Academic journal article University of Toronto Faculty of Law Review

Non-Binding Preliminary Agreements: The Duty to Negotiate in Good Faith and the Award of Expectation Damages

Academic journal article University of Toronto Faculty of Law Review

Non-Binding Preliminary Agreements: The Duty to Negotiate in Good Faith and the Award of Expectation Damages

Article excerpt

INTRODUCTION I DEVELOPMENT AND CATEGORIZATION OF PRELIMINARY AGREEMENTS II DUTY TO NEGOTIATE IN GOOD FAITH    i. Historical Backdrop    ii. Implied and Contracted Good Faith    iii. Negotiation Tactics and the Duty Of Good Faith    iv. The Enforcement of the Duty of Good Faith: Other Issues    v. Exclusivity Exception III DAMAGES: EXPECTATION AND RELIANCE 31 IV SUGGESTIONS TO AVOID BINDING PRELIMINARY AGREEMENTS 36 CONCLUSION 

A gentlemen's agreement is an agreement which is not an agreement, made between two persons, neither of whom is a gentleman, whereby each expects the other to be strictly bound without himself being bound at all. (1)

INTRODUCTION

One of the most difficult and important areas of contract formation concerns the enforceability of letters of intent or other preliminary agreements. (2) Such agreements are used for a variety of reasons, including: to memorialize certain agreed upon terms to prevent misunderstanding and selective memory, to identify and resolve open issues of a deal through negotiations, or to test the other party's level of commitment. (3) A preliminary agreement is used as a precursor to the enforceable contract, and as such is drafted to make the majority of the provisions non-binding. The few binding provisions are typically not agreement terms; rather they concern the rights and obligations of the parties during the interim period between the signing of the preliminary agreement and the execution of the definitive contract. Preliminary agreements are not imperative to the negotiation process as parties can skip them entirely and begin the contractual process with due diligence and the negotiation of the definitive contract.

Although preliminary agreements were originally conclusively unenforceable, in recent history preliminary agreements, and specifically the duty to negotiate a preliminary agreement in good faith, gained traction in several jurisdictions. (4) Most recently, the subject was brought to the forefront by a seminal case, SIGA Techs, Inc v PharmAthene, Inc, (5) in which the Delaware Supreme Court not only enforced the duty to negotiate the preliminary agreement in good faith, but also awarded the heretofore uncommon remedy--expectation damages. (6) Although the enforcement of an agreement to negotiate is a relatively new development, (7) the award of expectation damages in SICA is extraordinary and controversial. (8) The appropriate measure of damages has been debated by scholars, but SIGA appears to be the first case in which the state's highest court awarded expectation damages for a breach of preliminary agreement to negotiate. (9) Indeed, while there have not been many instances of courts awarding expectation damages for breaches of preliminary agreements to negotiate, a ruling in the affirmative remains a possibility given the precedent of SIGA, Venture Associates Corp v Zenith Data Systems Corp, (10) and Network Enterprises, Inc v APBA Offshore Productions, Inc. (11)

The duty to negotiate in good faith should not be enforced in preliminary agreements because it is difficult to determine at what point this duty has been fulfilled and the parties may walk away from the deal after negotiations in good faith failed. Indeed, because many terms of the preliminary agreement have been left open, good faith negotiation will be subject to negotiation tactics and could lead to no contract at all. Moreover, an award of expectation damages for breaches of preliminary agreements to negotiate in good faith is inappropriate because it implies the existence of a contract where there is none. Parties cannot have a justifiable expectation of what a contract will be at the preliminary stage as there are many open terms and the other party may have countervailing expectations of the definitive agreement. Courts cannot place a party in as good a position as if the party acted in good faith because such an action would fill the preliminary agreement's heretofore missing terms, which are unknown to the court and even to the parties themselves. …

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