Preliminary Agreement Explained: Useful Yet Risky
When two parties start discussing a deal, they often want to put something in writing before the full contract is ready. That’s where a preliminary agreement comes in. It helps capture the main terms of a future deal and sets the tone for negotiations — but it also carries risks if not worded carefully.
Understanding how a preliminary agreement works can save time, reduce misunderstandings, and prevent legal disputes later. Whether you’re running a business, investing in property, or forming a partnership, knowing the basics of this legal document is essential.
What Is a Preliminary Agreement?
A preliminary agreement is a document that outlines the key terms parties have agreed to before they sign a final contract. It’s like a handshake written on paper — it shows intent to cooperate while leaving room for negotiation.
It’s sometimes called a memorandum of understanding (MOU), letter of intent (LOI), or term sheet, depending on the context. While these names have slightly different meanings, they all share one goal: to record the progress of a negotiation before a binding contract is finalized.
For example, if two companies are planning a merger, they may first sign a preliminary agreement listing the purchase price, deadlines, and due diligence terms.
Key Features of a Preliminary Agreement
- Intent to Proceed:
The document shows that both sides are serious about reaching a final agreement. - Defined Main Terms:
Basic details like price, timeline, and responsibilities are included. - Non-binding Nature (Usually):
Most preliminary agreements are not legally binding, though specific clauses — like confidentiality or exclusivity — often are. - Legal Framework:
It sets the stage for future contracts and defines how both parties will move forward.
Why Businesses Use Preliminary Agreements
Businesses rely on these documents for several reasons:
- Speed: Deals can move faster when the essential terms are agreed upon early.
- Clarity: Everyone knows what’s expected before investing more time or money.
- Confidence: Helps build trust between parties, showing mutual commitment.
- Risk Management: Prevents misunderstandings that could derail final negotiations.
For instance, a startup and an investor might sign a preliminary agreement outlining funding terms before conducting full legal due diligence.
Binding vs. Non-Binding Preliminary Agreements
Not all preliminary agreements are created equal. Some are binding, while others are non-binding — and the difference matters greatly.
1. Binding Preliminary Agreements
These are enforceable in court. Once signed, both parties must follow through with the obligations stated. Common in real estate or franchise deals, they include clear terms and are intended to be final on specific points.
2. Non-Binding Preliminary Agreements
These express intent but do not legally force either side to finalize the deal. They’re often used in early-stage business discussions. However, some sections (like confidentiality or exclusivity) can still carry legal weight.
Courts often look at the language used — phrases like “subject to contract” or “non-binding” usually signal intent rather than obligation.
Real-World Example: Real Estate Negotiations
Let’s say a buyer and seller agree on a property price but still need to arrange financing and inspections. They may sign a letter of intent summarizing the price and payment terms.
If either party later changes their mind, the preliminary agreement may not legally force them to proceed — unless certain clauses are made binding. That’s why clarity in drafting is critical.
The Legal Perspective: Are Preliminary Agreements Enforceable?
This depends on jurisdiction and wording. Courts look for specific indicators to decide whether a document is binding:
- Does it use mandatory terms like shall or must?
- Is there clear intent to be legally bound?
- Are the key terms (price, time, object) defined precisely?
- Did both parties sign voluntarily and understand the terms?
If the document reads more like a roadmap than a contract, it’s likely non-binding. However, courts have occasionally enforced preliminary agreements when they believe the intent to be binding was clear.
Common Types of Preliminary Agreements
- Letter of Intent (LOI):
Outlines the preliminary understanding between parties before a final deal. Common in mergers, acquisitions, and partnerships. - Memorandum of Understanding (MOU):
Similar to an LOI, but used frequently in government or nonprofit collaborations. - Heads of Agreement:
Used in commercial deals to summarize key terms before detailed contracts are drafted. - Term Sheet:
Common in finance and venture capital deals, showing investment terms and equity details.
Advantages of Using a Preliminary Agreement
- Reduces Uncertainty: Everyone knows where negotiations stand.
- Saves Time: Avoids re-negotiating points already discussed.
- Shows Seriousness: Demonstrates professional intent to move forward.
- Sets Legal Boundaries: Defines what’s confidential or exclusive.
- Protects Investment: Especially important when one party incurs early costs like due diligence or feasibility studies.
Potential Risks and Drawbacks
While preliminary agreements can smooth negotiations, they also carry hidden dangers:
- Ambiguity:
Vague wording can lead to disputes over interpretation. - False Sense of Security:
Parties might assume the deal is final when it’s not legally enforceable. - Legal Exposure:
Even non-binding agreements can lead to litigation if one party acts in bad faith. - Negotiation Pressure:
Signing too early might limit flexibility during the final contract stage.
