Business Law: Letter of Intent or a Memorandum of Understanding

Agreements to Agree: How the Court Will Interpret Them

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An agreement to agree is a preliminary document exchanged by a possible buyer and seller to a transaction, such as a share or asset sale. Typically the agreement will include the major contract terms and leave the specific terms to be negotiated at a later date. The agreements can take the form of a Letter of Intent or a Memorandum of Understanding.

The big question surrounding these documents is whether they are binding on the parties. Do two parties have to go through with the deal? Parties can often suffer damages if one party backs out of the deal after an agreement to agree has been made. Before entering into one of these agreements, it is important to understand when the courts will find an agreement to agree to be binding.

In the Past

In the past, courts would often find that this type of agreement was not enforceable. Without an offer, acceptance and consideration, the court would rule that the agreement lacked certainty and that there was not a valid contract. More recent decisions have revealed that the court will look at agreements to agree on a case-by-case basis and in certain circumstances will find them to be binding.

The Intention of the Parties

One of the key considerations of the court is the intention of the parties at the time that the agreement was made. In the case, Georgian Windpower v Stelco Inc. (2011), the court states that it must determine whether the parties intended to create binding legal obligations in the first agreement or to defer them until the later agreement was signed.

The court further states in Georgian Windpower v Stelco Inc., that they will use an objective standard and will look at the conduct of both parties and the words used to determine the intention of the parties. The objective standard considers what a reasonable informed person would conclude if they observed the conduct and language used by the parties. The court will not consider the subjective intentions of the parties.

For example, in Georgian Windpower v Stelco Inc., the court looks at the word “agreement” used by the parties in certain circumstances as an indication that they intended to be bound and a reference to a “future agreement” as an indication that the parties did not intend to be bound until a final agreement was signed.

The Essential Terms

The other factor the court will consider is whether the agreement to agree included the essential terms of the contract. If all of the essential terms were agreed to, leaving only the minor details to be negotiated later, the court will be more likely to find that the agreement is binding.

In Bawitko Investments Ltd. V Kernels Popcorn Ltd. (1991), the court states that when both parties agree to all of the essential provisions to be incorporated in a formal document with the intention that their agreement will be binding, there is a binding contractual agreement, despite the fact that the formal contract has not been made yet. The court further states that, where the agreement is incomplete because essential provisions have not yet been agreed on, the agreement is too uncertain to be binding.

Duty to Negotiate In Good Faith

An agreement to agree can contain a provision which requires parties to negotiate the terms of a contract in good faith. Some relationships, such as a fiduciary relationship or an employment contract, give rise to an inherent duty of good faith. However there is no tortious duty to bargain in good faith in Canadian law. Absent one of these special relationships, the court can still find an agreement to negotiate in good faith to be binding.

In Molson Canada v Miller Brewing Company (2013), the court states that it is possible for an agreement to negotiate in good faith to be sufficiently certain to be binding. Similar to other provisions of an agreement to agree, the court will interpret whether the provision is binding by looking at the intention of the parties and whether the essential terms of the contract have been agreed to.

Breakup Fee: A Mode of Protection

A “Breakup Fee”, or “Termination Fee”, can be included in a Memorandum of Understanding or a Letter of Intent. The purpose of this fee is to protect the buyer if the seller backs out of the deal. A seller might be tempted to back out of the deal for several reasons, including if they receive a higher offer from another prospective buyer. This fee ensures that the buyer is compensated for time and legal fees in relation to planning, negotiating and investigating the possible transaction. A typical fee will be between one and three percent of the value of the deal.

Please contact Michael Paiva for more information about Memorandums of Understanding or Letters of Intent, or if you require assistance with a contract law matter.