Heads of agreements, offers to purchase, summary of terms or any other form of written documentation which indicates both parties’ agreement on a transaction could be considered a preliminary agreement (Preliminary Agreements). These preliminary agreements are frequently used for negotiating commercial terms pre-contract stage with the parties' intention of entering into a formal binding contract later on.

The recent case of Casdar Pty Ltd v Fanous [2017] VSC 616; BC201708791 reiterates the position established under the High Court’s decision of Masters v Cameron (1954) 91 CLR 353 in determining whether preliminary agreements are binding or non-binding.

It is prudent for both industry professionals and parties who are involved in preliminary negotiations to take reasonable care in the conduct and representations at the time the preliminary agreement was signed, the language used, eg "subject to contract", and the subject matter of the agreement.

The High Court’s decision of Masters v Cameron (1954) 91 CLR 353 considered whether an agreement for the sale of farm land was binding on the parties when the agreement was subject to the preparation of a formal contract of sale that contained terms and conditions set out in the agreement that was acceptable to the vendor's solicitors.

The High Court established three essential categories in determining whether preliminary agreements executed by the parties were binding or non-binding:

  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
  3. The intention of the parties is not to make a concluded bargain at all, unless and until they execute a formal contract.

The crucial element in the findings confirmed that preliminary agreements will bind the parties to it if it falls within the first and second items whereas in the third item, the parties were not contractually bound unless and until they actually bring the formal contract into existence.

The High Court determined that the agreement fell into the third item and pointed out that the preliminary agreement was not binding on the parties until a formal contract is entered into and given the use of the clause “subject to contract”, the words served the purpose of the third point.

When the words "subject to contract" are given their natural meaning, it creates an overriding condition so that what has been agreed upon must be regarded as the intended basis for a future contract and not as constituting a contract.

It is therefore crucial to consider the intention of the parties when the preliminary agreement was entered into and whether the specifics of the drafting ultimately serve the purpose between the parties.