Letters of intent and preliminary agreements

Two firms in Illinois, November, nineteen eighty seven. Ball-Co makes specialty valve components and has put its assets on the market. Empro wants them. After preliminary talks Empro sends a three page letter of intent. Two point four million dollars, six hundred and fifty thousand at closing, the rest on a ten year note secured by Ball-Co's inventory and equipment. Both sides sign it.
The letter says twice that its terms will be subject to and incorporated in a formal, definitive Asset Purchase Agreement. It says that Empro's purchase shall be subject to the satisfaction of certain conditions, among them the approval of the shareholders and board of directors of Empro. It even provides that Empro's five thousand dollars of earnest money comes back without set off if the deal does not close.
They negotiate through March. Security for the note is the sticking point. Ball-Co wants a security interest in the land under the plant. Empro refuses. Then Empro learns that Ball-Co is talking to someone else, and sues, claiming that the letter of intent obliges Ball-Co to sell to Empro and to nobody else.
So here is the question. Both parties signed a document with a price, a structure, and a closing plan. Is it a contract? Think about it before I go on, and notice who is suing whom. The party that wrote itself every escape hatch is the one insisting the other side was bound.
And now the question I keep asking. What exactly did these people promise each other? Read the letter and the honest answer is, to keep talking. Empro promised to buy if a definitive agreement was signed, if its board approved, if its shareholders approved, and if it was satisfied. Ball-Co promised to sell on the same conditions. Neither promised the deal itself. They promised the stage on which the deal might be made.
Here is the first line for the board. Parties who sign a preliminary document are bound only if they intended to be bound, and intent in contract law is objective. It is read from the words and structure of the document and the circumstances, not from what either side says later it had in mind.
Second line. A letter that makes itself subject to a definitive agreement, or to approvals within one party's discretion, ordinarily shows that the parties did not intend to be bound yet. Those are not magic words. A document can say subject to and still bind, if the whole of it shows that the formal contract was to be a mere memorial of a deal already made. But they are strong evidence, and a party who writes them has to live with them.
Third line. A promise to negotiate in good faith is a different animal from an agreement to agree. Failing to agree is not a breach of it. Refusing to negotiate is. And the remedy for that breach is what the refusal cost the other side, not the profits of the deal that was never made.
Now the case. Empro against Ball-Co, Seventh Circuit, nineteen eighty nine, Judge Easterbrook. The district judge dismissed the complaint after reading the letter, and the court of appeals affirmed. Empro argued that intent to be bound is a question of fact, so the case could not be dismissed on the pleadings. Easterbrook's answer is the first line on your board.
Empro treats intent to be bound as a matter of the parties' states of mind, but if intent were wholly subjective there would be no parol evidence rule, no contract case could be decided without a jury trial, and no one could know the effect of a commercial transaction until years after the documents were inked. That would be a devastating blow to business. Contract law gives effect to the parties' wishes, but they must express these openly.
Then the reading. Subject to a definitive agreement appears twice. The letter also recites, twice, that it contains the general terms and conditions, implying that each side retained the right to make and stand on additional demands. Empro insulated itself from binding effect by listing, among the conditions to which the deal was subject, the approval of the shareholders and board of directors of Empro. And the earnest money clause. So Empro made clear that it was free to walk.
And having made itself free to walk, Empro could not claim that Ball-Co was bound. Neither the text nor the structure of the letter suggests that it was to be a one-sided commitment, an option in Empro's favor binding only Ball-Co. Ball-Co's lawyer, returning the signed letter, had already written that some clarifications are needed on the security clause. Some clarifications are needed, Easterbrook observed, is an ominous noise in a negotiation, foreboding many a stalemate.
The court closed with the policy, and it is the reason the rule exists. Letters of intent and agreements in principle often, and here, do no more than set the stage for negotiations on details. Sometimes the details can be ironed out. Sometimes they can't. Approaching agreement by stages is a valuable method of doing business. A law that turned every letter of intent into a contract would end the practice, and businesses would lose a tool they use every day.
Empro asked at least for its reliance expenditures, the cost of negotiating and investigating. No. Outlays of this sort cannot bind the other side any more than paying an expert to tell you whether the painting at the auction is a genuine Rembrandt compels the auctioneer to accept your bid. Reliance on your own hopes is not the reliance section ninety protects.
Now the harder case, where the writing pointed the other way. In nineteen sixty nine the Arnold Palmer Golf Company, which designed and sold clubs but made none, wanted a factory. Fuqua Industries had one, a California club maker it had just bought, with Palmer's help and approval. After months of meetings the two signed a six page Memorandum of Intent.
It began, this memorandum will serve to confirm the general understanding which has been reached. Fuqua would take twenty five per cent of Palmer's stock in exchange for the club maker, seven hundred thousand dollars, and management services.
It set out the form of the combination, where Palmer's office would move, the licences, the loans Fuqua agreed to make, the employment contracts, all in unqualified words. Fuqua will transfer. Palmer shall possess. Fuqua agrees to advance. Fuqua put out a press release. The two companies have agreed to cooperate in an enterprise that will serve the golfing industry.
And then the last paragraph. The obligations of Palmer and Fuqua shall be subject to fulfillment of the following conditions. Preparation of the definitive agreement in form and content satisfactory to both parties and their respective counsel. Approval of such definitive agreement by the Board of Directors of Fuqua. Two months later Fuqua's chairman told its president he did not want to go through with the Palmer deal, and the deal was terminated. Palmer sued.
The district court gave Fuqua summary judgment. The word satisfactory, it reasoned, meant the definitive agreement might be unsatisfactory, so the parties had chosen not to be bound by the memorandum. The Sixth Circuit, in Arnold Palmer Golf against Fuqua Industries, nineteen seventy six, reversed and sent the case to trial.
