In the Beginning… Legal Aspects of Doing Business Before the Contract is Signed

Posted on June 6, 2008


Can we date before we are married? Can we crawl before we walk?  These
business sentiments are often echoed when businesses court each other.
Businesses understand that it is usually well advised to test drive
something before you spend a lot of money on it.  Lawyers, however,
often get nervous about this process.

Prior to forming a binding agreement in the employment context, you often face the issue of whether a person is an employee or an independent contractor.  In the merger and acquisition context, the issue arises as to when a deal is consummated and the extent that the parties must deal with each other in good faith.

To balance these issues, you may try and enter a letter of intent, i.e. a non-binding understanding of the relationship.  A recent article about outsourcing and the use of letters of intent in this area provided good insight – not just into outsourcing – but into the problems with letters of intent.  My takeaways from the article are:

  1. Loss of leverage by one side who needs a definitive agreement
  2. No clear standards or termination guidelines on the performing party; and
  3. Each party gains additional insight into the other which can prejudice the negotiation of the definitive agreement

That said, a letter of intent is usually preferable to having no contract. When I have clients that want to do business without going through the process of getting a full blown contract in place, I am skeptical, but try not to immediately say no.  The key questions to ask are:

  1. Have I promised more verbally or informally then I am really comfortable with?;
  2. What is the aggregate damage either party has outstanding? Can I pay the others party’s damages if I want to get out of the deal?; and
  3. Have I clearly conveyed, preferably in writing, that this deal is only temporary?

Please be aware that these questions are not a full-blown checklist, but if you have answered yes to any of them, you may have an issue.  When using contracts, documenting the relationship appropriately is always the best course of action.  The business realities of formality, however, in some situations sway you away from a formal and fully fleshed out contractual arrangement.  Just remember that the business justification needs to outweigh the risk of future misunderstanding.

Mike Goodrich, Goodrich Law Firm, LLC