Business negotiations sometimes end with the parties signing a Memorandum of Understanding (MOU) – contemplating further negotiations, with the intent that the MOU will be followed by a ‘formal agreement’ down the track.
The recent Supreme Court of Queensland case of Baldwin v Icon Energy Ltd  QSC 12 has considered a situation where the parties did not ultimately agree on the terms of a formal agreement – with one side alleging a breach of a MOU obligation to use ‘reasonable endeavours to negotiate’.
Southern Fairway Investments Pty Ltd (SFI) entered into a MOU with the defendant companies (together referred to as Icon) under which the parties agreed to use reasonable endeavours to negotiate an agreement for the supply of gas.
Icon was the proposed supplier of the gas and SFI was interested in purchasing that gas.
The MOU contained the following term:
1.3 Negotiation of terms and conditions
The parties agree to use their reasonable endeavours to negotiate by 30 August 2008 (and in any event no later than 30 October 2008) a Gas Supply Agreement using the principles set out in schedule 2 and including the following key factors…
Schedule 2 of the MOU was entitled ‘Key terms and conditions for the purchase of gas from Icon Energy’. It set out a number of potential terms for a gas supply agreement but concluded as follows:
These terms and conditions are indicative only and are submitted as a means of encouraging discussion…It is understood that for the avoidance of doubt that this document does not obligate any party to enter into any further agreement.
The parties were ultimately unable to agree on a gas supply agreement.
SFI started a court case in the Supreme Court of Queensland claiming that Icon did not negotiate as required by the MOU and that as a result SFI lost the opportunity of reaching a gas supply agreement worth $221 million.
Icon applied to the Court to strike out SFI’s claim, arguing that the claim was unsustainable because the obligation to negotiate the gas supply agreement was uncertain and unenforceable.
SFI relied upon the 2014 High Court case of Electricity Generation Corporation v Woodside Energy Ltd (2014) 251 CLR 640 where a gas supply agreement obliged the sellers to supply certain amounts of gas and to use ‘reasonable endeavours’ to make a further quantity of gas available. In that case, the obligation to use ‘reasonable endeavours’ was held to be valid.
SFI argued that the obligation in clause 1.3 of the MOU was similarly valid because the use of the term ‘reasonable endeavours’ in the context of an obligation to negotiate further gave the MOU a legal content that was certain.
Justice McMurdo stated that Australian law does allow scope for the enforcement of an obligation to negotiate. However, his Honour was of the view that this did not extend to agreements where the subject of the negotiation is as open-ended as to the formulation of the agreement itself.
The Court noted that in the Electricity Generation case (relied upon by SFI), the relevant agreement concerned an obligation to use ‘reasonable endeavours’ to make available further quantities of gas, rather than an obligation to negotiate the creation of a new agreement. The existing contract terms could therefore be used to determine what was meant by the obligation to use ‘reasonable endeavours’ and how far that obligation extended.
Conversely, the Court said that where the obligation concerned the negotiation of an entirely new agreement, the parties would not have the benefit of an existing contractual framework of rights or obligations to which the parameters of the obligation could be anchored. In these circumstances, it would not be possible to determine what was required by the parties with the necessary degree of certainty.
Ultimately, his Honour found that the provisions of the MOU requiring the parties to use reasonable endeavours to negotiate were legally unenforceable due to uncertainty. His Honour struck out SFI’s claim in its entirety.
MOUs often have an important role to play in commercial negotiations, particularly where parties need to move towards a final agreement in stages.
However, it is important to understand the limits of MOUs and to have terms drafted in a way that accords with the understanding of the all parties involved.
This particular case demonstrates that a term in a MOU requiring the parties to use reasonable endeavours to negotiate an entirely new agreement will be invalid and unenforceable.
Significant caution therefore needs to be taken in the drafting of MOUs or ‘informal’ agreements to avoid a costly legal battle about the negotiations that may follow the signing of a MOU or the terms of MOU itself.
It is always best to be very clear about the legal obligations that apply to the parties to the MOU including covering off important issues such as:
- the terms that have been finally agreed and are binding;
- the terms that need to be negotiated further;
- what things (specifically) the parties need to do as part of the further negotiations; and
- how disputes over the MOU might be resolved (e.g. by reference to an independent expert).