Here is why. At bottom, the question whether the parties intended a contract is a factual one, not a legal one, and, except in the clearest cases, the question is for the finder of fact to resolve. The court looked at the whole document. An extensive document that appears to reflect all essential terms, all described in unqualified terms.
It looked at the press release, which would tend to sustain Palmer's claim that the two parties intended to be bound. And it read the conditions paragraph as capable of two meanings, one of which was that the parties had bound themselves and the definitive agreement was to conform to the memorandum.
So Empro and Arnold Palmer are not in conflict. They are the two ends of the same test. Where the document says on its face that nobody is bound, and the conduct matches, a court can say so as a matter of law.
Where the document reads like a completed bargain, with a conditions clause at the end and a press release announcing a deal, the question goes to a jury. What decides which end you are at is the objective evidence of intent, and the words the parties chose are the largest part of it.
The last case answers a different question. Suppose the parties did not agree the deal, but did agree to negotiate it. Vernon, California, nineteen ninety nine. Baskin Robbins was closing an ice cream plant. A man named Copeland wanted to buy it, on one condition he made clear from the outset. Baskin Robbins had to agree to buy the ice cream he would make there. Co-packing, the trade calls it. Without it, he said, this deal doesn't work.
In May Baskin Robbins wrote him a letter. It would sell him the plant's equipment for one million three hundred thousand dollars. And, subject to a separate co-packing agreement and negotiated pricing, it would provide a three year co-packing agreement for three million gallons in year one and two million in each of the next two.
He signed the letter, the above terms are acceptable, and sent three thousand dollars. They negotiated price, flavours, quality standards, spoilage. In July Baskin Robbins wrote that its parent had made strategic decisions, the co-packing arrangement was out of alignment with our strategy, and it would not be engaging in any further negotiations. It sent his deposit back.
Copeland did not claim a co-packing contract. He could not. Price, flavours, quality and waste were all open, and a court will not write a seven million gallon supply contract from scratch. He claimed instead that the May letter was a contract to negotiate the co-packing agreement, and that Baskin Robbins had broken it by refusing, without excuse, to negotiate at all.
The California Court of Appeal, in Copeland against Baskin Robbins, two thousand and two, agreed with him on the law. We hold a contract to negotiate an agreement is distinguishable from a so-called agreement to agree and can be formed and breached just like any other contract. Here is the distinction.
If, despite their good faith efforts, the parties fail to reach ultimate agreement on the terms in issue the contract to negotiate is deemed performed and the parties are discharged from their obligations. Failure to agree is not, itself, a breach of the contract to negotiate. A party will be liable only if a failure to reach ultimate agreement resulted from a breach of that party's obligation to negotiate or to negotiate in good faith.
And then he lost anyway, on the remedy. Even if the plaintiff in this case could establish the defendant's liability for breach of contract he is limited to reliance damages, a form of recovery he has disavowed and defendant has shown he cannot prove.
He had claimed lost profits, many millions of dollars, from a deal that might never have been struck. Nobody can say the negotiation would have succeeded, so nobody can say what he lost by its not being held. What he could have recovered was what the broken promise to negotiate cost him. He had not pleaded it. Judgment for Baskin Robbins.
Now let's change one fact. The Empro letter of intent contains no subject to clause and no board approval condition. It sets the price, the note, the security and the closing date, and says counsel will prepare the formal papers. Ball-Co walks. Choose an answer before I go on.
Most people say Empro now wins, and I would say Empro now gets a trial. Take away the escape hatches and the letter reads like Arnold Palmer's memorandum, a completed bargain awaiting its memorial. Intent becomes a fact question, and the words counsel will prepare the formal papers cut both ways, as they did in Ohio. What has changed is not the answer. It is who decides, a judge on the pleadings or a jury on the evidence.
Change one fact again. Fuqua's board never approved the memorandum, and there was no press release. Choose.
Most people say Fuqua now wins on summary judgment, and they are probably right. The Sixth Circuit leaned on two things outside the paper, the board's earlier resolution and the press release. Remove them and you are left with a memorandum that calls itself a general understanding and conditions the obligations on a satisfactory definitive agreement approved by the board. Not the clearest case, perhaps, but much closer to Empro's end of the test.
Change one fact a third time. Copeland proves, to the dollar, that the co-packing deal would have earned him one hundred thousand dollars a year for three years. Choose.
Still not recoverable, and this is the point students resist. The damage from breaking a contract to negotiate is not the lost deal, because the deal was never owed. Baskin Robbins was free to negotiate in good faith and still say no.
What it was not free to do was refuse to negotiate at all. The measure is what that refusal cost Copeland, his wasted expense and lost opportunities, if he can prove them. He never tried. The profits, however provable, were never his to lose.
Here is what people get wrong here, and why it is tempting. The first mistake is reading a letter of intent as a contract because it has a price in it. Read for the words that say when the parties meant to be bound, and read who wrote them. The second mistake is thinking that a press release, a handshake or a public announcement binds anyone. It is evidence of intent, as Arnold Palmer shows, and only evidence.
The third mistake is awarding the deal to a party who was only promised a negotiation. Copeland gives you the two questions to keep apart. Was there a contract to negotiate? That can be yes. What does its breach cost? Never the deal itself.
Here is the rule, in one breath.
A preliminary writing binds only if the parties objectively intended to be bound by it, which words like subject to a definitive agreement ordinarily deny and a complete, unqualified memorandum may support, so that the clearest cases are decided on the paper and the rest by the finder of fact, and a separate promise to negotiate in good faith is enforceable, but only for the loss the refusal to negotiate caused, never for the bargain that was never made. Now, five questions.