Achieving a binding agreement
Agreements to Agree / Heads of Agreement / terms Sheet are often used during negotiations, particularly on complex matters, to set out the initial terms between the parties and give comfort that the parties believe they can work together before expending time and money on finalising the agreement. Disputes arise because one party wants to treat the Heads of Agreement as a contract while the other does not.
In order to establish a binding agreement there must be:
- an intention to be immediately bound expressed or implied in the agreement; and
- agreement on every term legally essential to formation of the contract.
Parties can leave further matters for agreement, however, in the absence of a formula or other means of forming agreement (eg arbitration) leaving issues “open” may undermine the legally binding nature of the agreement.
The New Zealand courts have suggested that there is a natural inference that parties to commercial agreements generally intend to contract by a document that each party will be required to sign. Note that the actions or words of the parties can displace this inference.
If you want to reach a binding agreement then you should use a detailed term sheet or heads of agreement. A “letter of comfort” is less likely to be binding.
If your client wishes to form a binding agreement based on a heads of agreement or term sheet:
1. Clearly state it is the parties’ intention to be legally bound and record the terms of the agreement in writing and have it signed (this is needed for land transactions).
2. Ensure that agreement has been reached on all essential terms. This is the key point – you cannot bind the parties in the absence of agreement on the essential terms. For a share investment, for example, this would include price, number and terms of shares. However, in my opinion it would also include the terms of the shareholder agreement, if there is one. For a rural transaction, it may also include employment/sharemilking terms if the investor is an equity manager; and terms of the annual plan and farming practices.
3. In the absence of agreement, ensure that matters to be agreed are subject to determination by a mechanism, formula or objective standard and limit the matters remaining to be negotiated. A simple “agreement to negotiate in good faith” or on “best endeavours” is a process agreement – if the parties don’t agree then they may not be bound. Use the phrase “best endeavours to negotiate” rather than “reasonable endeavours” or “good faith” – best endeavours is a stronger term.
4. Contracts to negotiate will not be held in all circumstances to be unenforceable where there is sufficient certainty to the term to be enforceable. If, for example, there is a provision in an existing enforceable contract to negotiate a particular point, then this may be enforceable. If the matter is important but not essential, then it is more likely to not be fatal to the agreement. If the matter is a term essential to that type of contract, and the parties have agreed an expert determination/arbitration clause then the court is likely to find agreement, as it can have regard to industry practice, expert evidence etc.
5. Include an arbitration clause or expert determination clause.
6. Note that some contracts are required to be in writing and signed to be enforceable. For example, dispositions of land (other than a lease for less than 1 year) and guarantees (see section 24 and 27 of the PLA 2007). This is why an agreement to lease is entered into prior to the formal lease.
Avoiding premature agreement
Clearly, the safest argument that no agreement yet exists is to expressly state, in writing and at the outset, that you do not intend to be bound until formal documentation is signed by all parties. The key initial requirement for a binding contract is to find that there was an immediate intention to be bound.
Practical mechanisms to reduce the risk of finding a binding agreement is in place before your client intends include:
1. Expressly state the agreement is “subject to contract” and not intended to form a binding agreement and that this is subject only to written agreement to the contrary.
2 State that agreements are “Draft”.
3. Avoid using phrases in communication that suggest the parties are in agreement or “almost there”, or any other form of representation.
4. Make clear that a stated position is a “condition” to contracting or is “essential”. The absence of agreement on “essential terms” reduces the risk that agreement has been reached.
5. Ensure funds are not advanced and/or the contract not performed until a contract has been signed.
The New Zealand courts have suggested that there is a natural inference that parties to commercial agreements generally intend to contract by a document that each party will be required to sign. The actions or words of the parties can displace this inference.
Parties’ negotiating an agreement must also be conscious of their obligations to not engage in misleading and deceptive behaviour in trade.
The law of estoppel may also apply. A person who leads the other party to believe that the contract is going ahead, before the formalities are complete, risks being estopped from denying the existence of a binding agreement in the circumstances where there is in fact no binding agreement. This requires detrimental reliance by the other party or some kind of material commitment made on the basis of the statement, representation or assumption.
Avoid feel good or soft obligations in negotiations – they are ambiguous and should be avoided or used with care. They do have a place in the contract itself (such as using reasonable or best endeavours where the parties will not agree to an absolute obligation) but should be used with care.
Process agreements do not mean that substantive agreement will (or must) be reached. Agreeing to negotiate (good faith / best endeavours) is a contract to try to agree. Breach lies in failure to try, not in failing to agree.
A sensible starting point to any argument on whether agreement has been reached can be found in the reasoning of the House of Lords in Walford v Miles [1992] 2 AC 128 (endorsed by the New Zealand Court of Appeal in Wellington City Council v Body Corporate 51702 [2002] 3 NZLR 486 [2002] 3 NZLR 486):
“Each party to the negotiations is entitled to pursue his (or her) own interest, so long as he avoids making misrepresentations. To advance that interest he must be entitled, if he thinks it appropriate, to threaten to withdraw from the further negotiations or to withdraw in fact, in the hope that the opposite party may seek to reopen negotiations by offering him improved terms … In my judgement, while negotiations are in existence either party is entitled to withdraw from those negotiations, at any time and for any reason. There can thus be no obligation to continue to negotiate until there is a proper reason to withdraw.”
