Preliminary agreements – often called ‘heads of agreement’ or ‘memorandums of understanding’ – are commonly used to outline the commercial intent of the parties for entering into the transaction and provide a key framework of the terms of a proposed transaction. These documents may be expressed as legally binding, non-binding or legally binding in part. In circumstances where negotiations fail and formal transaction documents are never finalised, difficulties can arise around whether the preliminary agreement is legally enforceable, and to what extent. In this article, Andrew Windybank of our corporate and commercial team considers how recent cases have dealt with issues relating to preliminary agreements.
The traditional approach – Masters v Cameron
In determining whether a legally binding contract exists, the parties must prove an intention to be legally bound by the document. The 1954 case of Masters v Cameron is the landmark decision in this area, establishing key principles to determine whether or not an intention to be legally bound exists in relation to preliminary agreements. The High Court case considered whether a preliminary agreement for the sale of a farming property formed a binding contract without the execution of a formal contract.
The Court held that agreements which remain “subject to” being dealt with by a formal contract may fall into one of three categories, namely:
- the parties have reached finality in arranging all the terms of their bargain and intend to be immediately bound to the performance of those terms, but at the same time propose to have their terms restated in a form which will be fuller or more precise but not different in effect;
- the parties have completely agreed upon all the terms of their bargain and intend no departure from or addition to that which their agreed terms express or imply, but nevertheless have made performance of one or more of the terms conditional upon the execution of a formal document; and
- the intention of the parties is not to make a concluded bargain at all, unless and until they execute a formal contract.
Recent expansion on Masters v Cameron’s principles
Key commercial terms to determine intent
Where it can be demonstrated that parties to a preliminary agreement intended additional terms to be included in a future contract, the courts have historically been reluctant to enforce such agreements due to the inherent uncertainty of the agreed terms. However, in recent times courts have demonstrated a willingness to “fill in the gaps” to uphold bargains despite the intention being obscurely expressed. Some have even suggested that these situations amount to a fourth Masters-style category (as considered in GR Securities Pty Ltd v Baulkam Hills Private Hospital Pty Ltd (1986) 40 NSWLR 631).
However, there still must be a sufficient degree of clarity as to the key commercial terms to establish an agreement as legally enforceable rather than as a starting point for further negotiations. This was illustrated in the following cases:
1) Non-binding preliminary agreement
- In Factory 5 Pty Ltd v State of Victoria (No 2)  the parties entered into negotiations involving a letter which stated that “we confirm that the parties have agreed that F5 is to be appointed as Concessionaire subject to reaching agreement on a legally binding Long Form Concessionaire Agreement to be provided by M2006 and subject to M2006 Board Approval”.
- At first instance, the trial judge found that the letter constituted a binding contract by differentiating between negotiations held for the purpose of reaching an agreement and those held for the purpose of accurately stating what is to be incorporated in a formal document. On appeal, however, the Full Federal Court held that there was no binding agreement for reasons including the lack of contractual consensus on “critical terms” and the letter being subject to a number of conditions that were never satisfied.
- In Nurisvan Investments Ltd & Anor v Anyoptian Holdings Ltd  a heads of agreement for the sale of a party’s shares in a company was deemed to be no more than an agreement to agree largely due to the scope of terms that were left for future negotiation. On appeal, the Court held that “where a document is missing certain key terms, a court will more readily infer that the document itself is not binding”.
2) Binding Preliminary Agreement
- In Stellard Pty Ltd & Anor v North Queensland Fuel Pty Ltd  the Supreme Court of Queensland found that a chain of emails constituted a binding contract for the sale of a roadhouse despite the lack of subsequent formal negotiations. The agent of the seller’s email to the buyer included details of price, deposit and the settlement date, and attached a draft contract which was immediately accepted by both parties. The seller later denied the existence of any binding contract.
- The Court held that despite maintaining an “agreement subject to a formal contract”, it was clear from the broader context of the detailed emails that the parties intended to be immediately bound by the negotiated essential terms and to formally record them later (essentially, the first category of Masters v Cameron).
The parties’ conduct – a key determinative factor in recent decisions
Whilst the language used in drafting the preliminary agreement will be important in deciding the parties’ intention, it is not determinative. Recent decisions indicate that the courts will endeavour to give effect to the commercial intent by considering the surrounding circumstances such as conduct both during and after the preliminary agreement.
The decision in Brice v Chambers & Ors  is indicative of the growing significance of conduct as a key factor in determining intention. Here, the Court of Appeal found that verbal negotiations for the sale and purchase of Wagyu cattle created a legally binding agreement between the parties. The Court took the view that the parties had engaged in a distinct pattern of behaviour which was consistent with the terms of the alleged agreement. The decision was despite the fact that not all terms were agreed or intelligible.
This judgment not only demonstrates how today’s Courts will weigh up surrounding circumstances when determining intention but also emphasises the risk that parties’ conduct can create during informal contract negotiations.
The cases considered in this article serve as a reminder that if you are party to a preliminary agreement, you need to ensure that you have concisely communicated your intention with respect to any proposed contract through both words and actions.
To minimise the risk of misinterpreting intention:
- be as clear and succinct as possible when stating the nature of your intention in the agreement;
- ensure that your conduct corresponds with your stated intention; and
- confirm that the preliminary agreement clearly identifies any critical terms which are to be included in the document.
Inconsistent language and behaviour as to the preliminary negotiations may lead to the Court finding that you have intended to be and are, bound by the terms of the agreement despite your lack of intention at the time.
This article is not legal advice. It is intended to provide commentary and general information only. Access to this article does not entitle you to rely on it as legal advice. You should obtain formal legal advice specific to your own situation. Please contact us if you require advice on matters covered by this article.
This article was co-written by Corporate Lawyer, Emma Morris.