Contract Realism and Formalism in Preliminary Acquisition Agreements and Negotiations Joseph A. Franco

Abstract

Preliminary negotiations in which a binding contract is imputed, and formal preliminary agreements, which may create a binding contract of undetermined scope, have special prominence in the corporate acquisition context. Case law in this area of preliminary dealings is arguably confused and unsatisfying. In recent years, contract scholars (including M&A scholars) have theorized about the purpose of such preliminary dealings primarily in the context of formal preliminary agreements, and they have also considered the role of informal negotiations and non-binding agreements in contract creation. Notwithstanding differences, these scholarly analyses have uniformly maintained that common law principles (if applied correctly) provide a coherent approach to preliminary dealing conduct. In contrast to this approach to preliminary dealings, this paper argues that, in the corporate acquisition context, preliminary dealings should be addressed under a different regime of formal contracting standards. The existing common law regime protects the integrity of preliminary dealing conduct (both formal and informal) at the risk of mistakenly imposing contract obligations on an unsuspecting party. In the distinctive context of corporate acquisitions, this approach fails to minimize efficiently the costs arising from the mistaken imposition of contractual obligations. Specifically, corporate acquisitions invariably conjoin features that alter the marginal social costs and benefits associated with contract formation, features which are uncharacteristic of many, if not most, contracting situations. Salient features in the corporate acquisition context jointly include: (i) an intrinsically multi-step bargaining process; (ii) the routine participation of sophisticated business counsel; (iii) potentially enormous contractual liability arising from contested (and generally equivocal) inferences where contractual clarity can be obtained at relatively low cost; and (iv) disproportionate windfalls or forfeitures for third-party stakeholders in the case of mistakenly imposed obligations.

This paper proposes an alternative formal regime: an enhanced statutory signed acquisition agreement requirement (“SAAR+”). The requirement would directly address preliminary negotiations in acquisitions where a binding contract might otherwise be imputed, as well as the ill-defined contractual status and scope of formal preliminary acquisition agreements. Drawing inspiration from Judge Friendly’s observation advocating a fairly simple bright-line approach in complex business negotiations generally, a SAAR would preclude the formation of a binding agreement based on preliminary negotiations regardless of specificity in the absence of a signed acquisition agreement. A simple SAAR formality, however, would do little to eliminate the contractual opacity that inheres in signed formal preliminary acquisition agreements which may or may not be binding and, if binding, whose scope may be ill-defined. This inherent opacity of formal preliminary agreements is addressed with the enhanced SAAR+ regime: a simple SAAR coupled with a default rule that would limit damage remedies to reliance damages unless the parties expressly contract otherwise, either to eliminate damages, or to allow damages in excess of reliance damages. The default rule would incentivize contracting parties to make their intentions explicit with respect to the intended status and scope of any formal preliminary acquisition agreement.