The purpose of this blog is to discuss the topic of negotiations that are broken off. When parties are in the negotiating phase there is no formal agreement yet. However, under Dutch law in some cases the party who breaks off the negotiations before a formal agreement has been reached has to reimburse the other party.
A contract is drafted by offer and acceptance of that offer. There can be extensive negotiations before an agreement is reached. This phase is called the pre-contractual phase. In this phase parties already agree on many points but are not yet in full agreement (e.g. the purchase price has yet to be determined). These negotiations may incur costs (e.g. for a due diligence). In many cases a party withdraws during a pre-contractual phase. This raises the following questions: (i) is it possible for a party to break off the negotiations without any costs and (ii) in which cases is a withdrawing party obliged to compensate the other party for the losses incurred?
The Supreme Court of the Netherlands ruled in the CBB v JPO judgment in 2005 that the basic principle is freedom of contract. This judgment is the standard ruling on the obligation to pay losses after breaking off the pre-contractual phase negotiations. There are two phases according to this judgment.
In principle the parties are free to break off negotiations considering the basic principle of freedom of contract. However, under certain circumstances the withdrawing party has to reimburse (part of) the costs.
In the second phase a party is not allowed to withdraw without consequences. As an exception to the rule of freedom of contract it is stipulated that a party may not break off the negotiations for unacceptable reasons. Breaking off may be unacceptable if the other party had justifiably expectations that an agreement would be reached. Breaking off may also be unacceptable on the basis of other circumstances, as set out below.
In the event that the other party has justifiable expectations that an agreement will be drafted, breaking off is unacceptable and may entail that the withdrawing party has to pay for the damages incurred.
The Supreme Court ruled in 1996 in ABB v State that the expectations the other party had at the time the negotiations were broken off, should be considered as a period of reflection. The fact that the other party had justifiable expectations at any earlier point in time is irrelevant. Moreover, the manner and extent to which the withdrawing party contributed to the creation of the other party’s expectations must be taken into account.
The Letter of Intent (LoI) can play an important role in whether a party can break off negotiations and whether the withdrawing party must incur losses. The LoI could contain an exception clause (e.g. the agreement is made subject to the approval of the general meeting of shareholders and without its approval negotiations can be broken off).
Justifiable interests of the withdrawing party may entail that the withdrawing party was still free to break off negotiations despite the justifiable expectations of the other party. The Supreme Court ruled this in the De Ruiterij/MBO judgment. This may be the case when unforeseen circumstances have arisen during the negotiations, e.g. an economic crisis.
When a party has unjustifiably broken off negotiations, the court may rule as follows:
Parties are in principle free to break off negotiations. In some cases, the withdrawing party may have to reimburse (part of) the costs to the other party (phase 1). If the other party had a justifiable expectation that an agreement would be reached, then breaking off may be unacceptable (phase 2). If breaking off is unacceptable the withdrawing party can be ordered to pay costs and lost profits.
Only under Dutch law does the possibility exist to claim compensation for costs incurred and lost profits due to broken off negotiations. However, there are only a few cases in which this claim was upheld by the Dutch court.
It seems the basic principle under English law is that a party cannot be held liable for costs incurred and lost profits due to broken off negotiations. Moreover, the House of Lords ruled in the Walford v Miles case in 1992 that there is also no obligation “to carry on negotiations in good faith”.
Despite the fact that under English law there is no doctrine of good faith during the negotiations phase, there are specific tenets to avoid unjust situations. E.g., it is prohibited to make misrepresentations: if a party made misrepresentations the other party must be reimbursed for the losses incurred. In short, breaking off negotiations without any consequences is easier under English law than under Dutch law.
Both under Dutch and English law conditions made (e.g. in the LoI) are taken into account and imply that a party can justifiably break off the negotiations if the specific conditions are not fully met.
Under the laws of the United States it is possible to break off the negotiations as long as an agreement has not been reached. It is possible to break off the negotiations at any time, for any reason without being liable for the losses of the other party. Even if it was unjustifiable to break off the negotiations, the withdrawing party can never be held liable for losses. Furthermore, under the laws of the United States the court cannot rule that the parties should keep on negotiating until an agreement has been reached.