Is our preliminary agreement binding?

17 February 2009 Topics: Litigation and dispute resolution

In the current economic environment there has been an increase in legal disputes where one party seeks to avoid being bound under a preliminary agreement and the other party seeks to enforce the preliminary agreement as a binding agreement.

It has become increasingly important for parties that are entering into commercial negotiations to make certain that any letter of intent, heads of agreement or memorandum of understanding clearly and unambiguously states whether the parties intend to be legally bound to the transaction immediately, or whether they wish to reserve their right to withdraw from the transaction later on and continue to negotiate before formal documentation is prepared and signed.

It is also equally important for parties entering into preliminary agreements to ensure that these agreements include all of the important terms of their bargain, as should they fail to do so, their agreement could be held to be void for uncertainty.

Generally, there are four requirements that a party will usually need to establish before an enforceable preliminary agreement will be found to exist by the courts. These requirements are:

  1. The parties have intended that their agreement have legal effect;
  2. The parties have reached agreement on all of the important terms of the transaction and these terms are sufficiently certain;
  3. Any condition precedents to the agreement have been satisfied; and
  4. The agreement is in the proper form.

It is not always an easy task to determine whether the parties are bound by a preliminary agreement despite the documents being signed, and there being an exchange of correspondence and negotiations being concluded.

Many disputes regarding preliminary agreements have been argued in the courts and it is clear from these cases that whilst the court will often have regard to material outside the agreement such as oral communications, the correspondence that has passed between the parties and the negotiations, there are no general rules for determining whether a letter of intent, heads of agreement or memorandum of understanding is binding and enforceable on the parties.  Each case is determined on its own facts.

Careful drafting is vital to reduce the risk that a court will find a preliminary agreement is not binding when the parties intended to be bound, or alternatively, finding that the party is bound to an agreement in circumstances where it did not think it was bound.

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This publication is for information only and is not legal advice. You should obtain advice that is specific to your circumstances and not rely on this publication as legal advice. If there are any issues you would like us to advise you on arising from this publication, please let us know.