Transactional counsel involved in mergers, acquisitions, and asset sales are aware that "no binding effect" language in a letter of intent ("LOI") does not have the "talismanic" effect of preventing the LOI from obligating the parties in any way. The issue examined in this article is the extent of the protection, and conversely the extent of the exposure, where such a provision is included in an LOI, especially where the provision is juxtaposed with an express requirement that further negotiations between the parties be conducted in good faith. The good faith negotiation clause may be sought by counsel for the purchaser/acquirer to provide sufficient confidence to expend the resources required to complete due diligence, negotiate documents, locate financing, and otherwise pursue the deal.
"No Binding Effect" Provision Enforced Absent Express Duty to Negotiate
At the threshold, the law is well-established that where an LOI expressly states that the parties thereto will not be bound to complete the transaction by the terms of a preliminary agreement and the agreement contains no express duty to negotiate, the parties will not be bound by terms of the agreement.1
"Good Faith Negotiation" Provision Must Also Be Given Effect
However, despite the frequency of LOI litigation, certain significant issues await further development by the Courts. Where the LOI contains unequivocal language requiring further negotiations in good faith, and especially if the LOI requires that such negotiations be consistent with material terms set out in the LOI, the issue becomes more complicated. Such "good faith negotiation" and "consistent with material terms" provisions would be rendered essentially meaningless were the "neither party is bound" provision given full literal effect. No principle of contact interpretation is better established than the rule that "a court should not adopt an interpretation which will operate to leave a provision of a contract without force and effect" and that "[a]n interpretation that gives effect to all the terms of an agreement is preferable to one that ignores terms or accords them an unreasonable interpretation."2 Thus, somehow, all of the LOI provisions must be given meaning. The New York Court of Appeals has held that such intent should be ascertained by considering "the entirety of the agreement" rather than "merely culling distinct provisions out of an entire agreement."3 It may be argued that where a party to an LOI makes nonnegotiable demands inconsistent with material terms that were specified in the LOI, the requirement of good faith negotiation may give rise to a claim. However, the LOI’s "neither party is bound" provision precludes any argument that a final deal must be reached.
Although there is no published case law on the precise issue in a New York court, other courts faced with a juxtaposed "good faith negotiation clause" and a "no intent to be bound clause" in an LOI have concluded that the obligation to negotiate in good faith is enforceable. The Seventh Circuit in the 1993 "Venture Associates I" case (Posner, J.) reversed the dismissal of a claim asserting breach of a letter of intent which contained an express good faith negotiation provision and also stated that "this is merely a letter of intent subject to the execution by Seller and Buyer of a definitive Purchase Agreement" and "does not constitute a binding obligation on either of us."4 Similarly, in another federal case, the District of Massachusetts denied a motion to dismiss a claim based on a letter of intent which stated that "[i]t is understood that this is simply a letter of intent and while we have agreed in principal [sic] as stated above and agree to proceed in good faith to work out the details of formation. . . . neither of us shall have any obligation to the other as a result of this letter as the creation of our venture is subject to the execution of formal agreements."5
Agreements to Agree Not Enforceable
Depending upon the facts in a given case, the good faith negotiation clause and the "no binding effect" clause may be reconciled as reflecting the parties’ intent and desire to obligate each other to in good faith negotiate non-material terms that are consistent with those agreed upon in the LOI, but not to be bound if they fail to reach ultimate agreement after negotiating in good faith. Under that interpretation, the "no binding effect" clause establishes that the LOI is not to be binding in the event of a subsequent failure to agree on non-material terms after negotiating in good faith.
