In principle, a contract is formed between the parties only when an offer receives an affirmative acceptance. If no agreement is reached, contract negotiations end without result. This principle of contract law means that a negotiation partner can refuse to enter into a contract without consequences – unless otherwise agreed.
Agreements are often preceded by Negotiation stage, This is when the parties explore the conditions for entering into a mutually satisfactory agreement. Negotiation aims to determine the content of the agreement and often to acquire additional information about both the subject matter of the agreement and the potential contracting party. Even a well-drafted agreement can later prove to be disadvantageous if background checks have not been carried out with sufficient accuracy.
The parties have negotiating freedom, Consequently, the mere negotiation of a contract does not itself create an obligation for either negotiating party to conclude the contract, nor does it give rise to liability for compensation for any negotiation costs incurred by the other party. However, there are exceptions to this main rule, which are briefly discussed below.
Reimbursement of negotiation costs
In some cases, however, reimbursement for expenses incurred during negotiations may be possible. This concerns situations where a negotiating party has committed what is known as a "pre-contractual fault," which gives rise to liability for damages towards the other party. Such a situation arises if one party has acted contrary to good practice during negotiations or has otherwise engaged in inappropriate negotiating behaviour.
Liability for damages may thus arise, for example, in a situation where negotiations have been prolonged without a genuine intention to conclude an agreement. In this context, it should be emphasised that the mere termination of prolonged negotiations does not by itself create liability for damages. An additional condition is that the negotiating partner can be considered to have intentionally prolonged the negotiations, for instance, by giving an overly optimistic impression of the likelihood of reaching an agreement. Liability for damages for negotiation costs may arise if one party did not have a genuine intention to conclude the agreement, but intended to obtain information about the other party's pricing or to obtain a cost estimate for their own project. In legal practice, liability for damages has indeed been considered to arise if, during the course of negotiations, the other party has developed justified expectations of concluding the agreement.
Similarly, liability for compensation may arise if, during negotiations, there has been a breach of generally accepted negotiation procedure, for example by providing misleading information, failing to disclose information, or by pressuring the other party.
AGREEMENTS IN THE NEGOTIATION PHASE
Before a final agreement is made, the parties can draft various agreements concerning the negotiation phase. Drafting agreements for the negotiation phase can be justified, for example, when the parties incur significant costs even in the preparatory phase, and they wish to reduce the associated risk.
Specific agreement on the distribution of negotiation costs, the formal requirements of a binding main agreement, and the protection of business and trade secrets is a good way to manage liability and cost risks when negotiating contracts of significant economic value. Opinions presented during negotiations and rough outlines of contract terms can be recorded in a negotiation protocol or a letter of intent, even if one does not yet wish to commit to the project. Parties may also agree on exclusivity, meaning a standstill period, so that while negotiations are ongoing, they may not negotiate with other candidates for the same contract.
Agreement; Letter of Intent or Memorandum of Understanding
A letter of intent is a document drawn up during contract negotiations, which records the parties' provisional agreement reached during negotiations and how they will proceed with outstanding issues. The law does not impose any formal or content requirements for a letter of intent.
A letter of intent may be necessary when the details of the main agreement are still so unclear that a binding offer or response cannot yet be given. For example, letters of intent are commonly used in connection with company arrangements. The parties usually agree by the letter of intent at the latest, or even earlier, on confidentiality through a separate non-disclosure agreement, which covers both the negotiations and the trade secrets and other information obtained from the other party during the negotiations.
Although a letter of intent is not a final agreement and does not by default oblige the parties to enter into a principal agreement, matters such as a standstill obligation can be validly agreed upon in a letter of intent. Usually, to avoid ambiguities, a letter of intent stipulates that each negotiating party bears its own negotiation-related cost risks and neither party is yet committed to the final agreement. The conclusion of a letter of intent may also have an impact when assessing potential liability for damages arising from negotiations.
Precontract or Preliminary Contract
A preliminary agreement binds the parties significantly more than a letter of intent, even though both can be used in some similar situations and for similar purposes. A preliminary agreement is comparable in binding force to a normal contract and can be defined as an agreement where the conclusion of the actual main contract is agreed upon for the future. Preliminary agreements are used when the parties have not yet reached an agreement on all the details of the contract, but are ready to commit to the contract. Typical situations for using a preliminary agreement include, for example, construction contracts and company acquisitions.
A preliminary agreement can also be drawn up conditionally. It is possible to agree that the obligation to enter into the main agreement ceases if, for example, the competition authority prevents the fulfilment of the agreement or the financing required for the agreement cannot be arranged. If no such agreement is made, the breach of the preliminary agreement will be assessed as a breach of contract, which will result in a liability for damages.
The parties undertake in a preliminary agreement to enter into a main agreement at a later date, based on the matters and terms agreed in the preliminary agreement. A preliminary agreement must satisfy the same formal requirements stipulated by law as the actual main agreement, which must be taken into account in agreements that require a specific form, such as a real estate transaction.
AGREEMENT ON THE BINDING NATURE OF THE PRELIMINARY AGREEMENT
In summary, the binding nature of agreements reached during the negotiation phase varies. The legal effects of an agreement depend, first and foremost, on what has been agreed within it. However, the content of a document takes precedence over its heading. Thus, a document named a letter of intent may subsequently be considered a pre-contract if its content indicates that a commitment has already been made to conclude the main contract.
As types of agreements, letters of intent and pre-agreements are practically established and indicate the degree of commitment, but the content of the document ultimately determines the binding nature of the contractual instrument. To avoid legal ambiguities, it would be good for the document to explicitly specify its non-binding nature or the intended degree of commitment. In addition, it is advisable to agree on the validity and termination of the agreement during the negotiation phase.
This article was written by
Jari Sotka
Lawyer, MBA
Phew. 040 544 0610
[email protected]
Amos Attorneys at Law Oy
www.amoslaki.fi
The author has worked as a lawyer and advocate for more than 25 years, focusing throughout his career on preventing and solving legal problems for small and medium-sized enterprises.