Real Estate Litigation

On March 19, 2002, a California Court of Appeal issued an opinion that could dramatically change pre-closing negotiations under California law. In Copeland v. Baskin Robbins U.S.A., the court ruled that "a contract to negotiate an agreement is distinguishable from a so-called 'agreement to agree' and can be formed and breached just like any other contract." The court also stated that the measure of damages in such cases is "not damages for the party's lost expectations under the prospective contract but damages caused by the injured party's reliance on the agreement to negotiate...[which] encompasses the plaintiff's out-of-pocket costs in conducting the negotiations. . . [and] may or may not include lost opportunity costs."

Background of the Dispute

In May of 1999, Kevin A. Copeland signed a letter agreement with Baskin-Robbins to purchase a Baskin-Robbins ice cream manufacturing plant and to negotiate a "co-packing" agreement under which Baskin-Robbins would purchase a yearly quantity of ice cream from Copeland. Several months later, Baskin-Robbins broke off negotiations, stating that Baskin-Robbins’ parent company had "recently . . . made strategic decisions around the Baskin-Robbins business" and that "the proposed co-packing arrangement [is] out of alignment with our strategy . . . [and, therefore] we will not be engaging in any further negotiations of a co-packing arrangement." Copeland then sued Baskin-Robbins, alleging, among other things, that Baskin-Robbins had breached its contract to negotiate the co-packing agreement.

The Court's Decision

The trial court ruled in favor of Baskin-Robbins on the grounds that no valid contract existed between the parties (that is, that the parties had merely "agreed to agree" on the terms of the co-packing agreement). The appellate court also found for Baskin-Robbins, but on different grounds. It held that in the particular case, Copeland sought only expectation damages for lost profits and had disclaimed any damages resulting from lost opportunities or reasonable reliance upon Baskin-Robbins' agreement to negotiate. However, drawing heavily from a theory expounded by Professor E. Allen Farnsworth in a 1987 law review article, the Court of Appeal concluded that an agreement to negotiate could be an enforceable contract because "parties should have some assurance their investments of time and money and effort will not be wiped out by the other party's footdragging or change of heart or taking advantage of a vulnerable position created by the negotiation." As of April 8, 2002, no notice of appeal had been filed in the case; however, it is possible that the California Supreme Court may choose to review Copeland of its own accord within the next several weeks.

The Effect of Copeland

Ordinarily under California law, when parties negotiate to form or modify a contract, neither party has any obligation to continue negotiating or to negotiate in good faith. However, an enforceable agreement to negotiate causes the implied covenant of good faith and fair dealing to attach to the negotiations and creates an additional (and potentially easier to prove) cause of action distinct from unjust enrichment and promissory fraud. If, as the Copeland court indicated, reliance damages may include lost opportunity costs, then breach of an agreement to negotiate could potentially be very costly to a company.

Recommendations

In light of the Copeland ruling, companies (particularly those transacting business in California) may want to

• pay particular attention to the language that they include in letters of intent or term sheets with respect to whether there exists an obligation to continue negotiations.

  
  
• consider explicit disclaimers in preliminary documents reserving each party's right to discontinue negotiations at any time or for any reason.
  
  
• spell out precisely what needs to be done to comply with the obligation to negotiate in good faith.

Also, nothing limits the holding of Copeland to written contracts. Companies should be aware that their conversations, e-mail or other business correspondence could potentially be construed as forming a contract to negotiate under some circumstances. As a result, some companies may be more hesitant to begin negotiations until a formal letter of intent or other document is in place that spells out exactly what obligation each party has to continue negotiations and imposes some limitations on potential liability should negotiations break down for any reason.