When negotiating business deals or any agreements, you should keep in mind a recent development in California law. If you agree to negotiate the terms of an agreement, you have an obligation to do so in good faith. You can be sued if you do not make a good faith effort to reach an agreement.
The law in California has long been that an agreement to agree later on an essential term of a contract does not create an enforceable contract. Even if there is a written document signed by both parties, there is no contract if they intended to leave an essential term open for future or further negotiation. For example, if both parties sign a letter that outlines their general understanding of a future agreement with the intention of drafting a formal contract containing the actual terms, which may be further negotiated, the letter is not a binding contract. Rather, the parties merely entered into an “agreement to agree” and have no obligation to fulfill the terms described in the letter.
In a recent case, Copeland v. Baskin Robbins U.S.A., the Second District Court of Appeal imposed a duty to negotiate in good faith. Having agreed to negotiate, the parties must make good faith efforts to reach an agreement. If, despite their good faith efforts, they ultimately cannot reach an agreement, they have fulfilled their obligation and no liability will ensue. However, if one of the parties refuses to negotiate or negotiates in bad faith, that party can be liable to the other party.
An example of an enforceable agreement to negotiate is where a lessor agrees to withdraw his rental property from the market and negotiate a lease with a particular prospective tenant. The lessor cannot then unilaterally terminate the negotiations and lease the property to someone else. He has an obligation to make a good faith effort to reach an agreement with the prospective tenant.
In the Copeland v. Baskin Robbins case, Copeland negotiated an agreement with Baskin Robbins for the purchase of ice cream manufacturing assets and the sublease of a manufacturing plant. That agreement was contingent on reaching a “co-packing agreement” by which Baskin Robbins would buy ice cream from Copeland. During negotiations on the co-packing agreement, Baskin Robbins broke off the negotiations because of strategic decisions made by its parent company. By breaking off the negotiations for a reason other than an inability to reach an agreement, Baskin Robbins violated its obligation to negotiate in good faith.
This obligation to negotiate in good faith does not apply to all negotiations. As the court explained in Copeland v. Baskin Robbins, when the parties engage in negotiations, under no compulsion to do so, they have no obligation to continue negotiating or to negotiate in good faith; only when they have an agreement to negotiate does the obligation arise.
A potential trap for the unwary is the concept of implied contracts. The law recognizes not only agreements to which the parties expressly assent, but also agreements that are implied by the parties’ conduct. Thus, conduct that implies an agreement to negotiate might subject the parties to an obligation to negotiate in good faith. If you engage in such conduct, you might unwittingly incur the obligation even though you never explicitly agreed, either orally or in writing, to negotiate.
The obligation to negotiate in good faith is new to California law. The courts may define its parameters further. In the meantime, you should be careful about entering into agreements to negotiate (e.g., letters of intent and letters of understanding). Unless you seriously intend to pursue the negotiations to completion, do not enter into an agreement to negotiate. That is not to say that you must actually come to terms; rather, once you agree to negotiate, you must make a good faith effort to reach an agreement. Having made that good faith effort, you have fulfilled your obligation even if you do not reach an agreement.
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