A preliminary agreement, such as a letter of intent, a memorandum of understanding or a term sheet, is a helpful tool during the negotiation for the sale or purchase of a business or other complex transaction. It allows the parties to organize the major terms on paper, structure future negotiations and set bench marks for reaching an agreement and concluding the transaction. Additionally, it is an opportunity to address confidentiality and cost allocation in the event that the deal falls apart. However, a preliminary agreement can also be a wolf in sheep’s clothing if it isn’t carefully drafted and fully understood. If the deal falls apart one party to the preliminary agreement may find that it has more teeth than originally thought. A preliminary agreement may provide that the parties have agreed upon certain key terms and identify other terms that they have yet to resolve. In most states, the law will bind the parties to their agreement on the agreed terms and impose upon them a duty to negotiate the remaining open terms in a commercially reasonable manner. Thus, the open terms are filled-in with terms that are usually included in deals such as that contemplated by the parties. In such a state, a party who wishes to terminate the preliminary agreement and walk away from the deal must have a commercially reasonable reason for doing so. Kentucky is not such a state. Under Kentucky law, a preliminary agreement will either be enforced as a binding contract or will not be enforced at all. Kentucky courts do not impose a duty upon the parties to an otherwise unenforceable agreement to negotiate upon commercially reasonable terms.
Under Kentucky law, a preliminary agreement will be enforced as a contract if the parties intend for the agreement to be binding and if the agreement contains all the material terms relating to the transaction. Thus, the intent of the parties with respect to whether they intend for the preliminary agreement to be binding or non-binding should be clearly stated in the agreement. If some parts of the agreement are intended to be binding and others not,the parties should clearly identify which are binding and which are not. Material terms are those terms upon which the deal ultimately depends. For instance, in the sale of a business the purchase price is a material term. However, the payment of the purchase price by certified check or wire transfer is not a material term. The general description of the business assets is material while the exact amount of inventory may not be material. If you don’t want a preliminary agreement to be binding, state clearly in the agreement it that it isn’t binding, leave some material terms for later negotiations by the parties and provide that no party has any obligation to take any action whether or not such action is described in the agreement. If you want a binding agreement, state that the agreement is a final and binding agreement and include all material terms.
“Four Rivers Business Journal,” January 2013