The spread of Covid-19 and government measures in response is leading businesses to reconsider whether they should go ahead with some deals currently under negotiation.

When can your business or your counterparty back out of a deal under negotiation?

Generally, a party can back out of negotiations at any time up until a binding contract is formed. However, in some circumstances it may be unclear whether or not a binding contract has been formed.

There is also the possibility that a party may be liable for costs incurred, work done, or services provided in anticipation of a contract or in reliance on representations made during negotiations.

Contractual liability

Generally, a binding contract is formed when the parties have agreed on the essential terms of the contract and intend to create legal relations. This is assessed by looking at the words and conduct of the parties from an objective perspective. Most contracts do not require any particular formalities (e.g. formal documents or signatures).

At one end of the spectrum, there may be a formal contract document signed by the parties. At the other end, it may be clear that the parties are only at the stage of tentative discussions with nothing recorded as being agreed.

Difficult scenarios can arise in between, particularly where the parties have recorded certain matters in a document which might be called a term sheet, letter of intent, memorandum of understanding, heads of agreement or similar (referred to as a "heads of agreement" below).

In such cases, it is important to consider the particular words used by the parties. If a heads of agreement is expressed as being "subject to contract", this may be a significant indicator that the parties do not intend to be contractually bound until a formal contract document is signed. However, a contrary conclusion can still be reached depending on the other or subsequent words, or conduct of the parties.

Some heads of agreement may express certain terms as binding and others as not. Some may describe the terms as agreed but subject to certain conditions, in which case there may be a binding contract subject to those conditions being fulfilled.

If the parties have exchanged drafts of a contract document, a binding contract may be formed even before (or without) the document being finalised or signed if all the essential terms are agreed and the remaining matters are inconsequential.

When considering whether to back out of a deal, it will be important to look carefully at what has unfolded between the parties to date from an objective perspective to assess whether any binding obligations have arisen.

In the event that a contract has been formed, it may be possible to be relieved from performance of contractual obligations under a force majeure clause or other means – see our article: The impact of Covid-19 on performance of contracts.

Non-contractual liability

Even if no binding contract has been formed, it is still possible for a party to have some liability when backing out of deal in some circumstances.

If a party has incurred costs, performed work or provided services in anticipation of a contract or in reliance on representations made by the other party, they may have a claim for payment. This involves an assessment of the reasonable expectations between the parties.

For example, if a party has been asked to provide services urgently, or on an interim basis, in the expectation that the contract will be sorted out in due course, they may be entitled to payment for any services provided in the interim even if the contract never eventuates and the other party backs out.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.