The Ninth Circuit Court of Appeals recently upheld a district court's finding that a signed document entitled "Final Proposal" is an enforceable ground lease agreement with a put and a call option to purchase, even though the document clearly contemplated that there would be -- in the future -- a comprehensive legal agreement "to finalize the agreement", there was no express lease term set forth, and the document stated "[t]he above terms are hereby accepted by the parties subject only to approval of the terms and conditions of a formal agreement."

The case, First National Mortgage Company v. Federal Realty Investment Trust, was decided on February 1. First National is a mortgage company that leased property in San Jose; Federal Realty is a publicly-traded real estate investment trust that has wanted to buy the property to develop a mixed-use project since the late 1990s. Negotiations continued over the course of several years, and proposals were exchanged. Instrumental in the court's decision is that the initial proposals included Federal Realty's standard non-binding clause (presumably language one would see in a non-binding letter of intent), but the non-binding clause was intentionally omitted from the Final Proposal. Apparently, the President and CEO of Federal Realty was not happy when he learned that the proposal drafts were not enforceable. Therefore, he removed the non-binding clause to ensure that "there was no way either party...could change any of the major points in the agreement."

After the signing of the Final Proposal, the parties were unable to agree on the terms of the formal agreement. But while the negotiations were ongoing, First National gave its tenant a notice to vacate and asked Federal Realty to reimburse the company for the resulting loss in rent. The real estate market then collapsed, and the parties could not reach an agreement. Consequently, First National sued Federal Realty for damages as a result of Federal Realty's anticipatory breach of the Final Proposal.

The court acknowledged that an "agreement to agree" is not a binding contract. However, it went on to say that the intention of the parties primarily determines whether a document is a final agreement or an unenforceable agreement to make an agreement. The court examined extrinsic evidence to determine the parties' intent, found that an enforceable agreement was created, and upheld the lower court's award of $15.9 million in damages to First National for lost rent and the loss of its put option under the Final Proposal.

Industry Trade Groups Voice Concerns

The International Council of Shopping Centers, the National Association of Real Estate Investment Trusts, the Building Owners and Managers Association International, the National Multi Housing Council, the National Apartment Association, the Real Estate Roundtable, and the American Hotel and Lodging Association filed a joint brief of Amici Curiae in favor of Federal Realty. The brief argued that by giving binding effect to a preliminary document that lacked many of the elements commonly found in final contracts in the real estate industry, the court will discourage parties from entering into preliminary documents that the real estate industry finds useful in negotiating real estate transactions. The brief also argued that the court's ruling will create "unexpected and unintended obligations in an industry where the near universal practice requires that final and binding transactions be documented by detailed and comprehensive agreements that unmistakably evidence the intent of the parties to be bound."

Unfortunately for the real estate industry (at least for those practicing in the Ninth Circuit), one must now take additional precautions to ensure that preliminary documents at the letter of intent stage remain just that -- preliminary expressions of an intent to agree. Furthermore, one should never remove non-binding language without being prepared to live with the consequences of thus creating an enforceable binding agreement.

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