Over the past decade, a subsect of contract law has been developing in Delaware regarding Type II agreements. You may be asking, what in the world is a Type II agreement? And what’s the difference between a Type I agreement and a Type II agreement?
Why does this even matter?
Type I agreements reflect mutual assent to “all the points that require negotiation” but contemplate memorializing the contract in a more formal document later. Type II agreements, by contrast, require that the parties “agree on certain major terms, but leave other terms open for future negotiation.”
Type I agreements are fully binding (think a letter of intent, or potentially, a term sheet). Type II agreements, however, give rise to a binding obligation to negotiate open issues in good faith. What does good faith mean? In this context, entering into a Type II agreement requires the parties to conduct due diligence to form a binding formal contract containing all material terms. In other words, if a formal binding contract is the goal on the horizon, the parties must work together to formalize their respective binding obligations in the “final” agreement. This concept is like the implied duty of good faith and fair dealing in contract formation, which is prevalent in many jurisdictions.
A common misconception is that a Type II agreement is an unenforceable “agreement to agree.” Most lawyers are taught in their first semester of law school that agreements to agree cannot exist as they lack consideration. While Delaware appears to have the most recent decisions interpreting this doctrine, other jurisdictions and their respective federal courts have addressed the doctrine, as well. These jurisdictions include New York, Vermont, and the District of Columbia.
But be careful.
Some jurisdictions, like Delaware, recognize Tyle II agreements as binding and enforceable contracts. As a lawyer, you may think you are drafting a general outline of the deal terms, but you may have just bound your client to a Type II preliminary agreement that may give rise to expectation damages. Type II preliminary agreements are not agreements to agree.
Mind blown yet? Tune in to the next post in this series: Type III agreements…
