Columbia Law School Professor Allan Farnsworth once confidently asserted that common law contract “doctrines, imaginatively applied, are both all that are needed and all that are desirable” to protect participants in preliminary contract negotiations and agreements (what I refer to collectively as “preliminary dealings”). In a recent article, I reject Farnsworth’s assertion as applied to preliminary dealings in corporate acquisitions. For that context, I propose that formal principles of contract formation, statutorily imposed, replace traditional common law principles.
The common law approach allows a binding agreement to be inferred where shared contracting intent may be lacking and tolerates binding formal preliminary agreements of unintended scope. To be sure, common law principles governing preliminary dealings may protect the legitimate expectations of contracting parties in many contexts, for example, where the expedients of commercial transactions favor streamlined predictable methods of contracting. Corporate acquisition transactions simply do not fit this mold and, as a result, common law principles needlessly impart unintended legal consequences to preliminary steps that could lead to, but may not result in, a formal definitive agreement.
In the corporate acquisition context, the salient contracting features include: (i) an intrinsically multi-step bargaining process; (ii) the routine participation of sophisticated business counsel; (iii) potentially enormous contractual liability arising from contested (and generally equivocal) inferences where contractual clarity can be obtained at relatively low cost; and (iv) disproportionate windfalls or forfeitures for third-party stakeholders in the case of mistakenly imposed obligations. Indeed, as practitioners are all too aware, repeated disclaimers in emails and draft proposals of an intent to create a binding agreement are required to avoid premature contractual entanglements.
The article proposes an alternative approach (including model statutory language) denominated as a SAAR+ (that is, a Signed Acquisition Agreement Requirement (plus)). The proposal is crafted to meet the two aspects of the preliminary dealing problem: putative formation of a binding acquisition agreement based on means other than execution of a formal agreement (think of the celebrated Texaco/Pennzoil debacle, or the proverbial handshake deal); and the ill-defined contractual status, scope, and consequences of formal preliminary acquisition agreements (such as the situation that gave rise to well-known Delaware Supreme Court decisions in SIGA v. PharmAthene). A simple SAAR proposal would preclude the formation of a binding agreement based on preliminary negotiations, regardless of specificity, absent a signed acquisition agreement. It would not, however, eliminate the contractual issues that arise in signed formal preliminary acquisition agreements, which may or may not be binding and, even if binding, are invariably of ill-defined scope. An additional statutory feature (hence the (+) in the label SAAR+) addresses this contractual uncertainty, imposing a default remedial limitation for breach of an executed preliminary acquisition agreement. In short, a non-breaching party would be entitled to reliance damages alone, unless the parties expressly contract around the default (i.e., either by eliminating damages, or by permitting damages in excess of reliance damages, including, for example, a termination fee). In this way, the regime encourages contracting parties to make their remedial intentions explicit in formal preliminary acquisition agreements at the time of contracting by either contracting around the default or implicitly consenting to the reliance damages limitation.
The proposal’s features are straightforward but in combination represent a fundamental reorientation in thinking about contracting in M&A, where different norms prevail than in, for example, ordinary commercial scenarios. At its most basic level, the SAAR+ proposal grounds contract formation in the acquisition context on formal expressions of intent. Accordingly, the SAAR+ approach promises greater contractual certainty where sophisticated counsel are engaged in a multi-step negotiation process.
Another feature of the proposal is its default remedy of reliance damages for breach of a formal preliminary agreement. Of course, parties can always negotiate around the default, but why start with a presumption of reliance damages? A no-damages default likely would be favored by many M&A contracting participants where attainment of a definitive agreement proves elusive. Reliance damages, however, are more closely aligned with related claims for promissory estoppel liability, claims that are separately foreclosed by the SAAR+ proposal. Elimination of such equity-based claims militates in favor of a formal expression of a non-reliance contracting intent. Expectation damages, a default alternative at the other end of the spectrum, is disfavored in part because of its potential to fan high-stakes litigation arising from indeterminate recovery for agreements never completed. This comports with actual practice. Preliminary agreements seldom include termination fees (a proxy for expectation damages). In contrast, termination fee provisions are fairly common in definitive agreements.
As for implementing the SAAR+ proposal, it envisions a model state statute, but state contracting statutes pose an obvious challenge: They only work if the parties’ actions are controlled by a jurisdiction where such a statute is enacted. However, this obstacle is hardly insuperable. Adoption of such a statute in significant corporate jurisdictions such as Delaware would provide a considerable leg up in its application to acquisitions involving Delaware entities. However, a potentially more powerful lever in preliminary dealings would be choice of law provisions in a formal preliminary agreement or even in supplemental preliminary agreements, such as confidentiality or exclusivity agreements. Ironically, courts tend to give effect to agreed upon choice of law provisions with respect to subsequent putative agreements, even though courts are reluctant to give binding effect to other contractual devices, such as disclaimers, to foreclose contract formation prospectively before reaching a formal definitive agreement.
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There is little benefit to perpetuating the common law’s general tolerance of formation uncertainty in the M&A context where well-resourced parties, with sophisticated counsel, seek prospective contracting certainty. Under the SAAR+ proposal, parties retain full contracting agency to reach whatever result is desired but must be express about their intentions. Ultimately, the proposal would enhance prospective contractual autonomy and diminish reliance on expensive and, sometimes surprising, hindsight judicial assessments.
This post comes to us from Professor Joseph Franco at Suffolk University Law School. It is based on their recent paper, “Contract Realism and Formalism in Preliminary Acquisition Agreements and Negotiations,” available here .