Precontractual Agreements

This article has been written by guest author Hector D. Marin.

Precontractual Agreements are used very often in business transactions. But from the case law that has been analyzed it is clearly inferred there is a great uncertainty about their effects. However some clear concepts of Precontractual Agreements with certain effects based on the following conclusions:

1.- There are different types of Precontractual Agreements.
The case law and the commentators clear indicate that the Precontractual Agreements are used for different purposes. The content of the Precontractual Agreement and the intent of the parties are different depending on the use of the Precontractual Agreement.

2.- The Letters of Intent or Agreements to Negotiate are binding and enforceable contracts that are used to set forth the conditions of the negotiation, clarifying the process of the bargaining and the obligations and the liabilities that the parties assume or may incur during the negotiation.

The Agreements to Negotiate are used to clarify the framework of the negotiation. Its principal aim is provide certainty to the parties about the negotiation process. The Agreement to Negotiate also contemplates a prospective contract: the one that it is going to be negotiated. But the intent of the parties is not to be bound by that prospective contract. However, the parties want to be bound during the negotiation process in order to have certainty about what can be lawfully done during the bargaining. In this vein, the parties regulate the negotiation process establishing the milestones, authorized representatives, investment sequence and so forth. This content is consistent with the intent to be bound.

The case law has recognized that an Agreement to Negotiate can be an independent binding contract. This case law has also clarified that the scope of these Agreements to Negotiate are different from the prospective contract. Therefore, the main effect of the Agreements to Negotiate is that the parties have to comply with what they undertook. The most common obligation that the parties undertake is to negotiate in good faith. Courts usually consider that its consideration is the no shop obligation. According to some case law, this duty limits the discretion of the party to break off the negotiation in three ways: i) parties have to comply with previous agreements upon the terms of the final contract, ii) parties are not allowed to try to scuttle the deal, iii) parties are not permitted to try to take advantage of the cost sunk by the other party in the negotiation process. It should be noted that this obligation does not entail an obligation to enter into a final unprofitable contract. It also should be taken into account that there are other obligations such as the confidentiality obligation that can be enforced.

The breach of these obligations may entitle the parties to obtain reliance damages. But as it has been explained that courts generally do not award damages for the high burden of proof. Expectation damages can be awarded in the rare case that the parties can prove that they would have entered into the final contract absent the breach of that obligation.

3.- The Agreements to Agree are Precontractual Agreements which contemplate the execution of a prospective contract, usually establishing the conditions under which that prospective contract will be executed. Their effect should be consistent with the intent of the parties. Normally that effect is not to be bound by the prospective contract unless those conditions precedent that are set forth in the Agreement to Agree are satisfied.

Generally the intent of the parties is not to be bound as if the prospective contract would have been executed. What they ordinarily do is to establish conditions precedent for executing the prospective contract. Consequently, even if the Agreement to Agree contains all the essential terms, it should not bind the parties unless those conditions are met.

4.- The Memoranda of Understanding are written memorials which record the partial agreements that parties have agreed upon. Their main effect is that during the negotiations the parties cannot insist on terms that are inconsistent or unreasonable with the partial agreements of the Memorandum of Understanding.

The complexity and the length of the negotiations require the parties to agree on certain and partial aspects of the prospective contract. Those partial agreements are intended to be binding to some extent. But that intent is conditioned at least to the execution of the prospective agreement. They are bound to not renegotiate again the aspects covered by those partial agreements. Accordingly, the case law that has dealt with this type of Precontractual Agreement generally finds that Memoranda of Understanding are not binding except for the obligation to negotiate in good faith, which includes the obligation not to renegotiate the partial agreements which the parties have entered into.

5.- The Authorizations to Proceed are Precontractual Agreements which contain the instruction to commence the performance of a prospective contract under certain basic conditions. Consequently, Authorizations to Proceed bind the parties to accomplish the performance and to pay for it under the terms that have been agreed.

In the Authorization to Proceed one party instructs the other to start the performance. The other party agrees to start. Ordinarily the basic terms of that performance are determined such as the price, the time and so forth. But the Authorization to Proceed does not contain all the essential terms of the prospective contract, and therefore it cannot supersede it or be considered as such.

In this vein, the case law that has adjudicated disputes which involve Authorizations to Proceed finds that the prospective contract has not been entered into. But courts usually award damages to the party who has done the performance. Those damages should be measured in accordance with the terms of the Authorization to Proceed. In the event that it is not possible to determine the damages using those terms, the criterion of the UCC or the custom of the industry should be used. When there is no request to commence the performance, the doctrine of restitution can be applied. In that case, the recovery should be calculated in accordance with the benefit of the party who accepted the performance.

6.- The effects of the Precontractual Agreements have to be determined on a case-by-case basis. The effects of the Precontractual Agreements can be claimed under different legal doctrines such as promissory estoppel, restitution or culpa in contrahendo. Ordinarily all of them may entitle the non-breaching party to reliance damages instead of expectation damages. Some of the factors that are considered to award damages are the intent of the parties, the language of the Precontractual Agreement, the conduct of the parties, their sophistication, the kind of transaction that is contemplated and its applicable custom, the sums of money that are involved or whether the parties incur in negotiation and transaction costs simultaneously. But in practice courts generally do not award any damages. One of the main reasons for not awarding damages is that it has to be proven the intent of the parties to be bound and the damages that are sought. And this is a very high burden of proof.