Binding Nature of Preliminary Agreements
The purpose of a preliminary agreement is to ensure conclusion of the main contract. Therefore, it is important that the preliminary agreement is binding. The validity of the preliminary agreement means that the parties undertake to conclude the main contract subject to the conditions agreed in the preliminary agreement, and to continue negotiations in respect of open issues until the main contract can be concluded.
The preliminary agreement can be made binding on either party or both parties. Mutual preliminary agreements are suitable for situations where the parties have not reached agreement on all details, but nevertheless wish to commit themselves to concluding the main contract in the near future.
If a party breaches the preliminary agreement, and does not, for instance, conclude the main agreement despite an agreement to such effect in the preliminary agreement, the other party may require conclusion of the main agreement, specific performance of the contract, or compensation for costs relating to the negotiations. The parties may also agree, in the preliminary agreement, on a contractual penalty payable by the breaching party to the other party.
As a last resort, it is possible to request a courts order for specific performance of the main contract. This, however, requires that the obligations of the parties have been defined in the preliminary agreement to a sufficient degree. In case the main performance obligation is not defined in the preliminary agreement, the court may take the view that the preliminary agreement does not require conclusion of the main contract. The main performance obligation refers to the essential part of the agreement, such as the object of sale in a sales agreement.
If an incomplete preliminary agreement is submitted to a court, it is possible that only the preliminary agreement is confirmed. In one case, a party requested the court to order the other party to sign a contract of sale referred to in the preliminary agreement. The court, however, was willing to confirm the validity of the preliminary agreement only, leaving the parties to conclude the open issues of the main contract or, in case the negotiations should fail, submit them to a separate court process.
Even if the preliminary agreement is binding, it does not establish any rights as contemplated in the main contract, such as rights of ownership. Therefore, it is not possible to, for example, resell an object of a preliminary agreement regarding sale of the said object.
Preliminary agreements are generally binding even in the event of major changes in circumstances.
A preliminary agreement may also contain conditions precedent, for example regarding obtaining of a certain license or financing or other corresponding future event. In order for the non-fulfillment of such condition to release the parties from their contractual obligations, the condition must be material and clearly observable by the other party. It is always advisable to include such conditions in the agreement.
The completion date of the main contract is usually set out in the preliminary agreement. If this has not been done, the main contract should be concluded within a reasonable time, if thus requested by a party. The term of the preliminary agreement should also be explicitly agreed. If neither party requests conclusion of the main contract, the preliminary agreement expires on the agreed date. If a term has not been determined, the preliminary agreement is valid for a reasonable period of time. It may be difficult to determine what constitutes a reasonable period of time. Invoking the preliminary agreement can be done informally, in other words, it may even be done orally. Continuation of negotiations may also be regarded as implied requirement to conclude the main contract.