WE SCRIBBLED OUR DEAL ON A
IS IT BINDING?
So you cut a
deal to buy a coin laundry at the neighborhood coffee shop and the closest
piece of paper was a napkin! Is the deal
binding? You wouldn't be the first
person to ask the question. Some people
expect to bind themselves by signing a napkin or other piece of paper, and
others don't. The issue is frequently
In Rennick v.
O.P.T.I.O.N. Care, Inc., 77 F.3d 309 (9th Cir. 1996), a physician and an
attorney sought to become the Canadian franchisee of a franchisor that provided
home medical services. A meeting was
held to discuss the acquisition of the franchise. The proposed franchisee circulated a written
agenda that indicated one of the purposes of the meeting was "to formulate
terms of a proposed initial agreement" establishing the business
relationship and also provided that the proposed initial agreement would be
subject to Board approval of all parties."
The meeting was held without lawyers.
Everyone came to
an "agreement" on the basic terms of the deal and at the conclusion
of the meeting, the physician suggested that the persons present
"formalize" the relationship by shaking hands. Everyone obliged and shook hands.
One of the
negotiators on behalf of the proposed franchisee testified in deposition that:
"At the end of
the meeting I volunteered that the way we had formalized relationships before
getting lawyers involved was to sort of do it on a handshake basis, and
that we wanted to feel that the people we were dealing with were as good as
their word. And we usually formalized
that by a handshake on the deal. So I
proposed that, having spent these previous months and these three or four hours
bringing into the best form we could our understandings, that we formalize the
deal by a handshake. And my recollection
is that [the franchisor representative] enthusiastically agreed to that and all
the principal parties got up and circulated around the room and shook hands
with each other on having made the deal."
attorney prepared a letter of intent that included an agreement that the
parties would "continue good faith discussions directed toward the
creation of formal written contracts."
The franchisor signed the letter, but added, however, that "this
letter of intent is of no binding effect on any party hereto." The franchisor later denied that it was
required to comply with the agreement.
franchisees asserted that either an oral agreement reached at the meeting,
confirmed by the handshake, or the letter of intent, created a binding
agreement. The Court of Appeal affirmed
the trial court's decision rejecting the agreement on the ground that no
contract was made.
The court noted
that the parties' understanding that they would later enter into more formal
agreements did not prevent an oral agreement from acting as a binding contract,
if that is what everyone intended. The
court also noted that a handshake can constitute sufficient evidence for a jury
to infer that the parties intended to be bound at the time.
The court also
stated, however, that the handshake must be interpreted in light of the agenda
and the letter of intent. The letter of
intent indicated that it did not bind the parties and that there would be no
contract until the boards of directors of the parties approved the written
A letter of
intent that refers to the preparation of a subsequent definitive agreement can
constitute a binding agreement. In such
circumstances, the letter of intent creates a binding obligation for the
parties to act in good faith in the preparation of definitive documents. In this particular situation, however, the
letter included express language that it did not bind the parties. It said, "this letter of intent is of no
binding effect on any party hereto."
The court thus concluded that "[I]f `there is a manifest intention
that the formal agreement is not to be complete until reduced to a formal
writing to be executed, there is no binding contract until this is done.'"
In another case
of Jacobs v. Freeman, 104 Cal. App.3d 177 (1980), however, subsequent
board of director approval was determined to not necessarily mean that the
parties do not intend to be bound.
In Jacobs v. Freeman, the parties
had entered into an escrow for the sale of property. The escrow instructions providing for the
sale obligated the seller to convey the land upon board approval. The court noted that the "seller's
agents were required to act in good faith by seeking board approval for the
transaction, and the board was required to consider the proposal
honestly." The court in Jacobs
v. Freeman focused on three fundamental principles of contract
contract must receive such an interpretation as will make it lawful, operative,
definitive, reasonable, and capable of being carried into effect, if this can
be done without violating the intent of the parties. . . .
principle is that `[i]n every contract there is an implied covenant of good
faith and fair dealing that neither party will do anything which injures the
right of the other to receive the benefits of the agreement. . . .' The implied covenant imposes upon the parties
an obligation that the contract presupposes they will do to accomplish its
"Third, in the
case of an uncertainty as to the meaning of the contract, when the uncertainty
is not remedied by other rules of interpretation, the language should be
construed most strongly against the party who caused the uncertainty to exist.
. . . Since the seller's agents prepared
the escrow instructions, any uncertainty not remedied by other rules of
construction must be construed against the seller."
It is thus clear
that individuals entering into a letter of intent should state expressly
whether they intend to be bound. Any
evidence of an intention to be bound could raise a good faith duty to continue
discussions and negotiations to reach a definitive agreement.
The moral to the
story? Get the lawyers involved!
[This column is intended to provide general information only and
is not intended to provide specific legal advice; if you have a
specific question regarding the law, you should contact an
attorney of your choice. Suggestions for topics to be discussed
in this column are welcome.]
Reprinted from The Journal
Myles M. Mattenson © 2007