Prior to entering into a final contract, parties frequently memorialize certain key deal points in preliminary agreements. These preliminary agreements are known by many names: letters of intent, term sheets, letters of interest, expressions of interest, or memoranda of understanding. Preliminary agreements often contain both non-binding provisions and binding provisions, such as an exclusivity provision or an agreement to negotiate in good faith. When a party breaches a binding provision in an otherwise expressly nonbinding preliminary agreement, the question inevitably arises: what is the proper measure of damages?

Although courts addressing this issue have generally held that the proper measure of damages is limited to out-of-pocket or reliance damages, dicta in an influential opinion by Judge Richard Posner leaves open the door for an award of “benefit of the bargain” or expectation damages such as lost profits. Venture Associates Corp. v. Zenith Data Systems Corp., 96 F.3d 275 (7th Cir. 1996). Judge Posner’s opinion, which has been favorably cited by a number of commentators, injects enough uncertainty into the damages analysis to expose unsuspecting parties to hundreds of thousands or even millions of dollars in damages, or, at the very least, subject them to litigation that is not easily or inexpensively resolved based on a preliminary agreement that a party thought to be non-binding.

In Venture, Judge Posner recognized the prickly issues surrounding preliminary agreements:

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 to negotiate toward a final contract. 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 contract? And can the victim of bad faith ever get more than his reliance damages?