Agreements to Agree Are Not Enforceable
An additional hurdle to the disappointed suitor who seeks enforcement of a "good faith negotiation" LOI is that the LOI may be unenforceable if it lacks clear guidelines against which to measure the parties’ efforts to negotiate in good faith. Of course, the LOI must be "reasonably certain in its material terms" to be enforceable.6 The courts may refuse to imply material terms without clear guidelines.7 However, to avoid defeating the expectations of the parties, "[s]triking down a contract as indefinite and in essence meaningless is at best a last resort."8 An express list of material terms set out in the LOI may satisfy the requirement of definiteness. Such terms in the LOI set up the claim that the counter-party’s subsequent demand for inconsistent terms is in breach of objective agreed guidelines. The LOI should to the extent possible identify the parties, specify the property to be conveyed, and identify the price and the terms of payment.9
For example, the First Department has held that a letter agreement to enter into a lease of real property "cannot be condemned as an agreement to agree simply because it does not contain most of the terms usually found in a formal lease."10 A different result was reached by the Court of Appeals where a lease renewal clause was held unenforceable because it stated only that the renewal rent would be an amount "to be agreed upon," without guidance of any sort as to how to fix the rent.11
Specific Performance or Benefit of the Bargain Damages May Be Available
The Seventh Circuit has held that where a party has acted in bad faith, the remedy for breach of an agreement to negotiate in good faith may be the same as for breach of the definitive agreement then under negotiation ("Venture Assocs. II").12 In Venture Assocs. II, the Seventh Circuit (Posner, J.) set forth a rationale for awarding full contract damages in the context of a claim for failure to negotiate the sale of a business in good faith. The Court held that:
Damages for breach of an agreement to negotiate may be, although they are unlikely to be, the same as the damages for breach of the final contract that the parties would have signed had it not been for the defendant’s bad faith. If, quite apart from any bad faith, the negotiations would have broken down, the party led on by the other party’s bad faith to persist in futile negotiations can recover only his reliance damages -- the expenses he incurred by being misled, in violation of the parties’ agreement to negotiate in good faith, into continuing to negotiate futilely. But if the plaintiff can prove that had it not been for the defendant’s bad faith the parties would have made a final contract, then the loss of the benefit of the contract is a consequence of the defendant’s bad faith, and, provided that it is a foreseeable consequence, the defendant is liable for that loss -- liable, that is, for the plaintiff’s consequential damages. [citation omitted]. The difficulty which may well be insuperable, is that since by hypothesis the parties had not agreed on any of the terms of their contract, it may be impossible to determine what those terms would have been and hence what profit the victim of bad faith would have had. [citation omitted]. But this goes to the practicality of the remedy, not the principle of it. Bad faith is deliberate misconduct, whereas many breaches of "final" contracts are involuntary -- liability for breach of contract being, in general, strict liability. It would be a paradox to place a lower ceiling on damages for bad faith than on damages for a perfectly innocent breach, though a paradox that the practicalities of proof may require the courts in many or even all cases to accept.13
A leading treatise is in accord: "[a] preliminary agreement makes dissatisfaction with closed terms unavailable as a reason for refusing to reach agreement on open terms. Such a refusal is bad faith."14 The question is whether it is practical and appropriate to allow expectation damages based on the potential, but unrealized, final contract. "The key is whether the court can determine what the economic benefit of the final contract would have been to the injured party."15
Thus, far from having a talismanic effect, "no binding effect" language in an LOI may not preclude a claim. The evaluation of such a claim (and thus the critical elements of LOI negotiation) are (i) the definiteness of the terms expressly stated in the LOI; (ii) the inclusion of a "good faith negotiation" requirement; and (iii) the inclusion of a provision requiring negotiation consistent with the material terms of the LOI. Even where the LOI expressly has "no binding effect," specific performance or expectation damages may be available to a jilted purchaser where a definitive purchase agreement would have been agreed but for the bad faith of the seller.
