A contract involves an offer by one party and an acceptance of that offer by another party, and most commercial contracts involve multiple offers and acceptances. Another contract element requires the parties to agree to the terms and conditions of the offers and acceptances, typically by a written agreement signed by both parties. However in some circumstances the parties’ agreements will be enforceable without a fully signed formal written contract.
In First National Mortgage Company v. Federal Realty Investment Trust, (9th Cir. 2/11/ 2011) Federal Realty sought to develop a mixed-use project on land held by First National. Over several years the parties exchanged proposals, counter proposals, revised proposals, and finally the parties executed a “Final Proposal.” The Final Proposal contained First National’s agreement to ground lease the property to Federal Realty, and included the right to require Federal Realty to buy the property during the 10 year period after commencement of the ground lease. It also included the right of Federal Realty to purchase the property at the end of the 10 year period. Final Proposal contained Federal Realty’s agreement to reimburse First National $75,000 to buy out its tenant’s lease. Federal Realty agreed to prepare the definitive agreement, and the Final Proposal ended: “The above terms are hereby accepted by the parties subject only to approval of the terms and conditions of a formal agreement.”
The parties never executed a formal agreement. During the negotiations First National terminated its tenant’s lease and requested reimbursement. Federal Realty refused claiming “we still do not have a binding agreement in place.” The real estate market turned, and First National filed a lawsuit. After a jury trial, which found that the parties intended the Final Proposal to be an enforceable agreement, First National was awarded damages in the amount of $15,901,274.
The 9th Circuit acknowledged that where there is a clear intention for the agreement not to be complete until the formal writing has been executed, no binding contract will be found until such writing has been fully executed. Nevertheless, the Court noted “an agreement is not unenforceable merely because it is subject to the approval of a final contract” and affirmed the award.
In an Order issued December 29, 2015 by the United States District Court in the Northern District of California in Bighorn Capital v. Security National Guaranty Case No: C 15-03083 SBA, the Court acknowledged the principle that “an agreement is not unenforceable merely because it is subject to the approval of a formal contract,” however it observed that, where essential terms are either absent or ambiguous, where contingencies exist and there is a no-fault deadline, it is likely that the parties failed to reach an agreement at all.
The owner and developer of Project entered into a term sheet with a capital partner who agreed to provide a secured loan to develop the Project, in exchange for a 50% interest in the Project. Capital partner agreed to fund loans “subject to negotiation, execution and delivery” of various documents. The Term Sheet provided that “[i]f this transaction is not funded within 45 days of execution hereof, this Term Sheet will become null and void unless mutually extended by both parties in writing.” The loan transaction was not completed, and owner argued that the capital partner failed to provide proof of its ability to fund. The capital partner claimed that owner failed to provide documents necessary to complete the loan.
Capital partner sued, with the complaint claiming the Term Sheet constituted a binding contract, and recorded a lis pendens on the Project, asserting a right or claim of ownership of the Project. Owner filed a motion to expunge the lis pendens, asserting that the Term Sheet was not an enforceable contract. The Court granted the motion to expunge as the capital partner had not demonstrated the probable validity of its real property claim because the Term Sheet was not a binding loan agreement.
The ultimate disposition of the case is unclear, however the Order makes it clear that the lack or ambiguity of material terms, contingencies to performance and the 45 day termination point, likely evidence the failure of the parties to reach an enforceable agreement.
In Vita Planning and Landscape Architecture v. HKS Architects (9/25/2015), the California Court of Appeal, directly addressed the enforceability of a negotiated but unexecuted contract. A Texas architectural firm entered into an agreement (“Prime Agreement”)with a developer for the construction of a luxury hotel in California, which agreement provided that all claims or disputes would be resolved by courts in Texas, applying Texas law. The Architect exchanged proposals with a California landscape design firm and ultimately provided a definitive agreement for execution. Based upon its concerns regarding the developer’s financial condition, the Architect included a “pay when paid” provision, absolving the Architect of paying for work performed by the landscape designer if the developer doesn’t pay the Architect. The definitive agreement for the design services incorporated the terms of the Prime Agreement, including the Texas choice of law and forum selection provision, but the agreement was never signed by either party. Nevertheless, services were provided and both parties ultimately acknowledged that the parties conducted themselves as if they had an agreement.
The project never materialized and the Architect was not able to collect on its judgment against the developer. The landscape designer sued the Architect in California state court, which ruled that the Architect was entitled to enforce the forum selection clause and have the case heard in Texas.
On landscape designer’s appeal, the Court of Appeal recognized that if the trial court’s determination of the existence of a contract is supported by substantial evidence, it must be upheld. Since the absence of signatures to an agreement does not render a contract unenforceable, the Court determined that the evidence supported the existence of an enforceable contract.
While California generally favors forum selection provisions in contracts, provisions which violate the state’s public policy will not be enforced. The Court noted that while “pay if paid” agreements are enforceable under Texas law, the California Supreme Court has ruled that such agreements violate public policy and are unenforceable in California. The Court also noted that California Code of Civil Procedure Section 410.42 expressly provides that agreements between a contractor and a subcontractor with offices in California that require disputes to be “litigated, arbitrated or otherwise determined outside this state” are void and unenforceable. The Court rejected the Architect’s assertion that the parties were “design professionals”, reversed the judgment and awarded the landscape designer costs on the appeal.
In summary, an unexecuted agreement does not mean that it is not enforceable. If a party intends not to be bound until a definitive agreement has been reached and signed, it must be clear in its communication and consistent in its conduct. In all circumstances it is in the best interest of all parties to negotiate and execute a definitive, comprehensive written agreement, describing all agreements and undertakings, as well as the consequences of any breach.
This article was written by Alfred M. Clark, III, a partner in the Los Angeles office of Locke Lord LLP and member of its Board of Directors. Al has more thirty-seven years’ experience counseling businesses and business owners in a wide variety of strategic and operational issues, with his principal practice area involves representing institutional lenders and private investors in real estate financing transactions, including forward commitments, construction, bridge and permanent financing, on properties as diverse as industrial facilities, office buildings, multi-family housing, residential tract developments, retail centers, hotels and specialty facilities. Al represents investors, landowners and commercial users in a wide variety of real estate transactions, including the acquisition and disposition of real estate assets, leasing, land use and condemnation issues, with many transactions involving sustainable development and property contaminated by hazardous materials.
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