The Design of Staged Contracting
36 Pages Posted: 1 Jun 2017 Last revised: 10 Nov 2017
Date Written: November 6, 2017
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, letter of intent, 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. Law firms warn their clients about the risk of inadvertently bringing on this type of legal enforcement, but with care, this risk is small. Rather, the parties are often unclear about the freedom they prefer for themselves or their counterparties to deviate from the terms of their midstream agreements. They expect these terms to be sticky to some degree, but do not think through how much and by what means to achieve this. Judges and commentators identify 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. 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
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