Endnotes:
1
See Scheck v. Francis, 26 N.Y.2d 466, 311 N.Y.S.2d 841 (1970) (no suggestion of a good faith obligation to negotiate an employment agreement); Prestige Foods, Inc. v. Whale Sec. Co., L.P., 243 A.D.2d 281, 281-82, 663 N.Y.S.2d 14, 15 (1st Dep’t 1997) (no express agreement to negotiate in good faith); Trade & Indus. Corp. (USA) v. Euro Brokers Inv. Corp., 222 A.D.2d 364, 368, 635 N.Y.S.2d 227, 230 (1st Dep’t 1995) (agreement specifically refuted any good faith obligation by reserving to each party the absolute right not to proceed); BMH Realty Ltd. v. 399 E. 72nd St. Owners, Inc., 221 A.D.2d 165, 633 N.Y.S.2d 141 (1st Dep’t 1995) (no express agreement to negotiate in good faith); Brause v. Goldman, 10 A.D.2d 328, 199 N.Y.S.2d 606 (1st Dep’t 1960) (involving claims for specific performance of preliminary memorandum for a lease; no suggestion of a good faith obligation to negotiate), aff’d, 9 N.Y.2d 620, 210 N.Y.S.2d 225 (1961); Adjustrite Sys., Inc. v. GAB Bus. Serv., Inc., 145 F.3d 543 (2d Cir. 1998) (the agreement at issue contained no express good faith language).2Ruttenberg v. Davidge Data Sys. Corp., 215 A.D.2d 191, 196, 626 N.Y.S.2d 174, 177 (1st Dep’t 1995) (quotations omitted). See also 67 Wall St. Co. v. Franklin Nat’l Bank, 37 N.Y.2d 245, 248, 371 N.Y.S.2d 915, 918 (1975) ("words are never to be construed as meaningless if they can be made significant by any reasonable construction").
3In re Riconda, 90 N.Y.2d 733, 738, 665 N.Y.S.2d 392, 396 (1997).
4Venture Assocs. Corp. v. Zenith Data Sys. Corp., 987 F.2d 429, 431 (7th Cir. 1993) (brackets in original, quotations omitted).
5Fickes v. Sun Expert, Inc., 762 F. Supp. 998, 1000 (D. Mass. 1991).
6Cobble Hill Nursing Home, Inc. v. Henry and Warren Corp., 74 N.Y.2d 475, 482, 548 N.Y.S.2d 920, 923 (1989), cert. denied, 498 U.S. 816 (1990).
7See, e.g., McGee & Gelman v. Park View Equities, Inc., 187 A.D.2d 1012, 591 N.Y.S.2d 656 (4th Dep’t 1992). See also Bernstein v. Felske, 143 A.D.2d 863, 533 N.Y.S.2d 538 (2d Dep’t 1988) (several material terms not agreed to); Mocca Lounge, Inc. v. Misak, 94 A.D.2d 761, 762, 462 N.Y.S.2d 704, 706 (2d Dep’t 1983) (clear that the parties "never reached an agreement as to the material terms" that the defendant would be obligated to accept); Candid Prods., Inc. v. Int’l Skating Union, 530 F. Supp. 1330, 1331 (S.D.N.Y. 1982) (bald agreement to negotiate in good faith, which did not specify any of material terms of the ultimate agreement, was unenforceable).
8166 Mamaroneck Ave. Corp. v. 151 East Post Road Corp., 78 N.Y.2d 88, 91, 571 N.Y.S.2d 686, 688
9Mattikow v. United Jersey Mortgage Co., 104 A.D.2d 973, 481 N.Y.S.2d 1 (2d Dep’t 1984), appeal denied, 64 N.Y.2d 605, 486 N.Y.S.2d 1025 (1985); Birnhak v. Vaccaro, 47 A.D.2d 915, 916, 367 N.Y.S.2d 792, 794-95 (2d Dep’t 1975).
10Four Seasons Hotels, Ltd. v. Vinnik, 515 N.Y.S.2d 1, 9, 127 A.D.2d 310, 321, (1st Dep’t 1987).
11Joseph Martin, Jr., Delicatessen, Inc. v. Schumacher, 52 N.Y.2d 105, 108, 436 N.Y.S.2d 247, 248 (1981).
12Venture Assocs. Corp. v. Zenith Data Systems Corp., 96 F.3d 275 (7th Cir. 1996).
1396 F.3d at 278-79. In Venture Assocs. II the Court affirmed the district court’s finding of good faith breach because the terms demanded by the seller that scuttled the deal, including a higher price, were not inconsistent with the preliminary agreement. 96 F.3d at 279 ("A preliminary agreement might contain closed terms (terms as to which a final agreement had been reached) as well as open terms, and thus be preliminary solely by virtue of having some open terms. [citation omitted]. The parties would be bound by the closed terms. There were no such terms here.")
14Burton & Andersen, supra, § 8.5.2 at 369.
15Steven J. Burton & Eric G. Andersen, Contractual Good Faith § 8.4.2, at 364-65 (1995).
The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.
