WHEN IS A CONTRACT A CONTRACT; ARE LETTERS OF INTENT BINDING

WHEN IS A CONTRACT A CONTRACT; ARE LETTERS OF INTENT BINDING?

HAROLD S. SMALL, J.D., CPA, and AEP

The California Court of Appeal (Second District) recently issued a decision that may have far reaching implications, and addressed an area that it stated was “an unsettled question in California: may a party sue for breach of a contract to negotiate an agreement or is such a ‘contract’ merely an unenforceable ‘agreement to agree?’” See Copeland v. Baskin Robbins (2002) 96 CA 2^nd 1252. In other words, can a letter of intent be binding? The Court in this case indicated that it was making “new law,” which is part of the reason for the articles in the August and September issues and drawing this matter to your attention.

Identifying the type of instrument is important. A letter of intent has been thought to be an informal document that sets forth in written form the preliminary understanding of the parties, which terms are to be subsequently set forth in another agreement. In some circumstances a letter of intent may be created in the form of a term sheet, memorandum of understanding, or some other written instrument setting forth the essential terms agreed upon and to be documented more fully in other agreements and documents to be executed by the parties.

From a drafting standpoint, parties to letters of understanding (or similar instruments) have relied upon including text stating that the letter of intent was intended to be non-binding, under the belief that they will not be bound by the terms of the letter unless they execute subsequent documents stating the intent to be bound. In other circumstances, parties have executed letters of intent containing language stating that the instrument is binding, although the parties intend to set forth the terms of the agreements reached on a more complete basis in documents to be subsequently prepared and executed.

In the Copeland case, the court addressed issues relating to a letter and stated “This letter details the terms which our ... executives have approved for subletting and sale ... and a product supply agreement...[with terms summarized]. If the above is acceptable please acknowledge by returning a copy of this letter with a non-refundable check ....” Copeland signed a statement at the bottom of the letter agreeing “[t]he above terms are acceptable” and returned the letter along with the required deposit. The parties continued negotiations over an agreement. Approximately two months later, Baskin Robbins broke off negotiations and returned the “non-refundable” deposit. The negotiations included consideration of subletting and sale of real property and equipment, and a separate co-packing agreement. When the negotiations terminated, Baskin Robbins offered to proceed with the sale and lease of the plant assets, but did not insist on doing so.

In the complaint, Copeland alleged [as summarized by the Court] that Baskin Robbins had entered into “...a contract which provided Baskin Robbins would enter into a co-packing agreement with Copeland under the terms set out in the May 1999 letter and additional terms to be negotiated. Baskin-Robbins breached this contract by ‘unreasonably and wrongfully refusing to enter into any co-packing agreement with [Copeland].’ As a result of this breach of contract Copeland suffered expectation damages ‘in the form of lost profits . . . as well as lost employment opportunities and injury to his reputation.’” Copeland had stated his damages consisted of “lost profits from [the] three year co-packing agreement with defendants” as well as lost profits from other sales he could have made had he acquired the plant and the profit he could have earned from selling the plant equipment. Copeland’s discovery responses did not provide or allege he could provide evidence of damages he suffered as a result of his relying on Baskin Robbins’ promise to negotiate a co-packing agreement. A motion for summary judgment was granted by the trial court.

On appeal, the Court indicated that “While courts have been increasingly liberal in supplying missing terms in order to find an enforceable contract they do so only where the ‘reasonable intentions of the parties’ can be ascertained.” It went on to state that “It is still the general rule that where any of the essential elements of a promise are reserved for the future agreement of both parties, no legal obligation arises until such future agreement is made. Here, ... a variety of complex terms [pricing, quality control standards, responsibility for waste] remained for agreement before the co-packing contract could be completed.”

Copeland pursued a different avenue in the appeal insisting that the parties had formed a co-packing agreement that was breached by Baskin Robbins by its refusal (without excuse) “... to continue negotiations or, alternatively, by failing to negotiate in good fath.” The Court pointed out that “Most jurisdictions which have considered the question have concluded a cause of action will lie for breach of a contract to negotiate the terms of an agreement” and cited cases from Illinois, Pennsylvania, and New York. The Court found Baskin Robbins arguments that “...there are sound public policy reasons for not enforcing a contract to negotiate an agreement” as “unpersuasive.”

The Court went on to indicate that Baskin Robbins had an agreement that required it to negotiate in good faith the terms of an agreement. It also stated that “...the appropriate remedy for breach of a contract to negotiate is not damages for the injured party’s lost expectations under the prospective contract but damages caused by the injured party’s reliance on the agreement to negotiate.”

Contracts today are reached through a series of negotiations and communications, “... by a series of compromises and tentative agreements on major points which are finally refined into contract terms.” Given the comments of the Court and this decision, next month’s column will address how to prepare a letter of intent and minimize exposure to the type of liability exposed by Copeland v. Baskin Robbins.

THE FOREGOING CONCEPTS AND IDEAS ARE GENERAL STATEMENTS AND ARE INTENDED TO PROVIDE CONCEPTS FOR CONSIDERATION IN BUSINESS AND TAX PLANNING. CAREFUL CONSIDERATION NEEDS TO BE GIVEN BY THE USER REGARDING THE USE AND APPLICATION OF THE CONCEPTS. YOUR LEGAL AND TAX COUNSEL SHOULD BE CONSULTED BEFORE THE IMPLEMENTATION OF ANY OF THE IDEAS INDICATED HEREIN. SHOULD YOU HAVE QUESTIONS REGARDING THIS MATTER, HAROLD S. SMALL, ESQ., CAN BE REACHED AT 12526 HIGH BLUFF DRIVE, SUITE 200, SAN DIEGO, CALIFORNIA 92130 OR AT 858.350.8888.