“So we have a deal, right?”
The answer to this question is not always as easy as it appears. Parties can, and often do, have different understandings (as evidenced by numerous court cases) of whether negotiations have culminated in a binding contract. This can have significant consequences if one party decides to walk away from the negotiating table but has unknowingly already entered into a binding agreement and may be liable for damages if the agreement is breached.
This article provides a brief overview of the legal landscape inCanadain determining the legal implications, if any, of documents exchanged during the negotiation process and some considerations that ought to be examined before and during this process.
The negotiation process
Canadian courts have fostered a competitive negotiating environment for businesses by allowing parties to freely negotiate and maximize their economic self-interest by upholding two key principles: 1) refusing to impose a duty of good faith (except in a few prescribed scenarios); and 2) not recognizing agreements to agree as imposing any legal obligations on a party. This allows the well-informed negotiator to engage in detailed discussions without creating unintended legal obligations.
Negotiations can range from formal talks with structured exchanges of written term sheets to informal coffee shop conversations ending in a handshake. No matter what the structure of the agreement is between the parties, difficulties can arise when certain aspects, or even the overall structure, of the deal have been agreed upon but the parties have not yet signed (or even drafted) the actual contract. Unforeseen consequences can materialize when parties do not fully understand the legal implications, if any, of a purportedly nonbinding document, such as a term sheet or letter of intent.
Is this a contract, an agreement to agree or a bit of both?
Two different structures generally advance the negotiation process, each with different consequences: an agreement to agree (not intended to be legally binding) or an agreement that imposes both binding and nonbinding terms.
Agreements to agree outline, in varying degrees of specificity and scope, the anticipated terms and conditions of the substantive contract. These types of agreements do not impose any legal obligations, provided the parties have not agreed upon all of the essential terms of the contract or have only agreed to broad principles of a potential contract, which require further clarification and negotiation. Furthermore, such agreements may expressly provide that the parties’ legal obligations are to be deferred until the execution of a formal contract. In this context, an agreement to agree will not be legally enforceable even if the parties have agreed upon all the essential terms.
Problems arise when parties have inadvertently agreed to all of the essential terms of a contract, (without expressly stating that such agreement is not meant to create legally binding obligations on either party) with sufficient clarity that can allow one party to argue that an enforceable contract has been formed. The fact that a formal contract has not been executed may not alter the enforceability of the initial agreement.
Hybrid agreements can impose limited legal obligations during negotiations, such as confidentiality restrictions, recovery of legal and/or due diligence fees and exclusivity periods, while expressly deferring the creation of a substantive contract.
Is this an enforceable agreement?
Canadian courts typically employ an objective, two-stage analysis to determine whether the parties have reached a binding agreement during the negotiations even if a formal contract has not been executed. In particular, courts assess whether:
1. A reasonable person would conclude the parties have agreed to enter into binding legal relations
2. If so, are the essential terms of the contract so vague and uncertain as to be incapable of reasonable interpretation and, consequently, meaningless?
Courts will analyze the “outward expression” of the parties’ intentions (e.g. exchange of term sheets) through oral or written evidence in and around the time of the negotiations. The parties’ subsequent conduct will be assessed on whether the parties governed their relationship in accordance with the terms of the purported agreement.
Even if a court concludes that the parties did intend to create a legal relationship, it must be satisfied that all essential terms were agreed to with sufficient clarity to give them proper meaning. Agreements have been held to be unenforceable when a key term was missing from the document at issue, such as the purchase price, commencement date or length of term.
Considerations for the negotiation process
Parties should have a clear understanding of their intentions prior to and during the negotiating process, particularly before executing a nonbinding document. A few matters to complete during this process include:
- Assess how the negotiations will be structured and discuss this process with the counter-party at the outset
- Have a thorough understanding of the essential legal requirements of the contract at issue
- Determine whether there should be an enforceable agreement on certain protective matters, such as confidentiality restrictions, payment of fees incurred (whether an agreement is reached or not), and time limitations for exclusive negotiations. Clearly indicate that only those terms are intended to be legally enforceable
- Clearly indicate on all term sheets that they are not intended to be legally enforceable and the execution of a formal contract is necessary to create legal obligations
Canadian courts will recognize a variety of contracts, so long as the objective evidence establishes that parties have agreed upon all essential terms and those terms are sufficiently detailed. Parties should exercise care in executing informal documents and have legal counsel review to determine what, if any, legal obligations will result. With a proper understanding of both the business and legal aspects of the potential deal, a party should be able to maximize its outcome in the negotiation process without any unforeseen surprises.