Don’t Be Bound by an American Contract before You Know It!

[deutscher Text]

When it comes to making contracts, German and American law shares the same basic principles. But when parties agree to make a formal contract at a later time, and essential contract terms remain open, what is the next step?

In America, what can happen is … a lawsuit.

The German Bürgerliches Gesetzbuch § 154 makes these kinds of cases simple:

“As long as the parties have not agreed to all terms of a contract, over which agreement was required, be it only according to the declaration of a single party, the contract is not entered into when there is doubt. Mutual understanding as to individual terms is also not binding, even when a writing has taken place.”

Frank R. Snyder/ Miami U libraries Digital coll.

Frank R. Snyder/ Miami U libraries Digital coll.

Where the BGB imposes clarity, however, the American courts provide multi-factor balancing tests that German companies are likely to find confusing.

This can be seen in a recent case in New York.  The great German sports apparel manufacturer and shoemaker Adidas A.G. (and its American affiliate Adidas America, Inc.) successfully warded off an alleged profit-sharing and licensing agreement with a plaintiff.

The plaintiff, a fashion designer, had negotiated with Adidas to create “streetwear-style designs” for the Adidas brand, which Adidas intended to use for National Collegiate Athletic Association (“NCAA”) basketball teams that it sponsored.

Negotiations progressed. The parties eventually expressed the intent to enter a formal contract in a letter agreement, but they never reached the final stage. No written contract was ever executed. Thus, at most, Adidas reached what United States law calls an “agreement to agree.”

Several key terms remained unresolved.  Adidas wanted to back-dated a licensing agreement and include a royalty charge—which the New York fashion designer rejected.  Adidas repeatedly said it wished to proceed to the formal, written contract but called the “letter agreement” a mere “work in progress.” Eventually, Adidas dropped the collaboration.

Having invested considerable time and obviously frustrated by seeing a potentially lucrative deal slip away, the fashion designer sued. Thus, the next stop was the Federal District Court for the Eastern District of New York.

There, the court agreed with Adidas. If the case had been decided under BGB § 154, there would be a clear rule of decision (no agreement as to all key terms, no contract as to any individual terms). Under the American common law, however, the court applied a two-tiered balancing test.

The court first divided preliminary “agreements to agree” (such as the parties’ “letter of intent”) into Type I and Type II:

I)              Fully biding preliminary agreements, created when the parties agree on all points that require negotiation (including agreement whether to be bound) but where the parties agree to memorialize their agreement in a more formal document later.

II)             Binding preliminary agreements, where parties agree on certain major terms, but leave other major terms open for further negotiation. Parties may leave discrete material terms unspecified but nevertheless agree on mechanisms for objectively setting material terms in the future.

Type I agreements would be fully recognized and enforced under German law and BGB § 154. Type II agreements would not.

In the United States, however, Type II agreements might be enforced. The court in the Adidas case set forth a five-factor balancing test:

(1)   whether the intent to be bound is revealed by the language of the agreement;

(2)   the context of the negotiations;

(3)   the existence of open terms;

(4)   partial performance; and

(5)   whether the alleged agreement is of the kind usually reduced to writing in the given business context in which it was made.

Upon further refection, the court also elaborated factor (5), which, in and of itself, required four additional balancing factors: (1) the size and complexity of the transaction; (2) the duration of the contract; (3) the subject matter of the contract; and (4) the amount of money to be exchanged. This addition thus made a total of nine factors for Type II agreements!

Not to despair, the New York designer could not pass the test, and Adidas won on a motion to dismiss.

But the American balancing factors game leaves lots of room for error and confusion.  Without sophisticated counsel, an unwary German business can find itself bound by an American contract before it realizes that it has triggered enough “factors.”

There are some simple preventative measures, however. The most important is the first factor: the parties’ intent to be bound. German businesses should work with experienced U.S. counsel to make sure to avoid making affirmative statements expressing the intent to be bound until and unless they have agreed to all material terms.

As the court counseled: “A party … can very easily protect itself by refusing to accept language that shows an intent not to be bound.”

The case is LPD New York, LLC v. Adidas America, Inc. and Adidas, AG, No. 15-cv-6360 (E.D.N.Y. March 27, 2017).