Partner Jay Leary and Senior Associate Louise Bell outline how to use short form agreements while avoiding long-term pain.
Short form agreements are commonly used in the resources sector and are known by a variety of names including a memorandum of understanding, heads of agreement, letter of intent and term sheet.
Depending on the specific project, short form agreements can be beneficial, often serving a purpose in the pre-contractual phase of negotiations, before a full form agreement can be negotiated at a later stage.
However, short form agreements are not without pitfalls, particularly if they are drafted in haste. To ensure a short term fix doesn’t become long term pain, the areas outlined below require careful consideration.
Reasons for using a short form agreement
At the outset, it is important to consider whether the benefits of negotiating a short form agreement outweigh the benefits of proceeding directly to the full form agreement. If a short form agreement is to be used, then the parties should consider how the drafting and negotiation process will be managed so that it does not cause unnecessary delays or costs to the overall transaction and/or create unnecessary tension between the parties.
Short form agreements not intended to be legally binding
If the parties do not intend a short form agreement will be legally binding, then the agreement should include an express statement to that effect. However, parties should be aware that if a short form agreement is not legally binding, there may be no legal remedies available to a party if the other party breaches or fails to perform the agreement. The parties should also be aware that even if a short form agreement includes an express statement that the agreement is not legally binding, a court may have regard to a party’s conduct (and the other party’s reliance on such conduct) in determining the intention of the parties, particularly in the absence of an appropriately drafted disclaimer clause.
Even if a short form agreement is not legally binding, it may be used by a party in subsequent negotiations to impose a ‘moral obligation’ on the other party not to depart from the positions taken by that other party in the short form agreement.
If it is unclear whether the parties intended the short form agreement to be legally binding, but the terms of the agreement are sufficiently clear and the agreement is either supported by consideration or in the form of a deed, then it will be presumed that parties intended to create a legally binding contract.
Short form agreements intended to be legally binding
If the parties want a short form agreement to be legally binding, then the agreement should expressly state this. However, even with this express statement, it may not become apparent to the parties that the terms of the agreement are not sufficiently clear or that fundamental terms have been omitted until they seek to put the agreement into practice. If this occurs, and a party wishes to enforce those terms of the agreement, a dispute between the parties may ensue.
Parties will often include in a short form agreement an obligation to negotiate in good faith the terms which have not been agreed but are important to the transaction. Parties should be aware that this obligation may not be held to be legally binding by a court.
The way in which the short form agreement deals with terms that have not been agreed will be particularly important where the parties intend that the short form agreement will continue to be binding for a specified term, even if they are unable to reach agreement on the full form agreement by a certain date during that term.
Short form agreements intended to be partially legally binding
If it is intended that the short form agreement should be binding in part only, then the individual clauses of the agreement that are intended to be legally binding should be clearly identified.
These clauses might include those relating to confidentiality and privacy, intellectual property, exclusivity, costs and governing law. If, however, the parties are primarily concerned about the protection of confidential information and exclusivity in the context of pre-contractual obligations, then the parties should consider whether a confidentiality and exclusivity agreement would suffice.
If the short form agreement includes a price or charge, then the parties should consider the circumstances in which that price or charge may be adjusted rather than stating a bare price.
Other considerations include the extent to which indemnities and warranties will be dealt with in the short form agreement and whether disclosure of the short form agreement to the ASX (or any other relevant stock exchange) is required.
Regardless of whether a short form agreement is intended to be legally binding, parties should consider the potential taxation implications of entering into a short form agreement.
To sign or not to sign
Determining whether a short form agreement should be used depends on the specific details of a resources project and what each party is seeking to achieve. Before making a decision, carefully weigh up the pros and cons. This will help avoid seeing a short form agreement become the basis of a drawn-out dispute.
This article first appeared in the December edition of National Resources Review magazine.
The contents of this publication, current at the date of publication set out above, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on this publication.
© Herbert Smith Freehills 2020