Print versionNegotiations often reach a stage where one or more parties want what they have agreed to in principle in writing, though negotiations are incomplete. A party usually puts forward a document under various names such as a "letter of intent", "memorandum of understanding", "agreement in principle" or "heads of agreement". There may be some deadline driving the request so that a party is unable to wait for concluded negotiations.
Where all parties need the letter of intent so as to achieve a mutual obligation such as a time line, then a letter of intent is unlikely to cause validity of or contract enforcement problems. Where all parties do not require the "written understanding" the party requesting the letter of intent may want and intend a binding contract eg to ensure it will be paid for services to be supplied or to cover itself via third parties while the other party may not want a binding contract until all negotiations are complete.
The general legal rule is that terms whereby the parties agree to agree or agree to negotiate, even with the additional requirement of in good faith, are unenforceable due to:-
(i) lack of certainty of terms as to what the parties mean and intend; and
(ii) the parties being obligated to agree or negotiate which has been said by courts to restrict their fundamental freedom to contract. .
Despite the general rule some comments in a recent New South Wales case Coal Cliff Collieries Pty Ltd ?v- Sijehama Pty Ltd (1991)24 NSWLR 1 may suggest otherwise as two of the three judges considered that a binding agreement to negotiate was possible in some circumstances although in this case all three judges agreed the heads of agreement was not a binding agreement to negotiate. The determining factor was that there was no mechanism such as arbitration to decide the issues the parties anticipated as unresolved.
The joint venture preamble stated ?this document will serve to record the terms and conditions subject to and upon which the parties agree to associate themselves as a joint venture for the purpose of developing and exploiting a coal prospect. The parties will forthwith proceed in good faith to consult together upon the formulation of a more comprehensive and detailed joint venture agreement and any associated agreement which when approved and executed will take the place of these heads of agreement but the consultation and negotiation of the additional terms by the parties shall not in the meantime in any way prejudice the full and binding effect of what is now agreed?.
It appears that in Australia the courts have departed from the position in the United Kingdom. In Coal Cliff Collier ?v- Sijehama the validity of an agreement to negotiate in good faith was considered Kirby P noted that a promise to negotiate in good faith might be enforceable when he said obiter:-
"I do not share the opinion of the English Court of Appeal that no promise to negotiate would ever be enforced by a Court. I agree with Lord Wright's speech in Hillas that provided there was consideration for the promise in some circumstances a promise to negotiate in good faith will be enforceable depending
on its terms".
One party claimed that a party's intention to walk away from all the other negotiated points agreed in the heads of agreement by scrapping the existing joint venture agreement represented a breach of the heads of agreement which required the parties negotiate in good faith.
An agreement to negotiate was considered in Hillas & Co ?v- Arcos Ltd (1932) All ER 494. The court viewed the agreement as in strict theory a contract if there is good consideration even though the negotiations may be fruitless and end without any contract ensuing.
Despite Lord Wright's view in the Hillas? case English cases follow a stricter approach re the illegality of heads of agreement fettering or extinguishing a parties freedom to contract through a term in a preliminary heads of agreement that states the parties will negotiate an agreement in good faith. The United Kingdom position is that its courts are more ready to apply common law precedent of freedom to contract with the consequence that the parties must be free to negotiate their deal without the risk of any liability if one of them decides to withdraw from the negotiations. In the case of Courtney & Fariborn a duty to carry on negotiations in good faith was considered repugnant to the adversarial position of the parties when involved in negotiations as the parties should be able to threaten to withdraw from the negotiations to improve their position. The restriction on the right or freedom to withdraw was held to contradict the principle of freedom to act in good faith
In Australia Brennan J said Walton Stores (Interstate) Ltd ?v- Maher 62 ALJR 110 that the freedom to withdraw from negotiations may be fettered or extinguished by mutual consent of the parties under a binding agreement. The decisions of the courts of Australia have given recognition to one aspect of an agreement to negotiate in good faith , that the freedom to withdraw from the negotiations might be fettered or extinguished Waltons Stores ?v- Maher 1988. The difference between an agreement to agree and an agreement to negotiate is the latter purports to impose upon the parties a duty to negotiate but not necessarily to agree.
An agreement to negotiate is meaningless if the parties have no intention to negotiate in good faith see Walford ?v- Miles (1992)2AC128The agreement to negotiate in good faith in contemporary contracting probably represents the intention of the parties to preserve their negotiating position in commercial business relationships and to agree on what prospective terms shall be included in a contract if and when such a contract eventuate however the added words may lead to greater uncertainty. The issue of the uncertainty of the agreement to negotiate in good faith is caused by what the contracting parties may mean by the term. Courts will not enforce terms that are uncertain.
