When is an agreement binding if there are still matters to be agreed?

There is a growing feeling that 2009 saw the economy turn a corner and that there may be real signs of recovery in 2010, with an upswing in most sectors and a commensurate increase in M&A activity. Understandably, that optimism is tinged with a measure of caution, which will be reflected in the way the parties negotiate. Two of the better known text books on the art of negotiation are “Getting Past No” (William Ury – The Bantam Dell Publishing Group) and “Getting to Yes”. (Roger Fisher, William Ury, Bruce Patton, 2nd Ed Penguin) Often, though, the parties fall between those two steps: whilst not openly disagreeing on a point, they hold open the question of whether or not they do agree and, if they do, what their agreement is. They agree to agree, or at least, not to disagree. They are, as it were, “settled on maybe”. This is, of course, a practical commercial solution to the problem. On a legal level, however, the uncertainty inherent in such arrangements can present significant issues if the agreement ever comes to be enforced.

The law’s concern is certainty – the parties have not specified obligations themselves and the courts are highly reluctant to write the parties’ contract for them. Where the parties have left something over to be agreed, what is there for the court to enforce? In answering that question, much will turn on precisely what has been left open and what has been finally determined.

Scenario 1: the parties simply agree to agree at some future date

This is the most basic form of agreement: the parties have no binding contract but agree to continue their negotiations with a view to reaching some unspecified future accord that will form the basis of their contract. Common examples are undertakings in which “The parties agree to negotiate in good faith with a view to concluding a contract between them for the sale of the asset.” In essence, they have agreed nothing other than to keep talking. Such bare agreements to agree are unenforceable: the court will compel neither the process of negotiation nor the entering into of any contract.

Scenario 2: the parties agree initial terms with a view to further discussion

Here, the parties reach an outline agreement on key points but there is something to indicate that further negotiations on those points is contemplated. The most common examples are agreements which are labelled “subject to contract” and agreements which are described as “heads of terms”.

The effect of these terms is a matter of interpreting the parties’ agreement. As such, it will be a question of fact in every case. Generally, however, marking the agreement as “subject to contract” will mean that it cannot, itself, be a contract and so cannot be enforced. The position regarding heads of terms is less clear and the Court of Appeal has strongly indicated that it would be willing to find a document to be binding even though it was headed “heads of terms”.

Scenario 3: the parties’ agreement is silent on the non-agreed issues

What if the parties simply do not address in their agreement the issue or issues that are outstanding? The question here is whether the agreement is sufficiently legally complete to form a contract:

“If parties have shown an intention to be contractually committed, albeit while deferring discussion of some aspect or some aspects of the deal, then the court will recognise a contract unless what remains outstanding is not merely important but essential in the sense that without it, the contract is too uncertain or incomplete to be enforced.”

The law’s concern is certainty – the parties have not specified obligations themselves and the courts are highly reluctant to write the parties’ contract for them. Where the parties have left something over to be agreed, what is there for the court to enforce? In answering that question, much will turn on precisely what has been left open and what has been finally determined.

Where the agreement is, as a matter of law, incomplete, then there will be no basis for a contract. However, where the agreement is complete despite a lack of detail, it may be the basis for a contract. In addressing this question, it is critical to keep in mind that the law assesses questions of formation by reference to what an objective, third party bystander would think. If such a person would consider that the parties had reached an agreement there will be a contract, even if the actual parties felt the outstanding issue to be critical.

What is required in order to demonstrate a complete agreement is, again, a matter of fact in every case, but the law can take quite a robust view. For example, in contracts for the sale of goods, the Sale of Goods Act 1979 provides that, where no price has been agreed, a reasonable price must be paid. In such contracts, therefore, specifying the price is not essential even though most parties, subjectively, may consider that to be a fairly critical term. In Bear Stearns, the fact that a delivery date had not been agreed did not prevent the court from finding the existence of a contract. The court emphasized that the rules on implication were always there to fill any gaps necessary to give business efficacy to what had been agreed.

Scenario 4: the parties agree a binding contract but hold open certain conditions for further agreement

What happens where parties settle certain terms of their contract but clearly state that further terms remain to be agreed? In a sense, this is a cross between scenario 1 and scenario 3. However, in this context the courts have shown an increased desire to hold the parties to their agreement to continue negotiations with a view to reaching a further agreement.

There is, therefore, a distinction to be drawn between bare agreements to agree, where the undertaking to negotiate or to reach a future agreement is not contained in a contract, and contractual agreements to agree, where the same undertaking is contained in a binding agreement between the parties. How the obligation to negotiate, let alone to agree, will be enforced is less clear. That lack of clarity, however, is precisely the issue because it is likely to result in an increase in cost and time for the parties to resolve it.

Scenario 5: the parties have a binding agreement containing an agreement to execute further documents

This is a very straightforward situation. If the form of the documents to be executed is agreed, then this is a simple contractual undertaking like any other. The parties have agreed not to agree something in the future but rather, simply to execute documents in an agreed form.

What can you do?

The commercial reality is that parties may not be able to agree on certain provisions of a contract but will want, in any event, to settle those that they can. The question is how to strike a balance which minimises the risk of future disputes. There are at least two points the parties should always keep in mind:

• Clarity is key. Ensure that you have specified whether the whole agreement is open to further negotiation, or whether there is a binding contract as to certain terms but that certain terms require further discussion. If you do not wish to be bound, “subject to contract” is more legally certain than simply heading the agreement “heads of terms”.
• It will always be easier to establish what has not been done than what has to be done. One of the main issues with enforcing agreements to agree is that the court is reluctant to write the parties’ contract for them. If the parties have specified that one of them is to pay the other a fixed sum in the event that no agreement can be reached, that is a very straightforward term for the courts to enforce. As such, an agreement to agree with a term providing for payment if no agreement can be reached is, de facto, an enforceable agreement, at least as to the specified sum.

Ultimately, much may turn on the position the parties have reached as to the outstanding terms: persuading the courts to enforce a genuine agreement to agree is always likely to be less challenging than asking them to resolve an agreement to differ.

Further information

This summary is part of the Allen & Overy Litigation Review, a monthly update on interesting new cases and legislation in commercial dispute resolution. For more information please contact Sarah Garvey sarah.garvey@allenovery.com, or tel +44 (0)20 3088 3710.