Is there an implied duty of good faith to continue to negotiate?
Under Dutch law, the relationship between parties in negotiations is governed by the principles of good faith, reasonableness and fairness. Generally, parties are free to break off negotiations unless they have led the counterparty to have justified expectations. If such expectations exist, ending the negotiations may be regarded as frustrating the reasonable expectations of the other party that an agreement would be reached. This is treated as a breach of good faith principles.
In Dutch case law, four separate negotiating phases are identifiable. The rights and obligations of the parties to the negotiations - and in particular whether unilateral termination is possible (with or without compensation for damages) - differ depending on which negotiation phase the parties are in. During the negotiations the parties may shift from one phase to the other and back depending on the specific circumstances. The four phases are:
1. introductory discussions: the discussions between the parties have not reached the stage where breaking off the negotiations would constitute a wrongful act (Phase 1)
2. discussions between the parties have reached such a stage that breaking off the negotiations would constitute a wrongful act if the breaking party did not compensate the other party for its costs (Phase 2)
3. discussions between the parties have reached such a stage that the non-breaking party has developed a justified expectation that an agreement will be reached (Phase 3), and
4. the parties have reached a binding agreement on the transaction (Phase 4). Note that this phase may even be reached before the parties have executed a written agreement.
The parties are, however, free to specifically agree on the negotiations process to be followed and the stage at which binding obligations will arise, so that the aforementioned phases and accompanying rights and obligations do not apply. Typically, this would be agreed upon in writing through a letter of intent or similar document before negotiations commence in earnest. Such document may state that no binding obligations will arise until, for example, an agreement in writing is executed or certain specific conditions have been met. It should be noted that these arrangements on the transaction process are subject to the requirements of reasonableness and fairness, and the fair expectations of the other party. Breach of these arrangements may again lead to liability for damages.
If, for example, the letter of intent provides that no agreement will be deemed to have been reached until a written agreement has been executed, then walking away from the transaction may still constitute a wrongful act if all conditions precedent (eg satisfactory outcome due diligence) have been fulfilled and the parties have (more or less) reached full agreement on the wording of the agreement. In such case the breaking party has to have a good reason for breaking off the negotiations, eg an unexpected development of results below budget or other unexpected material adverse change.
Generally, specifically agreed conditions precedent will be upheld by the courts if they are objective conditions. Conditions precedent such as availability of bank financing, a satisfactory outcome of the due diligence and prior board or shareholder approval are regular and will generally be upheld. However, invoking such conditions may still constitute a wrongful act if the withdrawing party has caused the non-fulfillment of the conditions, or if the justified expectation was created in the opposite party that conditions will be fulfilled. For instance, if the party invoking the conditions has throughout the process referred to the conditions as "a mere formality", or if it becomes clear that the corporate body whose approval was required, was actively involved in the entire process, invoking the conditions may still constitute a wrongful act. In other words, the principle of law applied is "substance over form". The factual behaviour of the parties and the expectations they have raised with each other as to the outcome of the negotiations will be taken into account in judging whether breaking off the negotiations was acceptable or not.
What are the consequences of termination of negotiations by one party unilaterally?
Under Dutch law, the breach of a binding agreement may give rise to liability on the part of the breaching party.
Even where there is no binding agreement, an unacceptable termination of negotiations could lead to liability for costs (negative contractual value) and - in extreme circumstances - for loss of profits (positive contractual value).
The consequences of unilaterally terminating negotiations will depend on which negotiating phase the negotiations are in:
Phase 1 - the parties are free to terminate the negotiations at will without consequence
Phase 2 - the parties may terminate the negotiations, but the terminating party may be required to compensate for the costs incurred by the non-terminating party
Phase 3 - If a party terminates the negotiations, it may be compelled to resume the negotiations by court order given in injunction proceedings. Terminations of discussions will constitute a breach of contract and may result in liability for damages, including loss of profit. Courts tend to be more reluctant to order a party to continue negotiations or to attribute damages on the basis of positive contractual value than on the basis of negative contractual value, and these will only be attributed under exceptional circumstances, and
Phase 4 - a binding agreement has been reached, and a termination of the negotiations will be considered a breach of contract. The non-breaching party may claim specific performance and/or compensation of damages.
What is the potential impact on third party rights?
Unless specifically stipulated otherwise, agreements and negotiations do not create third party rights. However, if certain expectations were created in a third party (for instance that a transaction would take place) on the basis of the conduct or (verbal or written) undertakings of a party, the party breaching those expectations may be liable on the grounds of tort.