Venture Associates Corp. v. Zenith Data Systems Corp.

• Decision Date: 18 September 1996
• Docket Number: Nos. 95-3574,96-1922,s. 95-3574
• Citation: 96 F.3d 275
• Parties: VENTURE ASSOCIATES CORPORATION, Plaintiff-Appellant, v. ZENITH DATA SYSTEMS CORPORATION, Defendant-Appellee.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 275

96 F.3d 275

VENTURE ASSOCIATES CORPORATION, Plaintiff-Appellant, v. ZENITH DATA SYSTEMS CORPORATION, Defendant-Appellee.

Nos. 95-3574, 96-1922.

United States Court of Appeals Seventh Circuit.

Argued May 28, 1996.

Decided Sept. 18, 1996.

Forrest L. Ingram (argued), Donald L. Johnson, Tobin M. Richter, Leo G. Aubel, Aubel & Aubel, Chicago, IL, for Plaintiff-Appellant.

Thomas F. Bush, Jr., Thomas A. Doyle, Saunders & Monroe, Chicago, IL, Craig A. Newman, Michael D. Schissel (argued), Arnold & Porter, New York City, for Defendant-Appellee.

Before POSNER, Chief Judge, and CUDAHY and EASTERBROOK, Circuit Judges.

POSNER, Chief Judge.

One of the most difficult areas of contract law concerns the enforceability of letters of intent and other preliminary agreements, and in particular the subset of such agreements that consists of agreements to negotiate toward a final contract. See Steven J. Burton & Eric G. Andersen, Contractual Good Faith: Formation, Performance, Breach, Enforcement §§ 8.4-8.5 (1995); 1 E. Allan Farnsworth, Farnsworth on Contractsss 3.8a-3.8c, 3.26b-3.26c, pp. 186-207, 328-352 (1990); 1 Corbin on Contracts §§ 2.8-2.9, pp. 131-162 (Joseph M. Perillo ed., rev. ed.1993). When if ever are such agreements enforceable as contracts? If they are enforceable, how is a breach to be determined? Is "breach" even the right word? Or is the proper rubric "bad faith"? Could the duty of good faith negotiation that a letter of intent creates be a tort duty rather than a contract duty, even though created by a contract? And can the victim of bad faith ever get more than his reliance damages? These questions lurk on or just beneath the surface of the principal appeal, which is from a judgment by the district court, after a bench trial, finding that the defendant had not acted in bad faith and was not liable for any damages to the plaintiff. Federal jurisdiction is based on diversity of citizenship, and the substantive issues are governed by Illinois law.

The defendant, Zenith Data Systems Corporation (ZDS), owned Heath Company, the manufacturer of "Heathkits"--do-it-yourself kits for building stereos, computers, and other electronic systems. Heath was losing money, and in 1990 ZDS decided to sell it together with a related subsidiary, Prokit, but we shall generally use "Heath" to denote both Heath and Prokit. ZDS hired an investment banker to find someone who would buy Heath at a price, then estimated at $11 million, at which ZDS would lose no more than $6 million on the sale, the loss being calculated with reference to the net asset value shown for Heath on the books of ZDS. One of the prospects that the investment banker found was the plaintiff, Venture Associates Corporation. Apparently the investment banker did not conduct a credit check of Venture. Instead he relied on a representation by Venture that its most recent acquisitions had been of companies with revenues of $55 and $97 million.

On May 31, 1991, Venture sent a letter to the investment banker, for forwarding to ZDS, proposing to form a new company to acquire Heath for $5 million in cash, a $4 million promissory note, and $2 million in preferred stock of the new company--a total of $11 million, the price ZDS was seeking. The letter stated that it was "merely a letter of intent subject to the execution by Seller and Buyer of a definitive Purchase Agreement (except for the following paragraph of this letter, which shall be binding ... ) [and] does not constitute a binding obligation on either of us." The following paragraph stated that "this letter is intended to evidence the preliminary understandings which we have reached regarding the proposed transaction and our mutual intent to negotiate in good faith to enter into a definitive Purchase Agreement, and [ZDS] hereby agree[s] that, pending execution of a definitive Purchase Agreement and as long as the parties thereto continue to negotiate in good faith," ZDS shall not "solicit, entertain, or encourage" other offers for Heath or "engage in any transaction not in the ordinary course of business which adversely affects" Heath's value.

The letter invited ZDS to sign it. ZDS refused, but did write Venture on June 11 stating that "we are willing to begin negotiations with Venture Associates for the acquisition of the Heath Business based in principle on the terms and conditions outlined in" Venture's May 31 letter. The next day, Venture wrote ZDS accepting the proposal in the June 11 letter.

