Matthew Solum ()
Sometimes the best way to kick-start a complex deal is by keeping things simple—get agreement on the material terms and aim to negotiate the ancillary terms later. These preliminary agreements can take various names and forms: term sheets, letters of intent, memoranda of understanding, or heads of terms. But while an agreement on the key terms can be useful in a negotiation, parties can leave the table with different understandings of what that preliminary agreement actually means and, importantly, whether and to what extent that agreement is binding. This can be particularly true where one party begins to act in reliance on a deal that is still inchoate. When deals do come to fruition with some sort of definitive documentation, these differences of opinion moot themselves and rarely ever matter. But when one party walks away and leaves the other holding the bag, it often falls upon courts to determine whether a term sheet amounted to an enforceable contract. Where a term sheet is not a contract, but merely an “agreement to agree,” New York law imposes an obligation to continue negotiations in good faith. See IDT v. Tyco Group, S.A.R.L., 13 N.Y.3d 209 (2009); IDT v. Tyco Group, S.A.R.L, 23 N.Y.3d 497 (2014).
A recent case in the Supreme Court for New York County, Commercial Division, demonstrates how this precise situation can play out. In GE Oil & Gas v. Turbine Generation Services, the court was faced with breach of contract and fraud allegations from Turbine Generation Services after its would-be partner, General Electric, walked away from a deal to form a new business venture. Index No. 652296/2015, New York County (Feb. 10, 2017). The proposed business venture—which TGS alleged was a “joint venture”—was envisioned to engage in oil drilling and fracking. To that end, GE loaned TGS $25 million, which TGS claimed was needed to start purchasing equipment. In a separate term sheet signed on the same day as the note, GE further “committed” to contributing a total of $100 million of equity at later points in time. But GE never put that equity capital into the alleged joint venture. Instead, TGS got stuck with a $25 million note to GE that it couldn’t repay (TGS already bought the equipment) and an underfunded business venture.
According to TGS, the note and the term sheet were inseparable (the term sheet was literally annexed to the note): The parties had agreed to a complex multi-step transaction in which GE would first provide short-term financing and, later, a more substantial equity investment. Consistent with its theory of the case, TGS further alleged that GE orally promised never to call the $25 million note. GE, for its part, disagreed that it had ever waived its right to collect on the note, and disagreed that its $100 million equity “commitment” in the term sheet was binding. The parties likewise differed in their explanations as to why the proposed venture fell apart. GE claimed discomfort with the financial situation of a third would-be partner (which was not a party to the lawsuit). TGS, on the other hand, claimed that GE secretly never intended to do anything more than make a loan, and that GE’s agreement to the term sheet was part of a fraud or, at minimum, not done in good faith.
In resolving TGS’s allegations, the court looked first to the language of the documents. One of the documents was a fully-baked, senior secured promissory note, perfected by a UCC-1, and backed by an unconditional personal guaranty from TGS’s principal. The other document was an eleven-page term sheet, which began by stating: “This summary of principal terms does not constitute a contractual commitment of any party but merely represents the proposed terms of a transaction.” It then set forth the terms by which GE could invest up to $100 million in equity over a period of time.
As to the note, the court granted summary judgment in favor of GE for all $25 million plus contractual interest.
As to the term sheet, the court found that there was no enforceable contract, but simply an “agreement to agree.” The New York Court of Appeals has addressed this issue recently and repeatedly in the IDT v. Tyco cases, and the high court has reduced the issue to a two-step inquiry: “whether the agreement contemplated the negotiation of later agreements and if the consummation of those agreements was a precondition to a party’s performance.” IDT I, 13 N.Y.3d at 214. Here, the court found this test satisfied. The term sheet contemplated the negotiation of later agreements, and those agreements were a precondition to GE’s equity investment. Having found that the term sheet was an “agreement to agree,” the court turned to TGS’s allegations that GE did not negotiate in good faith. In New York, an agreement to agree carries with it a duty to negotiate in good faith. IDT I, 13 N.Y.3d at 214 n.2. After reviewing the applicable law, the court ruled that TGS had not adequately alleged facts impugning GE’s good faith, and the court conditionally dismissed TGS’s breach of contract claim (with a period to re-plead). The court separately dismissed TGS’s fraud claim on grounds that it had pled neither scienter by GE nor reasonable reliance on any alleged oral promises.
While the court’s decision left TSG with only one apparent theory to pursue—GE’s alleged lack of good faith in negotiations—that thread may be thin. The New York Court of Appeals has held, “[t]here is such a thing as a good faith impasse; not every good faith negotiation bears fruit.” IDT II, 23 N.Y.3d at 503. And courts have dismissed these types of claims where they are not substantiated by specific factual allegations evincing bad faith. E.g., Prospect St. Ventures I v. Eclipsys Solutions, 23 A.D.3d 213 (1st Dep’t 2005) (rejecting “conclusory” claims of bad faith negotiation that are “devoid of any specific factual allegations”).
Even if a plaintiff can demonstrate a lack of good faith on the part of its counterparty, that plaintiff is left with a very difficult damages case. New York courts have held that a party that fails to negotiate in good faith may be liable to the non-breaching party, but the damages recoverable might be limited to the party’s out-of-pocket expenses. See, e.g., MG West 100 v. St. Michael’s Protestant Episcopal Church, 127 A.D.3d 624, 626 (1st Dep’t 2015). The “profits that plaintiffs may have made under the prospective contracts contemplated by the MOU cannot properly be awarded as damages … since the MOU was merely a preliminary agreement by which the parties planned to proceed with their initial efforts … .” Id. In other cases, however, court will award the amounts associated with the failure to consummate the deal. See, e.g., Network Enterprises v. APBA Offshore Productions. In Network Enterprises, a television producer purchased an option from a network to air 10 half-hour episodes at $40,000 apiece, at dates and times to be agreed. 427 F. Supp. 2d 463 (S.D.N.Y. 2006). The producer exercised the option, but then made no effort to schedule the dates and times, and refused to pay the network the per-episode fee. The court awarded the network $400,000, which it reasoned was caused by the producer’s failure to engage in good-faith negotiation.
In sum, term sheets can be enforceable on their own terms or as agreements to agree. In the latter instance, an agreement to agree imposes an obligation to negotiate in good faith, though not an absolute obligation to consummate a deal. And if the obligation is breached, the damages that the non-breaching party will be able to recover are the damages that flow from the failure to negotiate.