Are agreements in principle, letters of intent and memoranda of understanding binding?

The legal position

Incomplete agreements. An agreement that is too vague, or that leaves essential matters unresolved, is described as inchoate. It has not progressed beyond negotiation, and the courts will not enforce it. An agreement to agree the price at a later date is therefore not a binding contract, because the bargain is incomplete. The position is different where the agreement itself provides a workable mechanism for settling the outstanding term, such as valuation by an independent person or an agreed formula. In a contract for the sale of goods that is silent as to price, the buyer must pay a reasonable price (Sale of Goods Act, s 10). That provision does not assist parties who have prescribed their own method of fixing the price where that method fails.

Agreements to negotiate. A bare agreement to negotiate, even one expressed as an agreement to negotiate in good faith, is unenforceable. A "lock-out" agreement is different. It is a promise not to negotiate with third parties for a period, and it may be enforceable if it is supported by consideration (something of value given in return for the promise) and is limited to a specified period.

"Subject to contract." These words raise a strong presumption that the parties do not intend to be bound until a formal written contract has been prepared, signed and exchanged. Until then, either party may withdraw without liability. The presumption is strong but not conclusive. Where both parties proceed to perform as though agreement had been concluded, the court may find that they abandoned the "subject to contract" condition and concluded a binding contract.

Letters of intent and letters of comfort. A letter of intent signifies a serious intention to proceed with a transaction, but it is frequently not intended to be binding in itself. In letters of comfort, language that promises an outcome, such as an undertaking to ensure a particular result, may be binding. Language that merely describes a present state of affairs or a current policy ordinarily will not be.

Commercial agreements. In commercial dealings there is a presumption that the parties intended to be legally bound. The presumption is not easily displaced; parties who do not intend to be bound should say so in clear and unambiguous language.

Practical implications

Heads of terms and memoranda of understanding are commonly used in advance of a lease, the sale of a business or a joint venture. Some of their provisions, such as those relating to confidentiality and exclusivity, are often intended to bind at once, while the remainder is left to the final contract. Whether that intention is achieved depends entirely on the drafting.

The principal risk arises where performance begins before the formal contract is concluded. One of two consequences may follow. The parties may find themselves bound on terms that were still under negotiation. Alternatively, work may have been done without any contract at all, leaving the party who performed it with a claim only for a reasonable sum (a quantum meruit) for the value of the work.

The "subject to contract" formula is particularly common in property transactions in the Caribbean. It protects both parties only for as long as both act consistently with it.

Recommended steps

A preliminary document should state expressly which of its provisions are binding upon signature and which are not. Provisions often made binding at once include confidentiality, exclusivity for a fixed period, and responsibility for costs.

A party that does not intend to be bound should mark the document "subject to contract" and refrain from any conduct inconsistent with that position, including performance, until the formal contract has been signed.

A party undertaking preliminary work, such as designs, proposals or site preparation, should agree in writing the basis on which it will be remunerated if the transaction does not proceed.

A party requiring exclusivity should obtain an undertaking limited to a fixed period and supported by consideration.