Winter 2007-08 Letter of intent binds the parties to negotiate in good faith

Number 66
Winter 2007

U.S. District Court

Letter of intent binds the parties to negotiate in good faith

Even though a letter of intent may not be binding with respect to the ultimate obligations that the parties expect to include in the definitive agreement, it does compel good faith negotiations. WHTV Broadcasting Corp. v. Centennial Communications Corp., 2006 U.S. Dist. LEXIS 81738.

Sale of business

WHTV Broadcasting Corp. and a related not-for-profit company began negotiations to sell stock and assets in Puerto Rico to Centennial Communications Corp. The assets included licenses issued by the Federal Communications Commission for the operation of a wireless “cable television” system. Centennial’s particular interest, as stated in the court opinion, was to acquire so-called “multichannel multipoint distribution service” (or “MMDS”) as a “last mile” solution.

MMDS is what is commonly known as “wireless cable television” because it is normally used to broadcast over the air television programming similar to that usually offered by wired cable providers. The “last mile” is the point of interconnection between the network and a customer that subscribes to the service. This “last mile” was to give Centennial the ability to reach subscribers.

Letter of intent

The parties executed a letter of intent on November 29, 2000, in which they set forth their mutual goal of carrying out the proposed sale and purchase of the operation. They also agreed therein to negotiate in good faith and to execute a definitive agreement within a stated period. The letter also indicated that theretofore Centennial had conducted “limited due diligence,” and that the contemplated transaction was conditioned to the purchaser’s satisfaction with the results of a more in-depth examination of the sellers’ affairs. Otherwise, the letter of intent expressly granted Centennial the right to discontinue negotiations.

Walk away

Even though as late as March 16, 2001, WHTV had asked Centennial in writing to confirm its interest in the acquisition, and thereafter Centennial indeed continued the negotiations and asked WHTV to draft a definitive agreement, on April 24 the professed purchaser informed that it would not go ahead with the transaction. It indicated that the conditions of the letter of intent were not met because the due diligence investigation turned out to be adverse.

The plaintiffs sued, claiming breach of contract and bad faith negotiation. Centennial moved for summary judgment in its favor.

Conditions precedent

No one contested that the proposed transaction was subject to a series of conditions precedent, one of them being a successful due diligence investigation. Nevertheless, the plaintiffs averred that Centennial had voluntarily prevented said conditions from being fulfilled.

The U.S. District Court for the District of Puerto Rico explained in its opinion that there is a difference between “a fully enforceable contract subject to conditions precedent, and a preliminary contract subject to such conditions.” It called the latter a “means to a contract rather than its end,” quoting from the decision in the celebrated case of Prime Retail, L.P. v. Caribbean Airport Facilities, Inc., 975 F. Supp. 148 (D.P.R. 1997). “In a preliminary contract the parties ‘do not bind themselves to conclude the deal but only to negotiate in good faith toward conclusion within the agreed framework.'” The judge went on to point out clauses in the WHTV-Centennial letter of intent that made it such a preliminary contract, among these:

• that the parties “will negotiate in good faith a definitive agreement,” and
• that “the Purchase Price will be adjusted (up or down as applicable) by an amount to be agreed upon.”

Due diligence

Plus there was also the need for Centennial to be satisfied with its due diligence. The letter did not specify what factors Centennial could take into consideration to determine satisfaction, only that they had to be reasonable. As is to be expected, Centennial called the judge’s attention to a number of reasons why the results of its investigation were not up to standard.

First and foremost were WHTV’s financial problems, which turned out to be greater than expected by the prospective purchaser. Centennial convinced the judge that the numbers originally provided by the plaintiffs were not accurate. Secondly, but equally as important, was that development of the technology sought by Centennial was not adequate. As to this second point, the court found evidence that WHTV’s equipment turned out not to be viable for the purchaser.

Conclusion: Centennial showed sufficient reasonable grounds to walk away.

But there’s more.

Good faith negotiations

The judge next examined the Puerto Rico doctrine of culpa in contraendo, that is, the legal obligation to negotiate in good faith, which applies to preliminary contracts as well. In short, a party may be liable in damages even in the absence of a binding agreement, if it fails to negotiate in good faith, when the other party has reasonable expectations that an agreement would finally be reached. The following factors may be considered, as listed in the opinion:

• the development of the negotiations,
• how they began,
• their course,
• the conduct of the parties throughout the negotiations,
• the stage at which the interruption in negotiations took place, and
• the parties’ reasonable expectations to form a contract.

The District Court concluded that WHTV indeed presented evidence that Centennial did not alert it of the problems encountered until it had decided to terminate the letter of intent. Instead Centennial continued actively negotiating and encouraging WHTV to draft the definitive agreement. “With this scenario,” wrote the judge, “the entry of summary judgment finding that Centennial at all times acted in good faith and while employing reasonable commercial efforts is inappropriate.” The case continued, albeit limited to the culpa in contraendo cause of action.

© 2007 Goldman Antonetti & Cordóva, LLC