An agreement to negotiate with the imposition of the words good faith has been said to reflect the modern assumptions of commercial parties Blackpool & Fylde Aero Club Ltd ?v- Blackpool Borough Council 1990 1 WLR 1195 1201 so that a duty of good faith may give business efficacy to agreements to negotiate. The nature of the modern duty to negotiate in good faith may be ascertained by looking at the usual practice of ordinary mean dealing with each other in similar transactions R Powell Good Faith in Contracts 1956 9 CLP 16,18. It is the norm to which members of an identifiable group in the community generally adhere. Having regard to the above the modern duty of good faith concerns a contractual relationship at arm's length between ready willing and able parties. It deals with contractual relationships of a commercial nature with no obligation on the parties to subordinate their respective interests provided they act fairly and honestly. The idea of fairness is therefore concerned with achieving procedural fairness without interfering in the substance of the deal.
In Con Kallergis ?v- Calshoie Pty Ltd it was a duty for negotiations to be conducted in good faith or honestly and reasonably. The court viewed such an agreement to be uncertain because the parties were not obliged to resolve any dispute by arbitration or other form of dispute resolution.
In Australia Media Holdings v- Telstra Corp (1998) 43 NSWLR 104 the court followed the approach of Kirby J in the coal Cliff's case to find unenforceable an obligation to act in good faith in negotiating a new sporting joint venture. This case dealt with complex business relationships between large organisations involved in the transmission of pay television services. In considering the validity of the duty to act in good faith the court applied the certainty test to find such a duty unenforceable. The duty was found uncertain because there was no provision for the resolution of any outstanding matters or uncertain matters.
The practical effect of the Coal Collieries and the above cases based on the Australian approach is that the parties should state clearly as to what their intentions are when they have not reached final agreement and where parties want a preliminary heads of agreement to agree that is binding they must agree to an enforceable procedure eg negotiate for 2 months after which a facilitator could be appoint to see if they could achieve final agreement or not.
On the other hand a letter of intent or memorandum of understanding whilst failing to be enforceable in the context of the terms requiring negotiations in good faith, can actually be construed as a valid and binding contract for preliminary work on the basis of other terms that are enforceable. To avoid doubt about whether parties are contractually bound any letter of intent should include a clause along the following lines
Except for clauses ? nothing in this agreement is intended to or does create a legally binding agreement between the parties.
Or alternatively:-
Except for clauses this agreement is intended to and does create a legally binding agreement between the parties.
The best minimal risk exposure course is to resist commencing anything where legal liability may arise until a contract is in place. At the start of what are to be lengthy negotiations it is good to deal with the issue of what happens if negotiations fail as the general rule is that if negotiations break down the loss lies where it falls there are exceptions based on unconscionable misleading and deceptive conduct promissory estoppel meaning a person has relied on a non contractual promise in circumstances where it would be inequitable to allow the promisor to renege.
For example the Heads of Agreement may state that:-
Each party acknowledges that if negotiations do not result in a contract signed by each of them it is not entitled to any compensation from any other party for any reason connected with the negotiations or their termination except compensation for any claim that by law may not be excluded and
If a party wishes to be paid for any goods or services supplied to another party before a contract is signed by each party it must obtain that party?s written consent to that supply and payment.
Parties need to create a checklist of issues at the pre-contract stage which forms the basis for a project protocol and milestone summary as the parties progress in the negotiations towards the final agreement. Such a checklist is in effect a memorandum of the understanding of the parties. For example in the Coal Cliff Collieries Pty Ltd ?v- Sijehama case there were many heads of agreements documents exchanged during negotiations until one was signed.
The 19 pages of heads of agreements contemplated a final joint venture agreement and other agreements yet to be signed. One point was left open regarding a nett profit formula and one party purported to scrap the entire 19 page heads of agreement on this one outstanding point. Negotiations had been continuing from 1976 - 1985.
However the court decided that in essence the parties had only reached an agreement to agree stage and the party therefore had no contractual obligation to continue to negotiate.
References:-
TRH Cole, 'Law ? All in Good Faith' [1994] BCL 18
Sir A Mason 'Contract & Its Relationship with Equitable Standard and the Doctrine of Good Faith' The Cambridge Lectures 1993
P Griard, 'Good Faith In Contract: Principle or Placebo ?' 1983 5 NSW Supreme Court Law Review 309
H D Hunter, 'The Duty of Good Faith and Security of Performance' 1993 6 JCL 19 Hibbet & Maloney, 'Good Faith in Commercial and Construction Contracts' 1993 9 BCL 183
R Harrison, 'Good Faith in Sales' London Sweet & Maxwell 1997
HK Lucke, 'Good Faith & Contractual Performance' in P D Finn ed Essays on Contract Sydney The Law Book Company 1987 160
Sean Mullen © The University of Queensland
