Term sheets, letters of intent and other preliminary documents can be useful for parties in complex negotiations, allowing them to handle the major issues of the deal first and worry about the details later. Agreements that say the parties will negotiate a future agreement in good faith can be enforceable. But how to do you ensure that your agreement will be enforced and that you will have recourse if the other side doesn’t live up to its end of the deal? The answer, like many areas of the law, lies in careful drafting and precision. Several states, including California and New York, have long enforced agreements to negotiate in good faith. In 2013, in Siga Technologies Inc v. PharmAthene Inc., the Delaware Supreme Court affirmed that an express agreement between parties to negotiate in good faith is enforceable in that state as well. It also ruled that a breach of such an agreement in Delaware can, in some circumstances, entitle the non-breaching party to damages equal to what it would have received had the underlying agreement been fully performed. California and other states have typically limited damages to things like legal and advisory fees.
There are exceptions, as states like Virginia and Texas, for example, have refused to enforce agreements to negotiate at all. But assuming you are in a jurisdiction where these types of agreements can be enforced, it is important to make sure the language is precise in order to ensure it will hold up in court.
Case-in-point: Schwanbeck v. Federal-Mogul. In that case, a man named Schwanbeck was negotiating with Federal-Mogul to to buy a division of the company. As part of the discussions they entered to a letter of intent, which stated, in part: “This letter of intent is not intended to create, nor do you or we presently have any binding legal obligation whatever in any way relating to such sale and purchase…” In the next paragraph, it said: “However it is our intention, and we understand, your intention immediately to proceed in good faith in the negotiation of such binding definitive agreement.”
After the deal fell apart, Schwanbeck sued Federal-Mogul in Massachusetts state court. He alleged, among other things, that the company had breached its obligation to negotiate in good faith. The trial judge and the Appeals Court concluded that Schwanbeck and Federal-Mogul made a contractual obligation to negotiate in good faith, though they disagreed on whether Federal-Mogul lived up to its obligations (The trial court said no, the Appeals Court said it had).
But the Supreme Judicial Court took a different view of the case. It found the two sides had not actually committed themselves contractually to an obligation to negotiate. The court said the letter of intent clearly stated certain contractual commitments to which the two sides were binding themselves. And just as clearly, the two sides followed those commitments with an expression of their intent to proceed to negotiate in good faith, the court said.
“That this expression of intent follows the parties’ disclaimer of binding effect and begins with the word ‘however’ does not elevate its status from a mere expression of intent into a binding obligation,” the court wrote.
The bottom line is that if you want to create a binding obligation to negotiate, it is important to understand the laws of different jurisdictions. Be sure to choose a state governing law that permits such agreements (i.e., California, Delaware, New York). In addition, pay careful attention to the details. As the Federal-Mogul demonstrates, it is important to make sure the agreement is clearly stated as a binding contractual commitment, rather than simply an expression an intention to proceed to negotiate in good faith.