WE SCRIBBLED OUR DEAL ON A NAPKIN.
IS IT BINDING?

So you cut a deal to buy a coin laundry at the neighborhood coffee shop and the closest piece of paper was a napkin!  Is the deal binding?  You wouldn't be the first person to ask the question.  Some people expect to bind themselves by signing a napkin or other piece of paper, and others don't.  The issue is frequently litigated.

In Rennick v. O.P.T.I.O.N. Care, Inc., 77 F.3d 309 (9th Cir. 1996), a physician and an attorney sought to become the Canadian franchisee of a franchisor that provided home medical services.  A meeting was held to discuss the acquisition of the franchise.  The proposed franchisee circulated a written agenda that indicated one of the purposes of the meeting was "to formulate terms of a proposed initial agreement" establishing the business relationship and also provided that the proposed initial agreement would be subject to Board approval of all parties."  The meeting was held without lawyers.

Everyone came to an "agreement" on the basic terms of the deal and at the conclusion of the meeting, the physician suggested that the persons present "formalize" the relationship by shaking hands.  Everyone obliged and shook hands.

One of the negotiators on behalf of the proposed franchisee testified in deposition that:

"At the end of the meeting I volunteered that the way we had formalized relationships before getting lawyers involved was to sort of do it on a handshake basis, and that we wanted to feel that the people we were dealing with were as good as their word.  And we usually formalized that by a handshake on the deal.  So I proposed that, having spent these previous months and these three or four hours bringing into the best form we could our understandings, that we formalize the deal by a handshake.  And my recollection is that [the franchisor representative] enthusiastically agreed to that and all the principal parties got up and circulated around the room and shook hands with each other on having made the deal."  (Emphasis added.)

The physician's attorney prepared a letter of intent that included an agreement that the parties would "continue good faith discussions directed toward the creation of formal written contracts."  The franchisor signed the letter, but added, however, that "this letter of intent is of no binding effect on any party hereto."  The franchisor later denied that it was required to comply with the agreement.

The proposed franchisees asserted that either an oral agreement reached at the meeting, confirmed by the handshake, or the letter of intent, created a binding agreement.  The Court of Appeal affirmed the trial court's decision rejecting the agreement on the ground that no contract was made.

The court noted that the parties' understanding that they would later enter into more formal agreements did not prevent an oral agreement from acting as a binding contract, if that is what everyone intended.  The court also noted that a handshake can constitute sufficient evidence for a jury to infer that the parties intended to be bound at the time. 

The court also stated, however, that the handshake must be interpreted in light of the agenda and the letter of intent.  The letter of intent indicated that it did not bind the parties and that there would be no contract until the boards of directors of the parties approved the written contract.

A letter of intent that refers to the preparation of a subsequent definitive agreement can constitute a binding agreement.  In such circumstances, the letter of intent creates a binding obligation for the parties to act in good faith in the preparation of definitive documents.  In this particular situation, however, the letter included express language that it did not bind the parties.  It said, "this letter of intent is of no binding effect on any party hereto."  The court thus concluded that "[I]f `there is a manifest intention that the formal agreement is not to be complete until reduced to a formal writing to be executed, there is no binding contract until this is done.'"

In another case of Jacobs v. Freeman, 104 Cal. App.3d 177 (1980), however, subsequent board of director approval was determined to not necessarily mean that the parties do not intend to be bound.

In Jacobs v. Freeman, the parties had entered into an escrow for the sale of property.  The escrow instructions providing for the sale obligated the seller to convey the land upon board approval.  The court noted that the "seller's agents were required to act in good faith by seeking board approval for the transaction, and the board was required to consider the proposal honestly."  The court in Jacobs v. Freeman focused on three fundamental principles of contract interpretation:

"First, a contract must receive such an interpretation as will make it lawful, operative, definitive, reasonable, and capable of being carried into effect, if this can be done without violating the intent of the parties. . . .

"The second principle is that `[i]n every contract there is an implied covenant of good faith and fair dealing that neither party will do anything which injures the right of the other to receive the benefits of the agreement. . . .'  The implied covenant imposes upon the parties an obligation that the contract presupposes they will do to accomplish its purpose.

"Third, in the case of an uncertainty as to the meaning of the contract, when the uncertainty is not remedied by other rules of interpretation, the language should be construed most strongly against the party who caused the uncertainty to exist. . . .  Since the seller's agents prepared the escrow instructions, any uncertainty not remedied by other rules of construction must be construed against the seller."

It is thus clear that individuals entering into a letter of intent should state expressly whether they intend to be bound.  Any evidence of an intention to be bound could raise a good faith duty to continue discussions and negotiations to reach a definitive agreement. 

The moral to the story?   Get the lawyers involved!

[This column is intended to provide general information only  and
is  not intended to provide specific legal advice; if you have  a
specific  question  regarding the  law,  you  should  contact  an
attorney  of your choice.  Suggestions for topics to be discussed
in this column are welcome.]


Reprinted from The Journal
Myles M. Mattenson © 2007