What is a Contract to Agree?
Contracts closely related to an option have been called various things, including a "contract to agree", "contract to make an I option agreement" or "agreement to grant an I option", but I’ll refer to an agreement to grant an option as a "contract to agree" to simplify matters.
A contract to agree is an agreement where one or more parties agree to deal with a particular piece of property in a certain way in the future, most often by granting an option (also known as a right of pre-emption) over the property to another party at a value to be agreed in the future. It is useful as it doesn’t trigger any SDLT liability at the time of signing, but the parties are bound to grant the option at a later date. However, unlike most property agreements, it is not a "legally binding contract". As Mr Justice Jacob said in SSI v Olympic:
The contract to agree is really a reference to the obvious step, common to all contracts, that if you enter a legally binding contract you are bound by it and you cannot thereafter change your mind . In a contract to agree you can change your mind, so such a contract cannot be binding because to be binding is, virtually by definition, to be a legally binding contract because the phrase means that if you are bound to do something you cannot lawfully recede from the obligation. It’s essentially a hybrid between a legally binding agreement and an agreement to agree, which can create uncertainty and therefore becomes an issue when the parties cannot reach agreement. An issue arises, as Jacobs J highlights, when the parties have failed to agree on price and the seller argues that it does not have a binding contract and so can sell to a third party, citing, for example, the Court of Appeal authority Copeland v Greenhalf [1977] 1 WLR 880. The alternative view is that once it is clear that no agreement can be reached, a contract to agree is no longer binding. If there is a binding contract to agree, the parties must then agree and, if they don’t, the terms of agreement can be implied by a judge.
Legal Enforceability of Agreements to Agree
It is easy to see the appeal of contracts to agree, particularly in the context of partnerships or joint ventures. However, the risks are clear in the wake of a recent Court of Appeal decision in which a contract was held to be invalid because it was merely an agreement to agree.
The issue at the hearing was whether the substitute partnership agreement made between the parties was valid, ie as a binding agreement or merely an agreement to negotiate.
If enforceable, it would have been effective to govern their relationship and, potentially, grant the defendant an equitable lien over certain documents stored by the claimant in his office.
A contract to agree is an agreement to enter into a future contract or to agree a number of matters in the future. It can also be referred to as an "agreement to negotiate".
In this case, the framework partnership agreement set out principles to guide negotiations on the key commercial terms, but left many of these points to be the subject of further negotiation. The question before the Court was whether the framework agreement amounted to a binding agreement and was thus capable of supporting the defendant’s assertion that he could claim an equitable lien over certain documents.
Whilst these types of contract are common, it is often difficult to determine the circumstances in which they will be enforceable.
This was not the first time the case of Walker v Odgen had been heard. At first instance, the judge had applied the objective approach: when construing a contract, the question was whether a reasonable observer would think the contract bound the parties. On appeal, no challenge was made and the defendant lost his case.
Walker v Odgen therefore remains good authority for the proposition that where an agreement seeks to govern future conduct, the contract must be held in abeyance until negotiations are concluded and it is clear that the parties intend to be bound. Until that point, there will be no binding contract.
However, there remain grey areas as to when a mere agreement to agree does become binding.
So whilst it is clear that, generally, agreements to agree will not make it to court, where they have contractual force, it is still difficult to determine when that happens. As with the application of any general principle, the circumstances will be key.
Common Situations and Illustrations
Contracts to agree are seldom used these days but are useful in certain situations.
Here are a few common scenarios where a contract to agree might be considered and some practical implications to bear in mind. Acquisitions of land with proposals to develop it This situation arises quite regularly when, say, a developer wishes to acquire (for example) a field from a landowner. The landowner is usually open to agreeing the purchase price but wishes to include restrictive covenants in the contract to limit the use to which the purchaser can put the land or require the purchaser to obtain planning permission before undertaking any works. Alternatively, the landowner may wish to obtain a share of the profit from any later development. It may be impossible to ascertain with any certainty at the outset whether one lot or two will ultimately be developed (either together or separately). In these situations, the parties may agree a small inducement payment to ensure that the landowner will co-operate with any necessary planning application. Farming agreements Another area where they may be useful is where the purchase of a field is for farming purposes expected to last for several years and the parties anticipate that a further transaction is possible in the future once the land has been used. A restrictive covenant to keep the land as a field until the purchaser wishes to build would be agreed but the seller may only be happy to accept so long as he receives an up-front payment without which the transaction would be deemed ended. The predictive judgement in contracts to agree will be challenged here as the court may need to decide when in the future the purchaser intends to develop his field. On grant of a lease A landlord may wish to grant a lease but know that the tenant will not be able to make up his mind until it is "properly fit for letting." For example, when the lease requires building works to be done, a formal agreeing to agree contract can be used. In this case, however, there is a possibility that despite the rent having been set, the parties may miss out on a huge potential uplift in rent if it is possible to market the property as being available and letting it at an earlier date. There is also an additional problem that a landlord who wishes to agree to agree cannot insist on any condition or provision being included that the parties do not first formally agree to. Joint Ventures Where funding is not in place at the outset, a joint venture might decide to enter into a contract to give them the as much time as possible to secure the finance they need. A contracts to agree could be a handy tool to facilitate this. However, there is a very narrow scope for extending the length of time given to complete contracts to agree.