Let us pause here and ask what if any enforceable obligations were created by this correspondence. The use of the words "in principle" showed that ZDS had not agreed to any of the terms in Venture's offer. This is the usual force of "in principle" and is the meaning we gave the term in Skycom Corp. v. Telstar Corp., 813 F.2d 810, 814 (7th Cir. 1987); cf. Arcadian Phosphates, Inc. v. Arcadian Corp., 884 F.2d 69, 71-73 (2d Cir.1989); Itek Corp. v. Chicago Aerial Industries, Inc., 248 A.2d 625, 627 (Del.1968). That construal is reinforced by Venture's statement in its letter that the only binding obligation that ZDS's signing the letter would create would be an obligation of both parties to negotiate in good faith and, on ZDS's part, a further obligation not to entertain other offers or strip Heath of its assets--obligations that might be thought in any event entailed by the concept of good faith but which Venture thought useful to spell out. When last this case was before us, on appeal from an earlier decision (812 F.Supp. 788 (N.D.Ill.1992)) by a different district judge dismissing Venture's suit, we held that the exchange of letters had established a binding agreement to negotiate in good faith toward the formation of a contract of sale. The doctrine of the law of the case makes this determination binding in this second round of appeals in the absence of exceptional circumstances not here shown.

We therefore have no occasion to revisit the determination on this appeal, though we are mindful of the powerful argument that the parties' undertakings were too vague to be judicially enforceable--since courts, unlike the National Labor Relations Board or labor arbitrators, are not well equipped to determine whether people are negotiating with each other in good faith--or, if not, that the proper rubric for determining enforceability in such a case is not contract but promissory estoppel. See, e.g., Quake Construction, Inc. v. American Airlines, Inc., 141 Ill.2d 281, 152 Ill.Dec. 308, 322-23, 565 N.E.2d 990, 1004-05 (1990); Skycom Corp. v. Telstar Corp., supra, 813 F.2d at 817; Arcadian Phosphates, Inc. v. Arcadian Corp., supra, 884 F.2d at 73-74. This is the approach taken in some states. 1 Farnsworth, supra, § 3.26b, pp. 329-34. But interpreting Illinois law, we have held that agreements to negotiate toward the formation of a contract are themselves enforceable as contracts if the parties intended to be legally bound. See, besides the previous panel opinion in this case (987 F.2d 429, 432 (7th Cir.1993)), A/S Apothekernes Laboratorium v. I.M.C. Chemical Group, Inc., 873 F.2d 155, 158 (7th Cir.1989)- . Unfortunately, this is one of those issues of state common law on which the only decisions are either decisions by a federal court, or decisions (in this case one decision, Itek Corp. v. Chicago Aerial Industries, Inc., supra, 248 A.2d at 627, 629) by the courts of another state. The two federal cases that we have cited (the previous panel decision and the Apothekernes decision) cite between them only one Illinois decision, Inland Real Estate Corp. v. Christoph, 107 Ill.App.3d 183, 63 Ill.Dec. 9, 11, 437 N.E.2d 658, 660 (1981), and it does not contain a clear statement of the proposition. Nor have we found any Illinois decisions that do.

ZDS has not asked us to reexamine our decisions, so we shall let them stand, quite apart from the force exerted by the doctrine of the law of the case. Right or wrong, the position they take cannot be said to be unreasonable. The process of negotiating multimillion dollar transactions, like the performance of a complex commercial contract, often is costly and time-consuming. The parties may want assurance that their investments in time and money and effort will not be wiped out by the other party's footdragging or change of heart or taking advantage of a vulnerable position created by the negotiation. Feldman v. Allegheny Int'l, Inc., 850 F.2d 1217, 1221 (7th Cir.1988); Runnemede Owners, Inc. v. Crest Mortgage Corp., 861 F.2d 1053, 1056 (7th Cir.1988). Suppose the prospective buyer spends $100,000 on research, planning, and consultants during the negotiation, money that will have bought nothing of value if the negotiation falls through, while the seller has spent nothing and at the end of the negotiation demands an extra $50,000, threatening to cancel the deal unless the buyer consents. This would be an extortionate demand, and, as it is profoundly unclear whether it would be independently tortious, E. Allan Farnsworth, "Precontractual Liability and Preliminary Agreements: Fair Dealing and Failed Negotiations," 87 Colum.L.Rev. 217, 221-22 (1987), parties to a negotiation would want a contractual remedy. But they might prefer to create one in the form of a deposit or drop fee (what in publishing is called a "kill fee"), rather than rely on a vague duty to bargain in good faith. That is one reason why the notion of a legally enforceable duty to negotiate in good faith toward the formation of a contract rests on somewhat shaky foundations, though some contracts do create such a duty, see, e.g., PSI Energy, Inc. v. Exxon Coal USA, Inc., 17 F.3d 969, 972 (7th Cir.1994), which shows that some business people want it. Anyway we have crossed these bridges, for the time being anyway.

In the prior round of appeals Venture's principal argument, which this court rejected, was that the parties' exchange of nonidentical contract drafts during the negotiation period had created a...