A good rule of thumb: always have a lawyer review the document before signing.
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How to Draft a Strong Preliminary Agreement
When preparing a preliminary agreement, clarity and precision matter more than anything. Here’s what it should include:
1. Identify the Parties
Clearly state the legal names and addresses of all parties involved.
2. Define the Subject Matter
Explain what the deal is about — whether it’s a business sale, partnership, or service agreement.
3. Outline Key Terms
Include proposed prices, responsibilities, timelines, and any special conditions.
4. Specify Which Parts Are Binding
State explicitly which clauses (like confidentiality or exclusivity) are legally enforceable.
5. Add a “Non-Binding” Clause (if needed)
This makes it clear that the document is a statement of intent, not a final contract.
6. Include a Good Faith Provision
Encourages both parties to continue negotiating honestly.
7. Include Governing Law
Identify which jurisdiction’s laws will apply in case of dispute.
Common Clauses Found in Preliminary Agreements
| Clause Type | Purpose | Binding Nature |
|---|---|---|
| Confidentiality | Protects shared information | Usually Binding |
| Exclusivity | Prevents negotiation with other parties | Often Binding |
| Termination | Sets conditions for ending negotiations | Can Be Binding |
| Costs | Defines who pays for legal or admin expenses | Optional |
| Good Faith | Encourages continued honest discussions | Typically Non-Binding |
This table shows that even a “non-binding” agreement can include parts that hold legal force.
The Role of Good Faith in Negotiations
In many legal systems, parties are expected to act in good faith when negotiating. This means they should not mislead, withhold key information, or act dishonestly.
If one party uses the preliminary agreement to buy time or sabotage negotiations, they may still face legal consequences for bad faith, even if the document is non-binding.
When Should You Use a Preliminary Agreement?
Use it when:
- You want to secure commitment before drafting a full contract.
- You need to outline terms for financing or due diligence.
- You’re negotiating a merger, property sale, or partnership.
- You want to define confidentiality or exclusivity terms early.
Avoid it when:
- The deal is too complex for a summary.
- You’re unsure of final terms.
- You lack legal counsel to draft or review the wording.
Best Practices for Using Preliminary Agreements
- Be Clear About Intent:
Use plain language to say whether the document is binding or not. - Limit the Scope:
Include only the essentials. Leave detailed obligations for the final contract. - Consult a Lawyer:
Legal advice can prevent misunderstandings and protect your interests. - Keep Documentation:
Store drafts, emails, and negotiation notes in case questions arise later. - Set Deadlines:
Define how long the preliminary agreement remains valid to avoid confusion.
Real-Life Case Study
In one landmark case, two companies signed an LOI to collaborate on a real estate development project. When one side backed out, the other sued, claiming the LOI was binding.
The court ruled that while most clauses were non-binding, the exclusivity clause was enforceable. This shows that the details — not the title — determine whether a preliminary agreement carries legal weight.
Expert Insight
Legal experts emphasize that preliminary agreements can be strategic tools if drafted correctly. According to Harvard Law School’s Program on Negotiation, preliminary agreements reduce negotiation risk by ensuring early alignment but must be drafted with precision to avoid accidental commitments.
In other words, they’re useful, but only if everyone understands what’s being promised — and what isn’t.
The Future of Preliminary Agreements in Business
As deals become more global and digital, preliminary agreements are becoming standard practice. With remote negotiations and virtual partnerships, having a clear written summary of intent protects both sides.
Technology has also made it easier to create and sign these documents through e-signature platforms. Still, human clarity remains the key — no digital tool can replace good legal drafting.
Conclusion: Useful but Handle With Care
A preliminary agreement can be your best friend or your biggest headache, depending on how it’s written. It’s a great way to record intent, build trust, and move deals forward — but it’s not a shortcut to a final contract.
Always define what’s binding, keep the language clear, and get expert review before signing. When done right, a preliminary agreement helps both sides move confidently toward a successful deal.
FAQs What Is a Preliminary Agreement
1. What is a preliminary agreement used for?
It records key terms and intent before drafting a full contract.
2. Is a preliminary agreement legally binding?
Usually not, unless specific clauses (like confidentiality or exclusivity) say otherwise.
3. What’s the difference between an LOI and an MOU?
An LOI is used mainly in business, while an MOU often applies to public or nonprofit partnerships.
4. Can a preliminary agreement be enforced in court?
Only if it clearly shows intent to be legally binding.
5. Who should draft a preliminary agreement?
It’s best prepared or reviewed by a lawyer to ensure clarity and legal protection.
6. When should I avoid signing one?
Avoid signing if you’re unsure of key terms or haven’t received legal advice.
7. How long does a preliminary agreement last?
Typically until a final contract is signed or a set expiration date passes.
