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In an article by Greg Erwin titled “Letters of Intent: Be Careful You Don’t Get More Than You Bargained For” that appeared in The Legal on Monday, April 5, the author emphasized the pitfalls in using letters of intent as preliminary documents in real estate deals. He pointed out that in some states there is no implied obligation to negotiate in good faith to reach a legally binding agreement and that parties who intend to have that kind of obligation must expressly state it.

The article did not attempt to cover Pennsylvania law on this issue, so this column will summarize some of the leading Pennsylvania cases on implied obligations to negotiate. While the law is not completely clear, it now appears that the Pennsylvania courts are unlikely to imply a duty to negotiate in good faith unless the letter of intent specifically provides for some duty to negotiate the contract.

Channel Home Centers Case

Years ago I was on the wrong side of a leasing case which dealt with this issue. In Channel Home Centers, Division of Grace Retail Corp. v. Grossman, our client had negotiated a preliminary agreement for the lease of a shopping center. The Grossmans owned the shopping center and were trying to procure an anchor tenant. They negotiated with Channel and, in December 1984, drew up a controversial letter that outlined all of the terms. Grossman had requested the letter of intent, saying he could present it to lenders to show he had a deal with Channel.

The letter provided, “To induce the tenant [Channel] to proceed with the leasing of this store, you, Grossman will withdraw the store from the rental market and only negotiate the above described leasing transaction to completion. Please acknowledge your intent to proceed with the leasing of the captioned store under the above terms, conditions and understanding by signing.”

Grossman contended that this letter was given on the condition that the lease would be completed within 30 days and that Channel, which was to prepare the lease, did not conform to the schedule. After entering into the letter of intent, Channel carried out some planning, prepared a survey and even claimed to have procured certain construction materials. Grossman applied for zoning approval.

In January 1985, more than 30 days after the letter of intent, Channel sent a 41-page lease to Grossman, who sent it back with proposed changes. Channel and Grossman went back and forth with negotiations on the lease and never signed it.

Meanwhile, Grossman received an offer from Mr. Goodbuys for the same space at more than double the Channel rent. The negotiations with Channel were terminated, and Grossman made a deal with Mr. Goodbuys in February 1985.

Channel sued to enforce the letter of intent, but the U.S. district court rejected Channel’s arguments on the grounds that the letter did not recite the mutual obligations essential to the contract and that it also clearly contemplated further negotiations. Channel appealed to the circuit court, which reversed and found in favor of Channel, holding that the letter imposed an obligation on Grossman to negotiate in good faith. The court also held that Grossman did not bargain in good faith with Channel when he terminated negotiations and accepted a higher offer from Mr. Goodbuys.

Later Pennsylvania cases indicate that the reason the court provided remedies under this type of preliminary agreement was that the landlord had agreed to negotiate the leasing transaction “to completion.” The court read into this that Grossman had obligated himself to bargain “in good faith.”

In a later decision, Philmar Mid-Atlantic Inc. v York Street Associates II, a letter of intent contained terms that were to be incorporated into a lease of space for Kentucky Fried Chicken. The letter concluded with a statement that it was non-binding and subject to the approval of a mutually satisfactory lease. When negotiations broke down, the proposed tenant filed suit and alleged that the landlord violated its duty to negotiate in good faith when it unilaterally withdrew an application for a zoning variance and terminated further negotiations.

The Pennsylvania Superior Court dismissed the tenant’s arguments and emphasized that the letter of intent did not disclose any agreement, not even an agreement to negotiate. “Instead, it provided specifically that neither party was to be bound until a mutually satisfactory lease had been negotiated and executed.”

Bala Plaza Case

In a more recent case, GMH Associates Inc. v. Prudential Realty Group, the Superior Court of Pennsylvania supported that reasoning. The legal opinions dealt with many important issues, but the one that seems to have stirred up the most attention in legal circles is the issue of a seller’s duty to negotiate in good faith.

The case involved a signed letter of interest to negotiate for the sale of the Bala Plaza in Bala Cynwyd. Although that letter allowed either party to terminate negotiations with notice at any time, the owner, Prudential, advised GMH that the properties were “off the market” during the negotiations and promised GMH an “exclusive” look.

Despite that, Prudential, while the deal was still under discussion with GMH, started actively negotiating with a competing buyer. At one point, according to the decision, Prudential denied and actively “concealed” the negotiations from GMH “in order to use the suitors for the property as pawns against one another in a scheme to drive up the purchase price of the property.”

The trial court had found that Prudential had breached its duty to negotiate in good faith and cited two federal circuit cases purporting to predict what the Pennsylvania Supreme Court would do on this issue. However, Judge James R. Cavanaugh, speaking for the majority of the three-judge panel of the Superior Court, disagreed with the conclusions of the trial court and the cited federal circuit court cases about what the Pennsylvania Supreme Court would do.

He stated, “[Our] courts have not determined whether a cause of action for breach of duty to negotiate in good faith exists in Pennsylvania.” However, he cited a principle that an earlier Superior Court decision had quoted “with approval.”

He then concluded that the letter of interest expressly provided that either party could terminate negotiations at any time for any reason without incurring liability to the other before it signed a written contract. He emphasized that the letter did not contain any provision requiring a duty to negotiate it in good faith, or one requiring the property to be taken “off the market.”

He also stated, “Thus, we conclude, if our courts were to recognize the existence of such a cause of action, that the duty to negotiate in good faith was not breached in this case by Prudential’s failure to keep the property off the market or to reveal that it was entering negotiations with GSIC [the Government of Singapore Investment Corp.].”

Pandora’s Box

The concepts of an implied duty of good faith or fair dealing in commercial contracts have created problems, not only for Pennsylvania courts, but also for courts throughout the country. Some commercial lawyers worry that these concepts can open a Pandora’s box of rights that are difficult to recognize and even more difficult to apply. Should a party have a duty to negotiate “in good faith,” even if the agreement is not otherwise binding, provides conditions that have not been met, and fails to tie down all of the material terms?

How many judges would look forward to deciding whether a party should be held liable for failure to negotiate “long enough” – or even “hard enough”? When the parties to a transaction run into a snag in negotiations, how will they be able to withdraw from these discussions without exposing themselves to liability?

If the courts hold parties to standards of “good faith and fair dealing,” there will be few safe-harbor rules, because courts cannot measure good faith by dollars, scales or minutes on a dial. Also, standards for what’s good and fair may vary from Wall Street to Walla Walla, from rabbis to real estate developers.

So far, the Pennsylvania courts have wisely decided not to take on that burden.

HARRIS OMINSKY is with Blank Rome, which has offices in Pennsylvania, New York, New Jersey, Delaware, the District of Columbia, Maryland, Florida and Ohio. He is a past president of the Pennsylvania Bar Institute.

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