Memorandum of agreement in Texaco v. Pennzoil

In 1984, two US companies – Pennzoil and Getty Oil negotiated a merger. They signed a ‘memorandum of agreement’. However, before the transaction was finalized Getty Oil broke off negotiations. The company concluded a merger contract with a third party – Texaco – which offered a higher price for the shares. Pennzoil brought an action against Texaco, declaring that Texaco had tortiously interfered with the transaction in process. To sustain the claim, Pennzoil had to prove that the ‘memorandum of agreement’ between Pennzoil and Getty Oil was binding and therefore, in respect of this document, Getty Oil had no right to break off negotiations to conclude a contract with third party. According to the court, the memorandum of agreement was binding, representing the prospects of the transaction. At first instance, it was held that Texaco had interfered with the prospects of the transaction; an award of 11 billion US dollars, including damages, interest and punitive damages was granted. On appeal, punitive damages were reduced from three to two billion. Nevertheless this amount remains one of the largest damages awards in US history.

The decision in Texaco v. Pennzoil gave rise to questions concerning a variety of areas of law. Focusing on the ‘memorandum of agreement’, why was it qualified as a prospect of a transaction? Can such document preclude the possibility of breaking off negotiations in order to accept a more profitable offer? Is this the case even if the document does not establish that negotiations are exclusive? Could an enforceable provision on exclusivity be included into letter of intent? If such a document binds the parties, what is the nature of the obligations it may contain, as compared to the effects of the final contract? How do these effects relate to freedom of contract? To what extent may the parties agree in advance on recovery in case negotiations fail? Could the parties have kept their negotiations non-binding by explicitly stating this in their ‘memorandum of understanding’? Could they have created some binding obligations to structure the deal, while remaining free to not conclude the final negotiated contract? In other words, could parties create by consent an arena for conducting parallel negotiations, retain their discretion to accept higher bids and deploy other negotiation tactics, while contractually specifying the scope of their eventual liability?