Risks and Pitfalls
While contracts to agree can be a useful tool in negotiations, they are not without their risks and drawbacks. From a contract law perspective, the biggest issue is that such contracts are inherently uncertain. Contract law, ideally, should provide a solid, enforceable framework. In order to be an enforceable contract, the agreement must have sufficient certainty; if it is uncertain, then it is not possible to know whether any particular obligation has been breached. The court will not determine a term where it cannot identify what duty is owed in the first place. The exact scope and positioning of the provisions must be clear, or there is a risk of ambiguity being taken against the drafter, and potential difficulties in enforcing the contract if the offending portion must be struck out as unenforceable. This problem is compounded by the tentative, open-ended nature of such contracts: even if there are provisions to guide certain "subsequent" agreements, they cannot reflect all of the future circumstances. Where a dispute arises, it will be necessary to prove a liquidated damage was incurred, which may be difficult to attribute to a particular breach. Contracts of this type leave scope for misunderstanding. The terms can be vague and subject to different interpretations, causing arguments about what parties thought was being achieved. This uncertainty may not be easily resolved due to their very nature. That said, this type of contract still has uses. Alternative methods exist to handle risk management, and external parties are often willing to assume risk above a particular sum. However, negotiating the terms carefully remains vital.
How to Draft an Effective Agreement to Agree
To draft an effective agreement to agree you need to ensure that there are precise terms in respect of the matters which must be agreed, time limits (if appropriate) in which the matters must be agreed and a penalty to be imposed if the matters are not agreed in the specified time.
For example:
"You agree that you shall, within 7 days of the date of this letter, respond to me with your comments on my Letter of Offer and that if we have not within such 7 days both signed the Land Purchase Agreement to purchase the land, the price shall be increased by £100,000".
However, even with the above, its effectiveness may be limited at best. For example, if it was to exceed 18 months and during that time prices had gone up 20% in the locality, in the vast majority of cases the Courts would not let the land be purchased at the significantly lower price . Again, however, in the vast majority of cases, if you were trying to agree a price for a sale of commercial property and the sale did not take place for 6 months and the property price had gone down 20% in the time it is likely that the courts would allow the price to be reduced to the lower amount (depending on how the commercial property market was at the time etc).
Therefore, if you are going to use an agreement to agree which has no certainty that it would result in a deal taking place, you need to ensure that you protect yourself and your client against the risk of any increase in purchase price by ensuring that the property has been specifically identified and that any increase in purchase price is reflective of that fact.
Contracts to Agree as Alternatives
The above is not a legally binding contract but another piece of evidence demonstrating the willingness of a party for an agreement to be made in the future. Thus, a contracts to agree can be valuable but is not recommended for high value or risky deals. Agreements to make an agreement are much more useful, including: – Heads of term or terms sheets – these are last minute documents used to show that a deal has been agreed in principle but puts the parties on notice that something more substantial is to follow. They almost always contain a clause that binds the parties to the relevant provisions, overriding anything in the rest of the agreement. – Memorandum of understanding – this is a more serious agreement which precludes any types of negotiations or discussions between the parties. In these agreements lawyers can be brought in to implement the negotiation process. In doing so the buyer can data room information and conduct due diligence. – Conditional head of terms – the most binding of the agreement to make an agreement, this is a legally binding contract conditional on certain events happening. In order to proceed, the buyer must negotiate or do certain things and, if they succeed, the contract will come into force.
Case Law
Plaintiffs who had entered into an agreement to purchase a flat in a development for £1.04 million brought an action for specific performance of the agreement to purchase their flat. Damages were not acceptable to them. The developer, Crest Nicolson Residential Limited, on the other hand submitted that the agreement between the parties was in fact a contract to create a contract for sale, which it then repudiated prior to exchange of contracts. Thus the developer contended that the plaintiffs had no enforceable rights against it and the defendant was under no duty to return the £15 , 000 reservation fee paid by the plaintiffs. This case went to trial and judgment was given for the plaintiffs. During the hearing it was found that the plaintiffs had not satisfied all the conditions precedent contained in the reservation agreement and the deposit should have been paid to an agent of the developer. The plaintiffs said that the defendant owed the plaintiffs the money under the contract. The court held that the plaintiffs’ argument would contradict the reservation agreement and was therefore rejected. The agreement came about due to a wrongful pre contract misrepresentation by a director of the developer. Here the court considered both the doctrine of mistake as well as that of actionable misrepresentation. The doctrine of mistake was held to be inappropriate and the court recognised that all elements of a successful action for negligent misrepresentation were satisfied. The court held that a mortgage could be taken to effect the agreement. In conclusion, the court found that the implied agreement had created a binding bargain between the parties. The reservation fee had been duly paid and the court ordered specific performance.