Article by Robert R. Carlson and Dalen Copeland
Is a preliminary agreement, such as a letter of intent, term sheet, or memorandum of understanding, binding on the parties to it? If so, to what extent? A recent Court of Appeals decision in California held that a letter of intent may constitute a binding contract to negotiate the terms of a future agreement in good faith. In Copeland v. Baskin Robbins, 96 Cal. App. 4th 1251, 1257 (2002), the court held that a contract to negotiate the terms of a future agreement is enforceable against the parties to that contract, as distinguished from an unenforceable "agreement to agree."
Generally, where any of the essential elements of a contract are reserved for future agreement, no legal obligation arises until the future agreement is reached. The court found, however, that an agreement to negotiate the terms of a future agreement does in fact create a legal obligation and may be breached by a party refusing to negotiate or by a party negotiating in bad faith.
Although Copeland is a California case, its ramifications may be widespread. First, the case may be followed in other jurisdictions. Second, even where the parties to a letter of intent have selected a different choice of law, if one of the parties is a resident of, or domiciled in, California, then that party may seek to have California law apply to that agreement. Therefore, the meaning of the Copeland case is worth considering when involved in preliminary negotiations anywhere in the country.
Background of Case
In Copeland, the plaintiff, Kevin A. Copeland, and the defendant, Baskin Robbins, entered into negotiations for Copeland to purchase an ice cream manufacturing plant that Baskin Robbins planned to close. Copeland made it clear at the outset of negotiations, and Baskin Robbins acknowledged, that the agreement to purchase the plant was contingent on Baskin Robbins agreeing to a co-packing agreement, where Baskin Robbins would purchase seven million gallons of ice cream produced from the plant in the first three years after Copeland took ownership. Baskin Robbins then sent Copeland a letter summarizing some of the proposed terms for the purchase of the plant and made mention of the separate negotiation for the co-packing agreement. The letter requested that Copeland sign the letter and make a deposit to Baskin Robbins if he agreed to the proposed terms. Copeland signed the letter and gave a three thousand dollar deposit. The parties then continued to negotiate. Two months later, Baskin Robbins, citing "strategic decisions", broke off negotiations. The court, basing its opinion on the language of the letter, held that the letter created an agreement to negotiate the remaining terms of the co-packing agreement.
Breach of Contract to Negotiate
A contract to negotiate may be fulfilled by good faith efforts by both parties to reach an agreement, even if they ultimately fail to agree. A party will be liable for breach only if the ultimate failure to agree results from that party’s refusal to negotiate or the party’s bad faith negotiations. The question of whether a party refused to negotiate or negotiated in bad faith is a question of fact for the jury.
Remedies for Breach of Contract to Negotiate
The court held that the appropriate remedy for the breach of a contract to negotiate is damages based upon the injured party’s reliance on the agreement to negotiate. Part of the reason the court would allow a plaintiff to recover under a theory of breach of contract to negotiate was that other remedies, such as unjust enrichment or promissory estoppel, were not adequate to remedy the injured party’s investment of time, money and effort which has been wasted by the other party’s improper ending of negotiations or negotiating in bad faith.
Conclusions
After the Copeland case, parties involved in preliminary negotiations must be extremely cautious in drafting documents that set forth general terms to be negotiated in the future. Any document expressing a preliminary agreement between the parties should be clearly and carefully drafted to negate any duty of either party to negotiate future terms. With this in mind, the following are sample provisions to consider including in a letter of intent:
This document (letter of intent, term sheet, memoranda of understanding) is non-binding and intended solely as a summary of the terms currently proposed by the parties. It is to be used for discussion purposes only.
The parties acknowledge that neither of them intends to enter or has entered into any agreement to negotiate a definitive future agreement pursuant to the terms of this document. Both parties agree that the terms mentioned here impose no burden to negotiate further terms, until a definitive future agreement has been drafted, discussed and executed. Either party may, at any time prior to execution of a definitive agreement, propose different terms from those summarized here. Either party may also unilaterally terminate all negotiations. In either instance, such party shall have no liability of any kind to the other party.
Each party is solely responsible for all of its own fees, costs, and other expenses in conjunction with the negotiation and preparation of a final agreement pursuant to this document.
By including provisions such as these in a letter of intent, the parties demonstrate their mutual intent to negate any duty created under Copeland to negotiate or enter into a definitive future agreement.
Client Alert is published solely for informational purposes and should in no way be relied upon or construed as legal advice. For specific information on recent developments or particular factual situations, the opinion of legal counsel should be sought. Paul, Hastings, Janofsky & Walker LLP is a limited liability partnership.
© 2003 Paul, Hastings, Janofsky & Walker LLP.