Preliminary agreements are often used in commercial transactions, and can serve many different purposes depending on how they are drafted and the type of arrangement involved.
Some examples of what preliminary agreements may be used for include:
- Facilitating due diligence. If parties to a preliminary agreement wish to begin conducting due diligence investigations, a preliminary agreement may contain confidentiality provisions and the required authorities;
- Recording essential terms. If the essential terms cannot be agreed upon, then the parties may as well ensure that they can elect not to proceed before more time and money is spent on a final contract;
- Outlining how the transaction is to progress. Particularly when dealing with large or complex transactions, the parties should be clear on how they are to proceed;
- Securing exclusivity. One or both of the parties may wish to prevent the other from negotiating with other interested parties until either the arrangement is finalised or the negotiations fall over; and
- Sunset provisions. As opposed to the previous point, one or both of the parties might wish to continue to look for better offers while negotiations are ongoing.
Binding or non-binding?
While preliminary agreements may simply be a record of the important terms of a commercial agreement, they can also be binding on the parties. Preliminary agreements may also establish a certain point at which the parties are bound or provide that certain provisions of the preliminary agreement are binding (such as confidentiality clauses), while others are not.
When considering entering into a preliminary agreement, it is important to think about:
- Whether the parties wish to be bound;
- When the parties wish to be bound; and
- The consequences (if any) of the parties not proceeding with the arrangement.
It is important for a preliminary agreement to be drafted clearly in order to avoid uncertainty as to when or if it is intended to be binding.
In determining whether a preliminary agreement is binding, the courts will consider the intention of the parties objectively. This can include matters such as what the preliminary agreement contains, how the parties have conducted themselves throughout the negotiations, whether there is any indication that the arrangement is a significant commercial decision, whether one or both of the parties has relied on the preliminary agreement, and whether the preliminary agreement and/or contemporaneous correspondence notes when the parties are to be bound. A simple agreement to agree will not be binding in Australia[i].
The courts will also look at the surrounding circumstances and whether there is sufficient certainty. It is therefore important to consider the commercial transaction as a whole when dealing with preliminary agreements.
Masters v Cameron
Masters v Cameron[ii] is the leading case in this area, and established the following three categories of agreements:
- Where the parties have agreed on the terms and intend to be bound. The formal agreement is still yet to be entered into, however the terms would be materially the same;
- Where the parties have agreed on the terms of the arrangement, however performance is conditional on the parties entering into a formal agreement; and
- Where the parties do not intend to be bound, unless a formal agreement is entered into.
The court determined that in each of the first two categories there is a binding contract, however in the third category there is not.
Where a party requires entry into the final agreement to be a mere formality, it is generally recommended that the agreement be finalised and annexed to the preliminary agreement.
If parties are sharing information, such as during the due diligence process, they may wish to ensure that the information remains confidential.
Guarantees and Indemnities
Often in commercial arrangements, enforceability is a significant concern for the parties involved. Guarantees and indemnities can form part of preliminary agreements, providing additional security and recourse.
Does the agreement reflect the intention of the parties?
It is important to determine what the parties wish to be included in a preliminary agreement, and what terms of the parties intend to be enforceable. Some more particular considerations include:
- Have the essential terms of the agreement been determined?
- What are the most important aspects of the agreement?
- At what point does each party want to be bound?
- Does the preliminary agreement reflect what was agreed?
- Has a party relied on any representations, and is this reflected in the agreement.
If you are considering entering into a preliminary agreement or require advice on a commercial arrangement, contact the experienced team at Miller Sockhill Lawyers on 07 5444 4750.
[i] Australian Securities and Investments Commission v Fortescue Metals Group Ltd and Andrew Forrest (2011) 190 FCR 364
[ii] Masters v Cameron (1954) 91 CLR 353