Pre-Closing Liability

Competition Policy and Antitrust

Article Snapshot

Author(s)

Omri Ben-Shahar

Source

University of Chicago Law Review, Vol. 77, Special Issue, 2010

Summary

This article analyzes Judge Easterbrook’s policy argument against enforcing pre-closing contract agreements.

Policy Relevance

While the policy of simply refusing to enforce anything but a finalized contract has the advantage of being a clear rule it lacks the subtly to encourage and reward parties who have made progress in a negotiation.

Main Points

  • Judge Easterbrook has penned several cases that have profoundly impacted contract law; the most notable of which are ProCD v. Zeidenberg and Hill v. Gateway 2000. However, one of Easterbrook’s lesser known cases, Empro v. Ball-Co, put forward a decisive opinion about the policy rational behind pre-closing liability.
     
  • The question arises when two parties, negotiating for a contract, enter into a letter of intent, or in some other way write down their mutual desire to enter into an agreement in the future, but then, after this pre-contract agreement is signed, one party backs out. Pre-closing liability, which is argued for by some legal scholars, would allow the remaining party to sue the party who backed out for violating the letter of intent.
     
  • In Empro v. Ball-Co, Judge Easterbrook held that pre-closing liability was against public policy. Easterbrook acknowledges that by entering into a letter of intent the parties have made progress in negotiation, but also indicates that the fact that no formal contract has been signed suggests that the parties still wish to reserve their right to walk away.
     
  • Thus, Easterbrook’s end decision results in no pre-contract liability whatsoever. This kind of “bright line rule,” has the advantage of simplifying future cases, where it will be unnecessary to look into the subject intent or plans of each party when a formal contract has not yet been entered.
     
  • However, Easterbrook’s rule against pre-contract liability is most convincing only when the choice is between no liability and imposing full contract liability. A better solution is to allow for recovery of partial damages in pre-contract liability cases.
     
  • Any pre-contractual liability rule must answer two questions: (1) when is a party liable for breaking off negotiations; and (2) what are the legal remedies available to the disappointed party. One possible solution to this problem is a policy of no-retraction.
    • Under the no-retraction theory, parties are only liable for breaking off negotiations if some kind of preliminary understanding is formalized in writing. This makes it clear that the parties have chosen to be partially bound, and then provides a basis for determining which party has broken the agreement.
       
    • Secondly, the remedies available under no-retraction would be the other party’s reliance expenditures which occurred after the parties entered into the preliminary understanding. This could include the cost of things such as negotiation, or preparing for the merger or acquisition.
       
  • This kind of partial recovery satisfies the dual policy goals of encouraging parties to continue in negotiations while still acknowledging that they have not yet entered into a formal contract. In this way, it is more advantageous than the all or nothing option proposed by Judge Easterbrook.
     

 

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