Preliminary agreements, such as heads of agreement and letters of intent, are often used in commercial transactions, and increasingly by Commonwealth agencies, statutory authorities and government-owned corporations. If they are drafted and used appropriately, they can maximise outcomes and value for money on complex and strategically important projects. Government agencies enter into a myriad of contractual arrangements to buy goods and services and to implement programs. Significant procurement processes generally begin with the issue of a request for tender to industry, followed by tender evaluation activities and detailed negotiations with a preferred supplier selected from the evaluation process. A preliminary agreement is a contract formed during contract negotiations, before entering into the final, detailed agreement for the delivery of the goods or services. The final agreement may be, for example, an outsourcing contract, a services contract, a capital equipment acquisition contract or a joint-venture agreement. Types of preliminary agreements often used in commercial contract negotiations are:
In this article, we’ll deal with preliminary agreements that create legal obligations between the parties. There are common types of preliminary agreements that are not intended to be legally binding, such as a memorandum of understanding or a letter of comfort. These sorts of agreements should clearly state that they are not intended to create legal obligations between parties. A typical example is a memorandum of understanding between Commonwealth agencies, setting out the framework, services and responsibilities for interagency projects or service-delivery arrangements. Another type is the letter of comfort, which is often requested but not commonly used by the Commonwealth, and is generally discouraged, because of the risk of it being held to be legal binding. When should preliminary agreements be used? Preliminary agreements can help the parties:
Achieve urgent objectives (for example, in relation to natural disasters, service-delivery arrangements or significant policy initiatives) by enabling the key terms of an arrangement to be agreed upfront.
- Establish a commercial framework for complex arrangements, by outlining the framework, key parameters and timing for complex arrangements requiring the negotiation of multiple transaction documents, or for collaborative projects that involve implementing multifaceted policy initiatives (for example, joint projects of the federal and state and territory governments).
- Reduce risk, by providing for the development of key contract plans/schedules, or the conduct of risk-reduction activities, to obtain further certainty before committing to a final, long-term contract (for example, in relation to complex, technology-based projects).
However, preliminary agreements should be used carefully, as they may also give rise to disadvantages and risks. In particular, it is often more efficient to prepare the final, formal document in the first place, and disputes can arise over the interpretation of general provisions that do not deal with the key contingencies, risks and liabilities in the same detail as a final agreement. It is also important to remember that government agencies need to comply with the Commonwealth’s financial management framework in approving preliminary contracts and any associated spending proposals. Key points to be addressed in preliminary agreements There are no usual terms for a preliminary agreement, and the contents of the agreement will depend on the specific arrangement and whether the parties envisage subsequently entering into a formal contract. As with all contracts, the key is to use in clear, plain English to outline the framework and key principles for the project and the responsibilities of all parties, and to allocate project risks. Preliminary agreements commonly include the following terms:
A statement about whether the parties intend the document to be legally binding.
An agreement to negotiate in good faith and/or use reasonable or best endeavours to undertake contractual obligations (while noting that an agreement to enter into a contract is generally not considered enforceable).
A sunset date detailing when the preliminary agreement expires.
Requirements about confidentiality and making public statements.
Whether, on entering into a final agreement, any work performed under the preliminary agreement will be treated as though it had been performed under the final, detailed agreement.
The consequences when the preliminary agreement expires or is terminated – for example, will the preliminary agreement automatically terminate when a final contract is entered into by the parties? Can the parties walk away from negotiations at any time without any costs?
Where initial work is to be performed by the preferred supplier under the preliminary agreement, the work should be carefully scoped, and caps and limits should be included on the amount payable under the agreement.
In appropriate circumstances, entering into a preliminary agreement during commercial negotiations can maximise outcomes and help to deliver major projects and policy initiatives on time and budget. Ultimately, commercial negotiations that are conducted in accordance with clearly communicated and understood expectations enhance both value-for-money outcomes and the relationships between government agencies and industry.
This article was first published in the Canberra Times, March 2011.