OCTOBER 15, 2013

By Oliver Herzfeld

Contractual counter-parties sometimes agree to contract on major terms while leaving other terms open and subject to further negotiation. In a prior Forbes column (available here), I reviewed a case where one party insisted on materially different terms to the previously agreed-upon major terms. But assuming the parties do not attempt to alter the major terms, what are the boundaries of the parties’ obligation to agree upon the open terms and enter into a final agreement? The recent decision in L-7 Designs v. Old Navy addresses this question.

Background

Todd Oldham is an artist, designer and TV personality best known for being the host of “Todd Time” on MTV’s House of Style in the 1990s. In 2007, Oldham’s company, L-7 Designs, and Old Navy entered into an agreement to agree that provided as follows:

"[I]t is the intent of the parties to develop and launch a line of products that will bear TODD OLDHAM Marks to be sold exclusively at Old Navy stores at a future time. [L-7] and Old Navy acknowledge and agree that the specific terms and conditions related to this proposed line of products bearing TODD OLDHAM Marks are to be negotiated and agreed upon by the parties in a separate agreement. The parties plan to enter into a separate agreement related to these products by October 1, 2008. The parties agree that this separate agreement will contain at least the following: (1) royalty fees paid to [L-7] of 5% of Old Navy’s retail sales for this particular line only (not all Old Navy products) and (2) agreement and final approval by both Old Navy and [L-7] as to the collections and products to be sold by Old Navy."

In April 2008, the parties commenced negotiations to finalize the license agreement. They communicated and negotiated until September 2008 when Old Navy conveyed an interest in postponing the agreement indefinitely. Oldham claimed material breach and threatened to sue Old Navy. The parties returned to the table and continued negotiating back and forth until February 2009 when Old Navy advised Oldham that it did not believe a collaborative partnership could be established and broke off talks. In response, Oldham commenced a lawsuit against Old Navy.

The Legal Standard

According to the court, under New York law, when parties agree to contract on major terms while leaving other terms open and subject to further negotiation, “the parties are bound only to make a good faith effort to negotiate and agree upon the open terms and a final agreement; if they fail to reach such a final agreement after making a good faith effort to do so, there is no further obligation.” The duty to negotiate in good faith only obligates a party to act honestly and try to reach an agreement. It does not require a party to accede to every demand of the other party or enter into an agreement at all costs. In contrast, bad faith requires a party to engage in some “deliberate misconduct.” And acting in one’s self-interest (e.g., in response to changes in business conditions, financial position or market factors), does not constitute bad faith.

The Decision

Applying the legal standard, the court held that Old Navy evidenced its good faith through its ongoing and meaningful negotiations over a ten month period with legitimate and substantial offers in accordance with the major terms of the parties’ original 2007 agreement. Old Navy’s decision to break off talks was motivated by legitimate business concerns including significant and material changes in the company’s (i) senior management team, (ii) target consumer demographic, and (iii) financial performance. Based on the foregoing, and the absence of any evidence that Old Navy engaged in deliberate misconduct or acted with any malice or ill will towards Oldham, the court granted Old Navy’s motion for summary judgment.

The Lesson For Contracting Parties

Notwithstanding Old Navy’s win here, the time, resources and costs it was required to devote to this dispute could have been avoided with some more thoughtful drafting of the parties’ original agreement. In particular, agreements to agree should include provisions to clarify the limitations of the parties’ obligation to agree upon the open terms and enter into a final agreement, a specific definition of the parties’ obligation to negotiate in good faith and limits thereto, and appropriate disclaimers and termination provisions to excuse each party’s ongoing obligation to negotiate a final agreement in the event of material adverse changes of business circumstances, market conditions and other common commercial factors and events. Doing so would help prevent similar problems if a proposed deal loses its luster.