Preliminary agreements – often called ‘heads of agreement’ or ‘memorandums of understanding’ – are commonly used to outline the commercial intent of the parties for entering into the transaction and provide a key framework of the terms of a proposed transaction. These documents may be expressed as legally binding, non-binding or legally binding in part. In circumstances where negotiations fail and formal transaction documents are never finalised, difficulties can arise around whether the preliminary agreement is legally enforceable, and to what extent. In this article, Andrew Windybank of our corporate and commercial team considers how recent cases have dealt with issues relating to preliminary agreements.
In determining whether a legally binding contract exists, the parties must prove an intention to be legally bound by the document. The 1954 case of Masters v Cameron is the landmark decision in this area, establishing key principles to determine whether or not an intention to be legally bound exists in relation to preliminary agreements. The High Court case considered whether a preliminary agreement for the sale of a farming property formed a binding contract without the execution of a formal contract.
The Court held that agreements which remain “subject to” being dealt with by a formal contract may fall into one of three categories, namely:
Key commercial terms to determine intent
Where it can be demonstrated that parties to a preliminary agreement intended additional terms to be included in a future contract, the courts have historically been reluctant to enforce such agreements due to the inherent uncertainty of the agreed terms. However, in recent times courts have demonstrated a willingness to “fill in the gaps” to uphold bargains despite the intention being obscurely expressed. Some have even suggested that these situations amount to a fourth Masters-style category (as considered in GR Securities Pty Ltd v Baulkam Hills Private Hospital Pty Ltd (1986) 40 NSWLR 631).
However, there still must be a sufficient degree of clarity as to the key commercial terms to establish an agreement as legally enforceable rather than as a starting point for further negotiations. This was illustrated in the following cases:
1) Non-binding preliminary agreement
2) Binding Preliminary Agreement
The parties’ conduct – a key determinative factor in recent decisions
Whilst the language used in drafting the preliminary agreement will be important in deciding the parties’ intention, it is not determinative. Recent decisions indicate that the courts will endeavour to give effect to the commercial intent by considering the surrounding circumstances such as conduct both during and after the preliminary agreement.
The decision in Brice v Chambers & Ors  is indicative of the growing significance of conduct as a key factor in determining intention. Here, the Court of Appeal found that verbal negotiations for the sale and purchase of Wagyu cattle created a legally binding agreement between the parties. The Court took the view that the parties had engaged in a distinct pattern of behaviour which was consistent with the terms of the alleged agreement. The decision was despite the fact that not all terms were agreed or intelligible.
This judgment not only demonstrates how today’s Courts will weigh up surrounding circumstances when determining intention but also emphasises the risk that parties’ conduct can create during informal contract negotiations.
The cases considered in this article serve as a reminder that if you are party to a preliminary agreement, you need to ensure that you have concisely communicated your intention with respect to any proposed contract through both words and actions.
To minimise the risk of misinterpreting intention:
Inconsistent language and behaviour as to the preliminary negotiations may lead to the Court finding that you have intended to be and are, bound by the terms of the agreement despite your lack of intention at the time.
This article is not legal advice. It is intended to provide commentary and general information only. Access to this article does not entitle you to rely on it as legal advice. You should obtain formal legal advice specific to your own situation. Please contact us if you require advice on matters covered by this article.