Enter into an Agreement

We’re now ready to take a look at the key elements in creating contracts. And this section is especially important because it’s going to give you that checklist to stuff into your pocket and keep in mind in your future contract negotiations. And specifically, there are four elements on the checklist. First of all, have you reached an agreement. Second, is there consideration. Third, is the agreement legal. And finally, must the deal be in writing. So let’s start with this first question. To a large extent, answering this question can be common sense. Did one side make an offer? Did the other side accept the offer? For instance, try your common sense on this scenario.

And by the way, this section in general is going to be a test of your analytical ability. I’ll try to give you several case examples and see how your logical skills match those of the court making a decision. So here’s the scenario. This happens to be based on a Chinese case, not precisely, I’ve made up a couple of facts, but loosely. So on Monday, a store offers to buy TVs from a manufacturer. Delivery of the TVs are to be made to the store. On Wednesday the manufacturer accepts the offer but tells the store, you have to pick up the TVs at our plant. On Friday the store says, okay we’ll pick up the TVs at the plant.

But then, after this series of communications, the price of TVs drops and the store no longer wants to go through with the contract or the agreement, if it is a contract. So that’s my question to you. Actually two questions, if you have a pencil and paper handy. The first question is, is there a contract here when the manufacturer sues the store, and second if there is a contract when was the contract made? Monday, Wednesday, or Friday? So, please write down your answer.

And again, I don’t think you have to have a great knowledge of law to answer a problem like this. I think you can use common sense. The answer is that, yes, there is a contract. There was an offer by the store. There was an acceptance by the manufacturer. But then a little bit tougher question is, when did the acceptance occur, Wednesday or Friday? And the answer to that question is Friday, because the Wednesday communication from the manufacturer was not an acceptance because they changed the terms of the offer. So legally, what the manufacturer is calling an acceptance is really a counter offer back to the store.

By counter offering, the manufacturer has killed the initial offer, and now it’s up to the store to accept, which the store did. So, the precise analysis is, manufacturer makes offer on Wednesday, store accepts on Friday, binding contract. Now, this principle of counter offer is especially important to any negotiator. When the other side makes an offer to you, you have to remember that if you accept the offer but add additional terms, although there are exceptions as with any legal rule, but if you add additional terms then you have killed the original offer and you can no longer accept it after that point. So you have to be very careful in the way you word your

acceptance if you don’t want to kill that original offer. In another unit I mentioned this case, where a college offered a job to a professor. She replied, granting some of the following provisions would make my decision easier, let me know what you think. And for example, she asked whether they would consider a higher salary. And she asked for no more than three new class preparations per year for the first three years. And the college search committee responded by saying we’ve decided to withdraw the offer of employment to you. Now as far as I know there’s no litigation connected with this scenario.

But if she had sued them, if for example, let’s say I had an additional fact, if she then accepted their offer after receiving this latest communication, would there be a contract? And the answer to that would be no for two possible reasons. Number one, they withdrew the offer, which a person making an offer is allowed to do before acceptance. So that’s the end of the offer. But a second possibility would be, a court could interpret her language easily as a counter offer, which would also kill the original offer. Although she worded it in such a way that it’s a little bit ambiguous as to whether it’s a counter offer or not. This would make my decision easier.

It’s not like saying I want these things or I accept your offer with the addition of these additional elements. But in any event, clearly because they withdrew the offer, which they’re allowed to do, there could be no contract, no acceptance after that point. Here’s a letter, in the examples I’ve given, the analysis is fairly straightforward and common sense, but here’s a letter that’s a little more complicated and convoluted. This appeared in our student newspaper at the University of Michigan. And allegedly it was written by a student who was rejected by a company after he sought summer employment, and this was his reply to the company in a humorous vein. Dear Company X, thank you for your letter on February 6.

After careful consideration, I regret to inform you I am unable to accept your refusal to offer me a summer associate position in your New York office. This year I have been particularly fortunate in receiving an unusually large number of rejection letters. With such a varied and promising field of candidate firms, it is impossible for me to accept all refusals. Despite your firms outstanding qualifications and previous experience in rejecting applicants, I find your rejection does not meet my needs at this time. Therefore, I will assume the position of summer associate in your New York office this June. I look forward to seeing you then. Best of luck in rejecting future applicants. Regards, Tom.

And, of course, this sort of turns offer and acceptance upside down and was written in humor. A more serious issue that relates to offer and acceptance, relates to the very common scenario where you’ve been negotiating with the other side, and you’ve developed a what looks like it’s going to be a deal.

You’ve looked at positions, you’ve explored all interests, you put together the interests, maybe build a larger pie and now you’re on the way to a deal. But the question is, how can you convert those discussions to an actual legal contract? That is a big challenge in any negotiation. And what many people do is to use what is commonly called a frame work agreement. You start to put together an agreement, a skeleton agreement, and then gradually you fill in the missing pieces. And these framework agreements go by a variety of names. Sometimes they are preprinted leases, or real estate contracts. They’re called memorandum of understanding, letters of intent, agreements in principle, memorandum of agreement.

A variety of terminology, all of which are examples of framework agreements. These are great negotiating tools to help you move from discussions to a legal commitment. The challenge however, is that at some point as you complete this framework agreement, you cross a line from a negotiating tool to an actual binding contract. And a fairly dramatic example of that occurred several years ago, where we have Pennzoil negotiating with Getty Oil to acquire Getty Oil, and they developed a framework agreement called a memorandum of agreement. Now, after they developed this agreement, another oil company, Texaco, decided that it was interested in Getty Oil. So Texaco enters the picture, negotiates with Getty Oil, and is successful in acquiring Getty Oil.

Now at that point, Pennzoil says wait a minute Texaco. Our memorandum of agreement was more than just a framework agreement. It was more than just a negotiating tool. It was actually a binding contract, and you interfered with our contract, and therefore you owe us damages. So Pennzoil sued Texaco, of course they could have sued Getty Oil too, but Getty Oil was part of Texaco, won the lawsuit, and Pennzoil was awarded damages of $10.5 billion. At that point Texaco said, wait a minute, we don’t have that much money in our checking account. And Texaco declared bankruptcy. So a misunderstanding about whether this agreement was a negotiating tool or a binding contract resulted in this huge loss to Texaco.

In bankruptcy, Texaco was able to reduce its loss to quote only $3 billion. But still, it was a huge financial hit for Texaco.

Penzoil in this case made a fairly unique move. Rather than hiring corporate lawyers to try the case, they hired a famous personal injury lawyer named Joe Jamail. And of course he was successful in the case, and this is a report on his success. The Pennzoil verdict remains the largest verdict upheld on appeal in legal history. The case later settled for $3.3 billion, and Jamail’s personal take was over $400 million. According to Jamail, we celebrated that night at my house by eating hamburgers and drinking beer. I’ve still got the $3 billion deposit slip on my wall. That year, Jamail made more than Michael Jackson, Steven Spielberg, Bill Cosby, and Eddie Murphy combined.

One last question that’s very important to this discussion of framework agreements. And that is, is there a practical tool you can use to avoid the risk that a court will consider what you think is a negotiating tool as a contract? And of course the answer to that is yes, and it’s a very simple solution. When you’re using framework agreements as negotiating tools, simply write at the top that this is only a negotiating tool and is not intended as a binding contract, until you agree that it is a contract. That way you should be protected from the risk of locking yourself into a contract before you intend to. So that concludes our look at whether an agreement has been formed.