Pre-contract or Final Contract? Differences, Implications, Importance
Updated: May 16
Have you heard the term "pre-contract" but not sure about its meaning? Or does it seem strange that there could be a "pre-contract" before the actual contract? You're right to raise these questions, especially if the legal world is not your specialty. Below, we explore the concept of the pre-contract, the difference between it and the contract it precedes, its importance in the business environment, and the associated legal implications.
What is a pre-contract?
A pre-contract is still a contract. However, unlike "final" contracts where the parties establish the performances they will have towards each other, through a pre-contract, they establish the conditions that must be met to conclude the final contract. In other words, the pre-contract is an agreement concluded between parties before signing a final contract, announcing the requirements that must be fulfilled before the latter is signed. It is a preliminary understanding that establishes the main conditions of the transaction and serves as a preliminary commitment between parties.
Why are pre-contracts concluded?
Parties enter into a pre-contract when they have an overview of the future transaction but not all conditions are met for it to be finalized immediately. This could be due to legal conditions or additional investigations that one of the parties wishes to conduct.
Delaying the final contract may be necessary when the law imposes forms of validity or effectiveness. For example, real estate transfer contracts must be concluded before a notary public. While parties may agree on all contractual conditions on the spot, obtaining the notarization requires choosing a notary office, scheduling a consultation, paying notary fees, and other formalities. The solution? Parties may now conclude a pre-contract, setting the conditions under which the transfer of ownership will take place, and later fulfill the necessary legal formalities before signing the final contract.
The pre-contract can also be useful when the subject of the final contract does not yet exist in a finalized state. Daily applications of this scenario exist in real estate, where developers of residential complexes or office buildings obtain the necessary construction permits, start construction work, and simultaneously seek clients. Interested individuals can purchase apartments or houses or lease office spaces before they exist through the pre-contract.
In more complex transactions, the pre-contract allows one party to conduct necessary investigations into the other party's business. Such checks can be of the due diligence type, verifying ownership titles of the other party's assets, contracts with contractual partners and employees, or the status of current or potential litigations. Why? Because such checks often require a duration of 1-3 months and the engagement of specialized individuals, such as lawyers or auditors.
The pre-contract allows for such checks while providing a guarantee for the final contract if the result is positive or the possibility of abandoning the final transaction if information is discovered that jeopardizes the final outcome. Such situations most often arise in mergers and acquisitions, business or asset transfers from one company to another.
What types of contracts can be preceded by pre-contracts?
The pre-contract is versatile and can be used in various fields and types of transactions. Most final contracts could theoretically be preceded by an pre-contract if practical considerations dictate. There is no legal limitation stating that certain final contracts cannot be preceded by pre-contracts; therefore, pre-contracts can exist whenever practical circumstances demand.
Some examples include:
Sale contracts:
Pre-contract: parties establish the main conditions of the sale, such as price and payment terms.
Final contract: includes all details related to the transfer of ownership, delivery, warranties, and other specific clauses.
Pre-contract: parties establish the main terms of the lease and may include a purchase option.
Final contract: details all obligations of the parties during the lease period, including expenses, maintenance, and specific terms.
Pre-contract: general conditions of services, such as duration and compensation, are established.
Final contract: includes specific details of the services, such as working methods, materials used, intermediate delivery deadlines, and other specific clauses.
Collaboration or business partnerships:
Pre-contract: parties establish the basic conditions of collaboration, including responsibilities and benefits.
Final contract: specifies details of the collaboration, including resource-sharing methods, decision-making procedures, the work plan for execution stages, and other relevant aspects.
Distribution or franchise agreements:
Pre-contract: parties outline the basic conditions of distribution or franchising, such as territory and marketing rights.
Final contract: specifies all details related to distribution or franchise, including party obligations, exclusivity clauses, and other specific aspects.
Construction field:
Pre-contract: parties establish general aspects of construction, such as estimated cost and completion terms.
Final contract: details all aspects related to construction, including technical specifications, work timeline, performance warranties, and other specific clauses.
Is a pre-contract binding?
Regardless of its name or purpose, any contract, including a pre-contract, is mandatory. As a consequence, the party that breaches it will be liable to the other party in any of the forms of contractual civil liability: they may be required to perform the obligations directly or equivalently, respond for termination or annulment of the pre-contract, pay damages for delay, etc.
In certain cases, the law is even more protective of pre-contracts, allowing them to be enforced directly. This is the case of the sales pre-contract, for which the law allows a judge to replace the consent of the opposing party for the execution of the final contract.
In other words, if the parties conclude a sales pre-contract, or one party makes a firm offer to buy or sell and later does not wish to honor it, the other party can obtain a court decision to get things done. The final contract will be represented by the pre-contract, alongside the court decision.
Advantages of pre-contracts professional templates
Fixes the parties' understanding: through a pre-contract, the parties will establish the main conditions of the future transaction. These can be detailed, including provisions such as price, payment terms, confidentiality clauses, and other essential aspects, or they may only contain the agreement to conclude the final contract within a certain period.
Offers flexibility in negotiations: parties can continue negotiations on secondary aspects of the transaction and make adjustments to transaction details until the contract is finalized. This flexibility is crucial in a continually changing business environment.
Protection of rights: the pre-contract can provide legal protection to parties in case of breach of preliminary commitments. This effect is obtained by including provisions regarding the consequences of non-compliance with the pre-contract, such as the payment of damages, penalty clauses (i.e., assessment of anticipated damage), the provision of an earnest (a sum of money that guarantees the performance of an obligation), or the termination of the obligation to conclude the final contract.
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