Top tips on pre-contract agreements

• Ask yourself whether a pre-contract agreement is the right approach

  Pre-contract agreements are common in commercial transactions, acquisitions, joint ventures, and strategic partnerships. The advantages are clear. They can signal seriousness and positive intent. By aligning on key terms such as price, timelines, scope and responsibilities, you can reduce misunderstandings early in negotiations and prevent wasted time.

  There are potential drawbacks though. For simple or low-value deals, the additional time and costs might not be justifiable. It might be quicker to move straight to the main agreement after all. It can also create constraints in the main agreement negotiations, anchoring expectations, with parties reluctant to move on from what was previously agreed, even if later due diligence has revealed issues.

  

• unintentionally creating a binding contract

  When it comes to drafting, it is better to be the methodical tortoise than the impulsive hare, and especially if you want to avoid terms that were intended to be non-binding instead interpreted by a court as sufficiently certain to actually be legally binding.

  If the parties want some terms to be binding and some non-binding, then make this distinction unmistakably clear in the drafting. Use headings to segregate between the two and add explicit wording such as ‘these provisions are legally binding’ and ‘these provisions are not legally binding’. Avoid using language such as ‘shall’, ‘must’ and ‘will’ in the non-binding section. Include ‘subject to contract’ and ‘no intention to create legal relations’ wording for all non-binding elements.

• Keep your commercial flexibility

  Be wary of locking yourself into commercial terms that may later need renegotiation. Keep terms high-level, avoiding too much detail. For example, don’t be overly specific in describing price, quantities or specifications. Reference that due diligence or internal approvals will be needed before commitments can be finalised. Add some qualifiers such as ‘indicative only’, ‘subject to further negotiation’ and ‘based on current understanding only’.

• Manage exclusivity carefully

  You might want to enter into a period of exclusive negotiation with the counterparty. If you want this exclusivity to be legally binding, then explicitly say so. Make sure that the exclusivity restriction is not drafted too broadly to prevent unrelated discussions with third parties. Condition the exclusivity upon the counterparty’s active and good-faith negotiation. Include some termination triggers, for instance if the other side fails to meet certain milestones.

• Protect yourself from confidentiality, IP and data protection risks

  It’s very likely that sensitive information will be shared both within the pre-contract agreement itself and during the ongoing negotiations. If the parties have not already signed a non-disclosure agreement to cover the overall negotiations, then be sure to include a confidentiality clause which is legally binding. If the parties will be exchanging any pre-contract deliverables, such as prototypes or feasibility reports, then clarify who owns the intellectual property in these. If personal data may be disclosed, for instance as part of due diligence, include appropriate legally binding data protection obligations.

• Avoid introducing early liability

  The key function of a pre-contract agreement is to allow the parties to explore a deal without committing to it. So, avoid the inclusion of early liabilities, such as warranties about information shared, indemnities, penalties or liquidated damages, and obligations to commence work. If included, negotiation leverage can shift dramatically, the freedom for a party to walk away is reduced, and most importantly the risk is increased that the pre-contract agreement may be characterised as legally binding.

• Make sure timelines are realistic

  Consider including clear next steps and milestones in the pre-contract agreement, for instance timelines for the completion of due diligence or the signing date for a long form agreement. Avoid though being overly confident like the hare, setting unrealistic expectations with timelines to meet milestones and therefore creating unnecessary pressure or disputes. Delays could result in claims by the other party for breach of good-faith obligations or exclusivity commitments. Include wording such as ‘target’ or ‘estimate’ when referring to milestone dates. You could build in the flexibility to agree new milestone dates with the counterparty.

• Use Conditions Precedent as a safeguard

  Including conditions precedent (for example completion of due diligence, board approvals, third party consents and regulatory clearance) in a pre-contract agreement can be an effective safeguard when navigating early-stage negotiations. Not only do they reinforce the argument that the pre-contract agreement is non-binding because final agreement is conditional on further steps, they can also create a roadmap of what needs to happen and by when.

• Plan for a way out

  Ensure that either party can walk away from negotiations with no obligation to enter into a legally-binding long form contract. You will want to avoid claims from the other party that they’ve relied on your promise, or you’ve acted in bad faith. So, include a clear exit clause stating that the negotiating process is non-binding, either party can withdraw at any time, and withdrawal carries no liability. Conditions precedent can also act as an exit mechanism, allowing either party to walk away without liability or penalty, if a CP is not satisfied.

• Consider who bears the costs for pre-contract work

  It might well be that one or both parties need to carry out design, scoping or feasibility work before a long form agreement can be signed. The pre-contract agreement might even expressly provide for this. Consider then who will bear the costs for this work, especially if the long form agreement is never signed. Any agreed cost-sharing must be specific and binding. Avoid accidental commitments to expensive preparatory work. Clarify that, unless expressly stated otherwise, each party bears its own costs, does work at its own risk and there is no obligation to begin any services.

  Just as the tortoise won by relying on discipline, structure, and clarity, a well-crafted pre-contract agreement benefits the parties that are methodical and patient. So always draft based not on how fast you can go, but what is the most efficient way to get to the finishing line.

If you are in the process of negotiating a significant deal, and would like to explore preparing a pre-contractual agreement, please feel free to get in touch