This article was first published in Australian Property Investor Magazine and is copyright and reproduced with their permission.
How can preliminary agreements save investors time and money?
Many thousands of dollars in lawyers’ time and countless hours of investors’ time are burnt everyday in the property world in failed attempts to negotiate real estate contracts.
“Is there a less frustrating, more time and cost-efficient way to go about negotiating real estate deals?” one jaded real estate client asked me recently.
“There sure is,” I replied, “use a form of preliminary agreement to reach initial agreement on the basic terms of the transaction and once you’ve done that you can then move forward comfortably to settle the wording of the formal agreements.”
Many of the more complicated commercial and industrial transactions, joint ventures and property syndications are brought together in this way and thereby avoid wasting time and legal costs in deals that don’t proceed.
These preliminary agreements are given a variety of badges, however the main ones are:
1.heads of agreement;
2.offer and acceptance;
3.letter of intent;
4.memorandum of understanding (MOU).
Motives and strategies for using them
Apart from the cost and time savings already mentioned, there are many and varied other reasons to use these legal documents:
1.to have something more concrete to show other prospective joint venturers and syndicate members;
2.to provide a level of commitment to the transaction to the other party;
3.to have something fundamental to show financiers to gauge their level of interest in the transaction;
4.for the ever increasing number of companies that require approval from directors before expending the company’s resources, to obtain board approval to proceed in a substantial way;
There are downsides though to using preliminary agreements. They add an extra layer to the documentation for the transaction, often resulting in delays in concluding final contracts and sometimes loss of the deal. So investors should always ask themselves, is a preliminary agreement really necessary or should they just “jump in” with formal contracts?
How binding are preliminary agreements?
This question has been before Australian courts many times and the issues are now settled. Whether these agreements are legally enforceable depends on the wording of the agreement itself and the circumstances that surrounded its making (eg. correspondence, emails and verbal representations made by the parties). The two fundamental legal issues that have to be looked at are:
1.Do the parties intend to be bound by the agreement? What was their intention at the time they signed the documentation?
2.Are the terms of the agreement complete and certain enough? Is there enough certainty to create a legally binding document?
Since no two sets of facts are the same and the courts have said that even small fluctuations in them can lead to different outcomes, great care must be taken in dealing with these two issues.
In the case of Masters vs Cameron, the High Court of Australia classifies cases into three different categories. In two of these categories the court said preliminary agreements are binding and in the third category they’re not.
The intention of the parties about whether it’s to be legally binding upon them or not can be clearly stated in their agreement. The issue will then be crystal clear, otherwise it will have to be determined by a court by looking at the wording of the agreement and the conduct of the parties before and after signing the document, including their communications (eg. letters, emails, telephone calls etc.).
I recommend you put it beyond any doubt by adding one of the following conditions to the preliminary agreement.
A legally binding agreement:
“Execution of this preliminary agreement by the parties will constitute a legally binding and enforceable agreement between them.”
Or an agreement that’s not legally binding:
“Execution of this preliminary agreement by the parties does not create a legally binding and enforceable agreement between them and only creates a statement of their intention. It does not create any rights or obligations on the parties and to put the matter beyond any doubt this agreement imposes no obligations on any of the parties to proceed with the transaction.”
From a practical point of view though, once the parties make a clear statement of their intention by adding one of the above alternative clauses to their agreement, they have to be very conscious of how they conduct themselves after that. For example, if they state that their agreement isn’t binding, they must be careful not to do anything that contradicts that statement (eg. by corresponding with each other as if it is certain the transaction will proceed).
Are the terms of the agreement complete and certain?
For the agreement to be enforceable not only must the parties have intended to be bound, they must also have recorded all of the essential terms of that agreement to constitute it as a binding agreement.
The agreement must therefore list the essential terms. This doesn’t have to be a complete list of the terms (and the parties don’t want it to be, as flexibility is always needed to negotiate a more comprehensive final contract).
Some examples of essential terms are:
1.The purpose and description of the transaction, eg. to acquire land to construct a small office building to be strata titled for the ultimate use as offices by the parties.
2.The purchase price and the deposit to be paid for the land.
3.The settlement date of the purchase and the commencement date of the project.
4.Any special conditions, eg. due diligence, feasibility etc.
5.The share each party is to take in the transaction and the voting rights they’re to have during the development of the project.
6.Is the strata titling of the lots to be in proportion to the parties share?
7.Who will be the builder?
8.How is the building price to be determined? Is it to be cost plus, or a fixed price contract?
9.The name of the funder.
10.Who has naming and signage rights for the building?
11.If one of the parties is to be the project manager, is a project management fee to be paid?
Preliminary agreements are a useful tool in the dynamic world of property investment.
I hope this article has gone some way to educating you on how and when to use them. Until you need this information, keep a copy of this article in your ‘investment tool box’ for future reference.
Rob Balanda is a partner in the Gold Coast based law firm MBA Lawyers. He is a highly regarded educator of property investors and estate agents and the author of the “Made Simple” series of books and Cd’s. www.mba-lawyers.com.au
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