How to Ensure that an Agreement to Negotiate in Good Faith is Enforceable

By Shep Davidson on February 4th, 2016Posted in Contracts, Letters of Intent

As I discussed in a prior blog post, agreements to negotiate in good faith can be enforceable. Nevertheless, I recently was reminded when re-reading Schwanbeck v. Federal-Mogul Corp., that if you really want an agreement to negotiate in good faith to be enforceable, you have to be precise in how you describe what the parties will and will not do going forward.

In Schwanbeck, the parties were negotiating the potential purchase and sale of a division of the defendant’s business. As part of that process, the parties entered into a letter of intent, which stated the following:

Of course, this letter is not intended to create, nor do you or we presently have any binding legal obligation whatever in any way relating to such sale and purchase other than (i) with respect to the cost of appraisers and the review of OSHA compliance and repairs to remedy flooding . . . and (ii) those arising from the Confidentiality Agreement . . . . No further obligation will arise until a definitive agreement is reduced to writing and executed by you, the New Corporation and us and then only to the extent provided for and subject to the terms and conditions (e.g., approval of our Board of Directors) which may be set forth therein.

However, it is our intention, and, we understand, your intention immediately to proceed in good faith in the negotiation of such binding definitive agreement. . . . [Emphasis added]

This deal ultimately fell apart, and Schwanbeck sued, alleging, among other things, that Federal-Mogul had breached its obligation to negotiate in good faith. The trial court agreed with Schwanbeck and awarded him millions of dollars in damages. The Appeals Court reversed the trial court’s decision, ruling that Federal-Mogul in fact had fulfilled its obligation to negotiate in good faith. The Supreme Judicial Court, however, took a fundamentally different view of this dispute and the commitments that were and were not made pursuant to the parties’ letter of intent:

It is a settled principle of contract law that “[a] promise made with an understood intention that it is not to be legally binding, but only expressive of a present intention, is not a contract.” … It is also elementary that an unambiguous agreement must be enforced according to its terms. … There is no ambiguity in the letter of intent between the plaintiff and Federal-Mogul. The parties clearly stated certain contractual commitments to which they were binding themselves and, just as clearly, they followed those commitments with an expression of their intention to proceed to negotiate in good faith. That this expression of intent follows the parties’ disclaimer of binding effect and begins with the word “however” does not elevate its status from a mere expression of intent into a binding obligation. [Emphasis added.]

Thus, while an agreement to negotiate in good faith can be enforceable, like any other agreement, it must be expressed as a contractual commitment and not just noted as an intention or expectation. Failing to understand this distinction and/or draft a contract carefully in this regard, could result in your client having no recourse for the other party’s failure to live up to its promise.

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