Attorneys and dealmakers beware: if a court in the Southern District of New York has its way, it may soon be possible to force a party to perform obligations set forth in a contract it never executed. In an opinion by Judge Richard Owen, in July 2003, that surely caused many sleepless nights for transactional practitioners, the District Court handed down a decision that raises many questions and is disquieting to those who hold to the belief that until both sides “sign on the dotted line,” there is no deal. This article summarizes the District Court’s decision, the subsequent vacatur of this decision by the Second Circuit, and suggests ways in which attorneys can avoid the pitfalls of Judge Owen’s decision, client embarrassment, and potential malpractice claims.
The case, AIH Acquisition Corp. v. Alaska Industrial Hardware, involved an acquisition company that sued the corporation it sought to acquire, the corporation’s majority shareholder and others, including the attorneys for the other defendants. The parties had entered into a commitment letter pursuant to which AIH Acquisition Corp. (“Acquisition”) would purchase Alaska Industrial Hardware (“AIH”). After lengthy negotiations and the expenditure of substantial sums to conduct due diligence, a stock purchase agreement was crafted which all parties agreed was final and required only the signatures of the parties, to be affixed the next day. However, at the last minute, the majority shareholder of AIH refused to sign the stock purchase agreement. Acquisition then commenced an action for, among other things, specific performance of the stock purchase agreement.
The District Court found that the parties had more than an oral agreement and that the signatures to be affixed to the agreement were unimportant to the enforcement of the contract. Citing Municipal Consultants & Publishers, Inc. v. Town of Ramapo, the District Court found that Acquisition had sufficiently alleged the “total written existence [of the stock purchase agreement] under circumstances where the mere lack of signatures is but a ministerial formality.” In Municipal Consultants, the Court of Appeals found that, even in the absence of a written agreement, if all details of a transaction have been agreed and there is “nothing left for future settlement”, the lack of a writing “did not leave the transaction incomplete and without binding force, in the absence of a positive agreement that it should be binding until so reduced to writing and formally executed.”
To support its conclusion, the District Court in AIH pointed to an e-mail sent by counsel for Acquisition to counsel for AIH, which stated, in its entirety, “Attached is the final SPA. Everyone, including the lawyers, has stated it final without qualification. Please endeavor mightily to have the SPA executed tomorrow. Thank you for your efforts.” (emphasis in original). Apparently, counsel for AIH failed to respond to this e-mail and gave no indication that it held a different view of the status of the transaction. As a result, since the parties had no agreement requiring execution and delivery of the stock purchase agreement to cause it to be binding, the District Court granted Acquisition’s request for specific performance of the stock purchase agreement even though it had never been executed by AIH. On March 8, 2004, the District Court entered summary judgment for Acquisition on its specific enforcement claim, declaring that the stock purchase agreement was “enforceable forthwith today.”
Thankfully, the Second Circuit stepped in on July 1, 2004 to vacate much of the District Court decision, including the District Court Order granting summary judgment on the specific enforcement claim, and remanded the matter to the Southern District (albeit to a different judge). The Second Circuit declared the record in the case insufficient to establish the specific enforcement claim as a matter of law, pointing out that, even if one concludes that an agreement among the parties was reached, it is unclear which version of the stock purchase agreement the defendants agreed to. However, those who disagree with Judge Owen’s decision would be wise not to celebrate too soon: since the matter has been remanded, it is possible that the same unseemly result may be reached once again by another judge.
This case should give pause to anyone involved in the give-and-take of negotiations and last-minute pressures and decision making that can be found in almost any transaction. In its decision, the District Court ignores the generally held notion that parties evidence their meeting of the minds by executing an agreement. Instead of assuming that parties do not intend to be bound until they take an affirmative step to do so – i.e., sign a formal, negotiated document – the initial ruling in AIH requires that parties state, up-front, that there shall be no agreement unless and until fully executed documents have been delivered. It makes for quite an awkward introduction between parties that may be working side by side for years to come, and creates an atmosphere of suspicion from the outset.
To a layperson, and to many lawyers, this result seems to ignore common sense and real-world experience. By their nature, transactions often require painstaking consideration of even seemingly minor points. Many times, particularly in complex transactions where multiple specialists on each side have been consulted, the parties may believe they are agreed on a point, only to find later – and, yes, sometimes even much later, in the large conference room at the signing ceremony — that some issue separates them. The fact that one of the attorneys has previously delivered self-serving correspondence to the other should not, in and of itself, create a right to specific performance.
How can one protect clients from such a shocking result? For starters, focus on the language of the non-disclosure and confidentiality agreement, term sheet or letter of intent executed at the beginning of the transaction. Be sure to include an explicit statement that neither party will be legally bound unless and until a definitive written agreement is formally executed and delivered by each of the parties. Note that a statement that the parties intend to embody their agreement in a signed document is insufficient. If the parties have decided to skip the term sheet/letter of intent stage and moved straight to formal documentation, make it clear in correspondence to the other side that all documents are subject to further negotiation and execution by the parties.
Next, be sure to respond to any correspondence that suggests, in any way, that a deal has been reached in the absence of executed documents. The District Court in AIH relied heavily on the fact that counsel for the defendant corporation did not reply to opposing counsel’s claim that the agreement was final. It is a common rule of construction that silence equals consent. A simple statement from its counsel to the effect that nothing is legally binding until executed and delivered could have saved AIH from being forced to perform the terms of the stock purchase agreement. It also could have saved counsel for AIH from a major embarrassment, a serious client relations problem, and a likely malpractice claim.
As the saying goes, an ounce of prevention is worth a pound of cure.