trust sold the shares or received a dividend as included in the DSA. However, the original draft of the DSA circulated by the Debtor’s lawyer included a similar term, and was rejected by the Trust through its lawyer. The Trust denied an oral collateral contract existed.

The Trust obtained summary dismissal of the Debtor’s claim before an Applications Judge.  The Debtor appealed. The Court dismissed the Debtor’s appeal and upheld the summary dismissal.

Oral Collateral Contracts: A Legal Framework

The central issue on appeal was whether an oral contract, collateral to the DSA, existed between the parties.

The Court identified five elements necessary for a collateral contract to exist:

1. Mutual intention to create a legal relationship;
2. Consideration from both parties in the agreement;
3. Collateral agreement terms that are certain and clear in both parties’ minds when the contract is made;
4. On its own, the collateral contract contains the necessary elements of a contract; and
5. The collateral contract cannot contradict the main contract.[9]

The Court held that none of these five elements existed.

Mutual Intention to Create a Legal Relationship

The intent to create legal relations was not mutual, as the only indications of the collateral agreement came from the Debtor to the trustee, not the other way around. The mutual expectation of trust between friends and a history of mutual generosity and forbearance may give rise to an “understanding or expectations”, but are not enough to constitute a binding intent to form a legal relationship.[10] A party’s subjective intentions or understandings are irrelevant in determining whether intent to form a legal relationship exists.[11] Intention to create legal relations must be clear. Courts will often assume that such an intention is absent from informal agreements amongst friends.[12] The Supreme Court of Canada refers to this as the “practical wisdom” embodied in the common law, that much of what may informally be agreed to in our day-to-day lives does not result in a contract.[13]

The Court held that the record was clear that the trustee’s intention to create a legal relationship in respect of settling the debt was limited to the terms included in the DSA.[14] The trustee was straightforward in communicating his lack of intention to enter into a legal relationship with the Debtor, beyond what was eventually included in the DSA, and was adamant in his responses that “his lawyer has explained the legal contractual terms to [the Debtor’s] lawyer and the rationale for those contractual terms.”[15] Accordingly, the Court found that the Trust had neither an objective nor subjective intention to create a legal relationship in respect of the alleged oral collateral agreement.[16]

Consideration

Consideration is a key element to contract formation, as it involves an exchange of promises between the parties. It is possible that the entering into a formal main contract could be consideration towards an oral collateral agreement.[17] However, in this case, the evidentiary record was void of objective evidence supporting such an argument. The Debtor’s options were limited: he could try to extend his payment obligations; be subject to enforcement; or settle the debt.[18] 

The Debtor chose to settle the debt through the DSA because that was the only practical option available to him: he could not afford the costs of a further extension nor to lose even more assets via enforcement at the full face value of the debt.[19] In this commercial context, the Debtor was a “term taker”,[20] facing regular threats of enforcement and legal proceedings if the debt was not resolved.[21] Through the course of negotiating an extension and then settlement of the debt, the Debtor was reminded by his own lawyers of his inability to prevent enforcement and its consequences.[22]

In this case, entering the DSA was not stand-alone consideration for the alleged oral collateral agreement. The Debtor agreed to the DSA knowing that the transferred shares and other property were less than the face value of the debt being settled, that the value of the shares could increase, and that he would obtain a full release from his debt even if the value of the shares crashed.[23] There was nothing else to exchange as consideration for a separate oral collateral contract.

Certainty of Terms and Essential Elements of a Contract

The Court held that the terms of the alleged oral collateral contract were not certain and clear to both parties.  One party’s subjective views about the agreement, or how it would later work, are irrelevant.[24] Parties will be found to have reached a meeting of the minds only where it is clear to the objective reasonable bystander, in light of all the material facts, that the parties intended to contract and that the essential terms of that contract can be determined with a reasonable degree of certainty.[25] 

The Court found that discussions between the parties lacked clarity around the alleged terms of a “reasonable premium or fee” by which any further increases in the value of the transferred shares would accrue to the Debtor’s benefit.  Firstly, the Debtor’s own evidence alleged two different versions of an oral collateral agreement, occurring at two different periods: the first occurred before the parties’ lawyers commenced negotiations and drafting of the DSA; and the second occurred in text messages sent by the Debtor to the trustee in the hours before the DSA was executed.[26]  Of note, the particular terms for the return of shares or cash if the value of the shares increased as alleged by the Debtor were previously included in his lawyer’s draft of the DSA and rejected by the Trustee’s lawyer. If the alleged oral collateral agreement was already reached prior to the parties’ lawyers being involved, then there was no need for the Debtor to still be making various proposals about it much later, after the DSA was drafted and just prior to it being signed.[27]

Secondly, it was the Debtor alone that was making the proposals by text messages and confirming his own proposals.[28] The Trustee’s responses were nothing more than clarifications and corrections to what the Debtor previously proposed and references back to what was presently reflected in the DSA prepared by the parties’ lawyers. There was never a meeting of the minds between the parties other than what was reflected in the DSA.[29] 

Contradictory Terms

Lastly, the Court considered the manner in which the alleged oral collateral agreement interacted with the DSA.  A collateral agreement cannot be established where it is inconsistent with or contradicts the written agreement.[30]

The Court found that the discrepancies between the sophisticated calculations used in the two triggering conditions included in the DSA (upon sale of shares or receipt of dividend) were inconsistent with the Debtor’s alleged third triggering mechanism for return of shares or cash: on the simple increase of the share value, regardless of whether they are sold, and regardless of expenses. Moreover, the Debtor’s alleged oral agreement for a third triggering mechanism would be triggered at a lower valuation of the shares (~$1.35M, gross) than the triggering value if the shares were sold or a dividend received, as included in the DSA ($1.5M, net).[31] The alleged orally-agreed third triggering mechanism would essentially render the first triggering mechanism included in the DSA moot and would make no business senses for the Trust.[32]

The Court ultimately concluded that the Debtor failed to establish every element of the test to prove the alleged oral collateral agreement, and the summary dismissal of his claim was upheld on appeal.

Takeaway

For oral collateral contracts, the seminal rules govern. Offer and acceptance must be clear and absolute. A mutual exchange in value must occur. The terms must be sufficiently clear and certain in the minds of both parties, and must not contradict the main contract.  Collateral contracts are not immune from these foundational principles.