Parties to commercial transactions often enter into short preliminary agreements which are commonly referred to as heads of agreement, lease proposals, letters of intent and memorandums of understanding.

These agreements are usually not enforceable because an agreement to agree is not recognised in law as an enforceable contract. However, there are numerous cases where the Courts have found a preliminary agreement to be binding if it contained all of the elements of a legally binding contract (see Sinclair Scott & Co Ltd v Naughton (1929) 43 CLR 310, Baulkham Hills Private Hospital Pty Ltd v GR Securities Pty Ltd (1986) 40 NSWLR 622 and PRA Electrical Pty Ltd v Perseverance Exploration Pty Ltd [2007] VSCA 310).

Do you have a legally binding agreement?

The starting point is to consider which of the following three categories the preliminary agreement falls into:

  1. The parties have reached finality in arranging all the terms of their bargain and intend to be immediately bound to the performance of those terms, but at the same time propose to have the terms restated in a form which will be fuller or more precise but not different in effect;
  2. The parties have completely agreed upon all the terms of their bargain and intend no departure from or addition to that which their agreed terms express or imply, but nevertheless have made performance of one or more of the terms conditional upon the execution of a formal document; or
  3. The intention of the parties is not to make a concluded bargain at all, unless and until they execute a formal contract.

The preliminary agreement will be legally binding if it falls within the first or second category above, but not the third category, according to the seminal case of Masters v Cameron (1954) 91 CLR 353. The elements of a legally binding contract (offer, acceptance, consideration, intention, completeness and certainty) must also exist.

While reference to the three categories in Masters v Cameron will continue to assist the Court, the overriding consideration remains whether, determined objectively, the parties intended to be immediately bound. In determining the parties’ intentions, the Courts will look at the wording of any correspondence exchanged between the parties, the nature of the negotiations, the history and behaviour of the parties and the circumstances giving rise to the dispute generally (see Pavlovic v Universal Music Australia Pty Ltd [2015] NSWCA 313 and Feldman v GNM Australia Ltd [2016] NSWSC 920).

In the recent case of Nurisvan Investment Ltd & Anor v Anyoption Holdings Limited [2017] VSCA 141, the Victorian Supreme Court of Appeal looked to the parties’ objective intention when considering whether a Heads of Agreement was binding and enforceable. The Court concluded that the use of expressions such as “wish” and “intention” in the agreement indicated an intention only to negotiate in good faith with respect to entering into a subsequent agreement. This was further supported by the scope of terms left for future negotiation. Therefore, the Court held that the Heads of Agreement did not actually bind the parties.

Conclusion

Parties to commercial transactions must clearly set out their intentions when entering into preliminary agreements. If the preliminary agreement is not intended to be legally binding, parties should not simply rely on a “subject to contract” term and should make it clear that the provision of the preliminary agreement does not constitute a formal offer, nor does its “acceptance” constitute a binding agreement between the parties.