Transactions of all sizes are frequently detailed under a range of pre-contractual agreements before reaching lawyers for full documentation. These include heads of agreement, letters of offer, and memorandum of understanding style of agreements. An important step to conclude negotiations and facilitate entry into a final contract, these agreements can also be the cause of a major dispute if the transaction does not proceed or if a party wants terms not covered in the agreement. This is often to the surprise of the parties. In this article, partner Mark Lyons offers a timely reminder about thinking twice before signing on the dotted line.
As a starting principle, pre-contractual agreements are not legally binding if they are mere agreements to agree to proceed to formal contract. However, there may be an intention for these agreements to give rise to legal obligations and the courts will support enforceability where the prerequisites of a legally binding agreement are satisfied.
This issue typically arises when a transaction does not proceed to formal contract, and the extent to which the agreement is enforceable is required to be determined. Too often, there is not enough thought about whether the obligation to sign a formal contract, or some other obligation, should be enforceable. The issue becomes unclear and ripe for dispute.
It is imperative parties are clear about whether the agreement (or some part of it) is, or is not, intended to be binding. General statements about enforceability, such as 'subject to board approval' or 'subject to contract', only go so far. These are certainly not get out of jail free cards, and should be accompanied by express provisions confirming the binding (if any) and non-binding aspects of an agreement.
Provisions commonly intended to be binding include:
Pre-contractual agreements are becoming increasingly complex, moving far beyond a simple summary of key commercial terms. We are seeing a variety of onerous or unusual obligations sneak into these agreements which would not traditionally be expected of preliminary negotiations. Transactions to watch include those for hotly contested assets and financing transactions with non-bank lenders.
These obligations are usually expressed to be binding on parties, irrespective of whether formal negotiations succeed and are fully intended to be enforced. For example:
There is a risk these provisions are enforceable against an unwitting party with the result of serious financial consequences.
In property transactions, it is common for most contract negotiations to be consumed by debating the level of warranty given about the property sold and any associated leases. It is no coincidence these commercial terms are also the ones we see most regularly overlooked in pre-contractual agreements.
In our experience, contract negotiations can be significantly expedited where the parties identify the terms of sale in the pre-contractual agreements. Examples include:
Taking steps to cover these issues benefits both parties, allowing a faster and smoother transition from in-principle agreement to formal contract. This reduces the risk of a transaction falling over, as well as avoiding unnecessary time delays and legal expense negotiating documents.
Falling into dispute on these agreements can be costly and time consuming. Our lawyers are experienced in a broad range of commercial and property transactions and can review and advise on these pre-contractual agreements. We can assist you with timely and cost-effective advice on these documents before they are signed.