Termination of negotiations: Do you have a claim if the proposed deal goes south?

Contractual liability

In order to claim that the contract that the parties are negotiating is indeed enforceable, it would be necessary to show all of the essentialia of that contract are present, and that both parties subjectively intended to conclude a contract.

The general principle in respect of negotiations is that parties are free to withdraw at any time until the conclusion of the actual agreement, provided the party withdrawing has acted in good faith. However, it may be argued that negotiations have created the expectation that a contract will eventually be concluded and should accordingly have legal consequences (particularly where one party has incurred expenditure in preparation for performance in terms of the contract). This argument is generally upheld in most European jurisdictions.

However, while South African courts have recognised that the principle of good faith applies to pre-contractual negotiations, the implications thereof are not yet certain, and parties are therefore still free to break off negotiations for any reason. The only exception to this general rule, from a contractual perspective, is where parties have expressly agreed to negotiate in good faith. Even so, the SCA in Southernport Developments (Pty) Ltd v Transnet Ltd held that an agreement to negotiate in good faith must include a deadlock breaking mechanism (such as an arbitration clause).

The difficulty generally lies in proving that the other party’s undertaking was an offer made with the intention to contract, and that it was not merely a proposal made during negotiations on the way toward a more precise and comprehensive agreement. The Appellate Division in Lambons (EDMS) BPK v BMW (South Africa) held that every case has to be judged on its own facts in determining whether the parties concluded a legally enforceable contract. The courts will apply an objective test based on the facts in order to determine if parties intended to enter into a binding and enforceable contract.

Delictual liability

If an aggrieved party is unable to show that all of the essentialia of the contract are present, and that both parties subjectively intended to conclude a contract, it may be argued that a party withdrawing from negotiations could be held delictually liable for negligently misrepresenting that they would continue to negotiate in good faith, and that a contract would eventually be concluded. Negligent misrepresentation may result in delictual liability where a person was under a legal duty to another to speak the truth, or to disclose facts not known to the other person.

For such a claim to succeed, it would be necessary to establish that:

• the misrepresentation was made;
• the person who made the representation was under a legal duty to speak the truth or to disclose facts unknown to the person claiming damages;
• the misrepresentation was made negligently (that is, a reasonable person in that person’s position would have made such a representation);
• the misrepresentation caused the other party to suffer damages; and
• the quantum of such damages.

The difficulty generally lies in the unlawfulness element; that is, in proving that the other party was obliged to disclose the actual state of affairs. The Full Court of the Western Cape High Court in McCann v Goodall Group Operations (Pty) Ltd 1995 (2) SA 718 (C) held that “a negligent misrepresentation may also be constituted by an omission, but, as in the case of negligent misstatement, liability in delict will only follow if… the defendant fails to comply with a legal duty to act in order to avoid the plaintiff’s suffering loss”. The Court then listed certain examples of such a duty, including situations in which the information is in the exclusive knowledge of one party; there are unusual characteristics relating to the transaction, or simply where public policy requires disclosure.

In light of the general rule that a party to negotiations may withdraw at any time, and that subjective intention to contract is required for enforceable obligations to arise, it is unlikely that a court will find that public policy requires disclosure of any commercial or other information to the other negotiating party. The former Rhodesian court in Murray v McLean 1970 (1) SA 133 (R), which judgment has been referred to with approval by various South African courts, held that there is no delictual remedy for an improper breaking-off of negotiations, regardless of whether one party has incurred expenses in anticipation of the contract.

The doctrine of legitimate expectation

The doctrine of legitimate expectation was incorporated into South African law in 1989 by the Appellate Division in Administrator, Transvaal and Others v Traub and Others, in which the Appellate Division confirmed that “even where a person claiming some benefit or privilege has no legal right to it, as a matter of private law, he may have a legitimate expectation of receiving the benefit or privilege, and, if so, the courts will protect his expectation by judicial review as a matter of public law”.

However, South African courts have expressed divergent views on the question of whether the doctrine of legitimate expectation applies to private relationships.

Even if one is able to convince a court that the doctrine of legitimate expectation forms part of our law of contract, the requirements of the doctrine must also be met, which our courts have summarised to be:

1. the expectation must be reasonable; and

2. the representation giving rise to the expectation must be –

    a)    clear, unambiguous and devoid of relevant qualification;

    b)    induced by the decision-maker (being the other negotiating party, should the doctrine of legitimate expectation extend to purely contractual relationships); and

    c)     one which it was competent and lawful for the decision-maker to make.

Due to the fact that negotiations are generally understood to precede a legally binding agreement, and that due diligence investigations are intended to merely allow a negotiating party the opportunity to explore the possibility of eventually concluding an agreement, it is unlikely that a court would find that either party could have reasonably expected that a contract would certainly be concluded.

Conclusion

Parties who have suffered damages as a result of another person withdrawing unreasonably from negotiations are unlikely to find comfort in the law of delict, the law of contract or the doctrine of legitimate expectation. Regardless of initial optimism, it is highly recommended that precautions be taken at the outset, to prevent later disappointment and protect against unnecessary financial loss. These may include:

1)   parties concluding a memorandum of understanding outlining the broad terms that have been agreed thus far;

2)   parties agreeing to continue negotiating in good faith, but including a deadlock breaking mechanism, such as an arbitration clause, in the agreement; and/or

3)   parties seeking precautionary legal advice prior to incurring any costs or expenses during the negotiation process, making any financial commitments, or signing on the dotted line.