Understanding a Non Binding Agreement in Business Law

Key Takeaways

• A non binding agreement outlines the intent to negotiate or collaborate without creating enforceable legal obligations.
• These agreements are useful during early business discussions, often serving as frameworks for future binding contracts.
• Common examples include letters of intent, memoranda of understanding (MOUs), and term sheets.
• While non binding contracts are not enforceable overall, certain clauses (like confidentiality or exclusivity) may be legally binding.
• Courts may sometimes enforce a non binding agreement if there's evidence of reliance, bad faith, or partial performance.
• Differences between binding and non binding contracts lie in intention, enforceability, and legal consequences.
• Combining binding and non binding provisions in a single document requires precise legal language to avoid disputes.
• Parties should clearly mark the agreement as non binding and consult an attorney to ensure clarity and protection.

A non binding contract is an agreement in which the parties are not legally obligated to carry out its terms. Their purpose is to state the parties' intention as part of the negotiation process. If both parties agree to the terms of the non-binding contract, they can sign a binding contract afterward. There are also other situations in which a contract may be non-binding.

Letter of Intent

A letter of intent is a type of non-binding contract. Either party can walk away from the agreement at any point without signing a binding contract. It may be signed at the beginning of the parties' relationship when they are getting to know one another.

Letters of intent should include language saying they are specifically non-binding. If you write such a letter, make sure to place the words “non-binding” in the first paragraph. If it's being sent by email, make sure “non-binding” is in the subject line as well. Also, include a statement indicating that neither party will be forced to sign a binding contract unless they are completely satisfied with the agreement.

Even a non-binding letter of intent may include provisions that are legally binding, such as a provision requiring confidentiality and non-disclosure of the letter's contents.

Other Common Types of Non Binding Agreements

While letters of intent are among the most common types of non binding agreements, several other documents also serve a similar purpose in business negotiations:

• Memorandum of Understanding (MOU): Often used between parties considering a joint venture or partnership. MOUs set forth mutual intentions but are generally not enforceable unless clearly stated otherwise.
• Term Sheets: Frequently used in investment or financing scenarios. These outline the key financial and legal terms being considered before drafting a final, binding agreement.
• Heads of Agreement: This document outlines the basic terms of a proposed agreement before the parties enter into a formal contract. It can be partially binding depending on its wording.
• Letters of Comfort: Often issued by parent companies to reassure a lender or third party that a subsidiary will meet its obligations—without assuming legal liability.

These types of documents are crucial for aligning expectations before committing to a formal legal relationship.

Binding vs. Non-Binding Contracts

A contract may be written or spoken; it states specific obligations between two or more parties. If it is binding, it can be enforceable either through state or federal court. In order for it to be legally binding, however, there are certain elements that must be in place:

• Each of the parties who take part in the contract must understand and agree to the provisions and terms of the contract.
• The contract must include an offer, which the other party or parties must accept.
• The parties in the contract must exchange consideration, which is an item of value, a service, or money. In some cases, it may be only one party who is required to give consideration.

Even if these elements exist in the contract, there are conditions under which the contract would still be non-binding. For example:

• Contracts may not be made by the use of fraud, threats, or coercion.
• Contracts must be thoroughly explained to and understood by all involved parties.
• Contracts may not include any criminal activity or anything that is illegal.

Key Differences Between Binding and Non Binding Agreements

To fully understand non binding agreements, it's helpful to contrast them directly with their binding counterparts:

This distinction is important when deciding which document to use during various phases of a business relationship.

Can a Non-Binding Contract Be Enforced?

A letter of intent is often the first written document that is exchanged and signed by parties to an agreement. It summarizes the terms of the agreement and serves as a reference point for further discussion and negotiation. It is typically identified clearly within the document as being non-binding.

These agreements are usually recognized as non-binding unless they include a provision that specifically states that it is binding, and no liability exists by either party, even if no final agreement is reached and nothing is exchanged.

However, there is legal precedent for enforcing certain non-binding agreements. In these cases, the judge interpreted the non-binding provisions of the letter of intention as binding because the parties should have agreed to those provisions in good faith. To prevent this, pay attention to the location representing the agreement's governing law, because states may interpret non-binding agreements differently.

When a Non Binding Agreement May Be Enforceable

Although a non binding agreement is generally not enforceable, courts may choose to enforce certain provisions—or even the entire agreement—under specific circumstances:

• Good Faith Reliance: If one party acts on the non binding agreement and incurs losses, courts may award damages to prevent unjust outcomes.
• Partial Performance: If parties begin fulfilling terms of the agreement, a judge may determine that a binding contract has been implied.
• Clear Intention to Be Bound: Even if labeled "non binding," contradictory language or behavior may override that designation.
• Bad Faith Conduct: If one party uses the non binding label to manipulate or deceive, courts may intervene.

To minimize this risk, always clearly identify which clauses are non binding and which—such as confidentiality, exclusivity, or dispute resolution—are intended to be legally enforceable.

Best Practices for Drafting Non Binding Agreements

To ensure your non binding agreement protects your interests and avoids confusion, consider the following best practices:

1. State the Non-Binding Nature Clearly: Use language like “This agreement is not intended to create legal obligations” prominently at the beginning.
2. Be Consistent Throughout: Avoid contradictory wording that might suggest the agreement is meant to be binding.
3. Identify Binding Clauses Separately: If including binding terms (e.g., confidentiality or non-solicitation), isolate them and use clear headings.
4. Define the Purpose: Explain that the document is for exploratory purposes or pre-contractual discussions.
5. Include a Governing Law Clause: Specify the jurisdiction whose laws will interpret the agreement.
6. Consult Legal Counsel: Before finalizing, have an attorney review the language to ensure the agreement reflects your intentions.

These steps reduce the risk of disputes and help both parties move toward a formal contract with clarity.

Combining Binding With Non-Binding Provisions

Sometimes parties are willing to make a binding contract but have yet to iron out every detail of the agreement. In such cases, which are usually complicated and large in scope, it is not unusual to have a document that includes both binding and non-binding provisions.

The transaction may be subject to important conditions, and it's beneficial to outline the procedures for addressing them. There are times when it's important to have such a written agreement, but parts of it may not be agreed upon if other obligations have not been met or milestones in the process achieved.

Attorneys are cautious when drafting letters of intent that include both binding and non-binding provisions, and due to an abundance of caution, they can be difficult to read. It's important to keep the following recommendations in mind:

• Be accurate and consistent with the wording of each provision and be careful about which are intentions and which are obligations.
• Include conditions precedent for the provisions to be binding.
• Thoroughly explain what needs to be done in order for a binding agreement to take place.

Frequently Asked Questions

1. What is the purpose of a non binding agreement?
   It outlines the intent of parties to negotiate or collaborate without creating enforceable legal duties.
2. Can a non binding agreement be partially binding?
   Yes, specific provisions like confidentiality or exclusivity may be legally enforceable even if the overall agreement is not.
3. Is a letter of intent always non binding?
   Not necessarily. While often non binding, it can include binding terms or become binding if not clearly labeled.
4. How do courts determine if a non binding agreement is enforceable?
   Courts look at language, actions of the parties, and context—especially signs of partial performance or bad faith.
5. Can I create a non binding agreement without a lawyer?
   While possible, it's advisable to consult a lawyer to ensure clarity and avoid unintended obligations. You can find experienced attorneys on UpCounsel.

If you need more information or help with a non-binding contract, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.