When a Business Partner Becomes a Frenemy

March 2015

Published In The Daily Journal of Commerce

Business, like politics, makes strange bedfellows. A competitor can become a valuable ally to a business under the right circumstances – for instance, one might decide to work collaboratively to buy an asset that neither party could afford alone.

But what happens if a collaboration breaks down, and an erstwhile partner once again becomes a fierce adversary? A recent Oregon Court of Appeals decision provided an important reminder that businesses must be careful so that "memorandums of understanding," "letters of understanding" and other agreements act in concert with others.

In Vukanovich v. Kine, the court upheld a jury verdict for breach of contract of almost $700,000 against the defendant, who refused to complete a real property purchase with the plaintiff, and then purchased the property himself.

The parties were separately interested in acquiring a specific subdivision. In order to minimize the threat of a bidding war, they agreed to work together to buy it. To that end, they executed a "letter of understanding" reflecting their agreement.

The defendant subsequently told the plaintiff that he would not go through with the joint purchase, ostensibly because he had better opportunities elsewhere. However, the defendant actually wanted to – and did – purchase the property outright. The jury found that the defendant's conduct had breached the letter of understanding.

There are three key takeaways from the court's decision in Vukanovich:

1. Make sure contracts are clear!

The defendant argued extensively, but unsuccessfully, at trial that the letter of understanding was not a binding contract. The parties' differing interpretations of the nature of the letter ultimately resulted in protracted litigation and an expensive jury verdict against the defendant.

When considering entering into any kind of memorandum or letter of understanding, make sure that: (a) the fellow collaborator agrees with your understanding of your collective relationship; and (b) your written agreement clearly expresses the intention of the parties. When one party thinks that a binding contract has been formed, and the other believes that the agreement is merely a nonbinding expression of mutual desire, the specter of litigation looms large.

2. Be careful sharing confidential and/or proprietary information in joint collaborations.

Part of the plaintiff's breach of contract argument was that the defendant had obtained the plaintiff's confidential and/or proprietary information pursuant to the letter of understanding, and then used it to formulate his individual purchase of the subdivision.

Be leery of sharing confidential information with a potential competitor pursuant to a memorandum of understanding; today's collaborator can be tomorrow's competitor. In cases where sharing sensitive business information is necessary, insist on reciprocal nondisclosure agreements with clear penalties for violations.

3. If the collaboration fails, don't take an ex-collaborator's words at face value.

The appellate court rejected the plaintiff's argument that the defendant had defrauded him by telling him that the defendant was no longer interested in purchasing the subdivision, but then buying it shortly thereafter. A necessary element for fraud is that the defrauded party justifiably rely on the fraudulent representation. The court said that the plaintiff's reliance on the defendant's disavowal of further interest in the subdivision was not justifiable.

If an agreement to work together fails, assume that the now-competitor will still pursue the object of collaboration. A sophisticated businessperson should not rely on a representation to the contrary, and if one does, the courts may not support a claim of fraud. Instead, be proactive and include in the agreement what each party can or cannot do with respect to the object of collaboration.

Memorandums of understanding are useful tools. However, a properly drafted one not only addresses the positive aspects of a prospective deal, but also the key issues if the collaboration should fail. Had the memorandum of understanding in Vukanovich been drafted more thoroughly, the plaintiff probably could have avoided lengthy and expensive litigation.

Matt Mertens practices in the firm's business, litigation and business & restructuring practice groups. Contact him at 503-972-2522 or mmertens@sussmanshank.com.

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