The Design of Staged Contracting

34 Pages Posted: 1 Jun 2017 Last revised: 23 Feb 2018

Albert H. Choi

University of Virginia School of Law

George G. Triantis

Stanford Law School

Date Written: February 22, 2018

Abstract

In negotiating complex business transactions, parties decide whether, when, and how to invite legal enforcement of the rules that govern their relationships, particularly in their use of midstream agreements that reflect some agreement on a number of provisions but contemplate further negotiation (variously labeled memorandum of understanding, agreement in principle, commitment letter, letter of intent, or term sheet). Under the common law of most U.S. jurisdictions, the parties have an intermediate option between enforcement and no-enforcement of such midstream agreements: a duty to bargain or negotiate in good faith or with best efforts. At the core of this duty is an expectation of some fidelity to the terms specified in the agreement. While parties expect these terms to be sticky to some degree, they often do not think through how much and by what means to achieve this. Existing scholarship focuses on the protection of specific investments as the principal goal of the commitment to bargain or negotiate. We suggest, however, that the benefit of the flexible standard of good faith or best efforts comes more broadly from mid-stream regulation of the negotiation process. Once parties have searched for and chosen their respective contracting partner, they need the incentives and flexibility to tailor and optimize the terms of their deal, while also efficiently constraining value-claiming behavior and allocating exogenous risks during their negotiations. The recognition of such broader objectives can allow us to justify how and why, in certain cases, courts are willing to enforce the obligation with more robust remedy of expectation damages, instead of reliance damages as had been advocated by prior scholarship. Building on our earlier work on strategic ambiguity, we also show that concerns about the uncertainty of a flexible legal standard can be addressed.

Keywords: Preliminary Agreement, Letter of Intent, Memorandum of Understanding, Duty to Negotiate in Good Faith

Suggested Citation

Choi, Albert H. and Triantis, George G., The Design of Staged Contracting (February 22, 2018). Virginia Law and Economics Research Paper No. 2017-13; Stanford Public Law Working Paper. Available at SSRN: https://ssrn.com/abstract=2977676 or http://dx.doi.org/10.2139/ssrn.2977676

Albert H. Choi (Contact Author)

University of Virginia School of Law ( email )

580 Massie Road
Charlottesville, VA 22903
United States

George G. Triantis

Stanford Law School ( email )

559 Nathan Abbott Way
Stanford, CA 94305-8610
United States

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