Publication

In its judgment (case No. C29244819) of 5 July 2023, the Supreme Court of the Republic of Latvia ruled that a preliminary agreement constitutes a contract. Voluntary non-performance of such an agreement grants the right to seek the enforcement of the main contract through judicial proceedings. The court may also establish the essential terms of the main contract if they can be identified based upon the provisions of the preliminary agreement.[1] The judgment has clarified the legal implications of entering into a preliminary contract, addressing longstanding case-law that has evolved over more than a decade.

Previously, the court ruled a preliminary agreement does not grant either party the right to demand the conclusion of the main contract; rather, it allows the possibility of seeking damages from the party that refuses to finalise the main agreement. This conclusion is based upon the principle that if a preliminary agreement were considered as a binding legal transaction requiring the conclusion of the main contract, it would violate the parties’ autonomy (i.e., their right to choose with whom, when, and under what conditions they wish to engage). Only in exceptional circumstances, such as in property purchase agreements, can it be established that the preliminary contract inherently necessitated the final agreement.[2]

However, in the recent judgment, the Supreme Court contended that the argument regarding the infringement of parties’ autonomy, by allowing a preliminary contract to confer the right to seek the conclusion of the main contract through judicial means, is unfounded. According to the principle of the parties’ autonomy, such rights can be restricted by both legislative action and by the individuals involved in the contract themselves.[3] Thus, a preliminary agreement can be viewed as a voluntary limitation of one’s autonomy, reflecting a commitment to engage with a specific party in the future and to create new obligations based upon the relevant type of legal transaction. Consequently, the Supreme Court effectively recognises that in cases of non-compliance with a preliminary agreement, individuals have the right to compel the conclusion of the main contract.

Given that over a year has passed since the issuance of the Supreme Court’s judgment, it would be beneficial to analyse how the recent changes in the case-law regarding the legal consequences of a preliminary agreement have influenced the outcomes of cases in both the first instance and appellate courts in similar contexts.

In this brief overview, our goal is to offer valuable insights into the purpose of preliminary agreements, the evolution of the case-law and how these judicial insights are applied in practice.

The purpose of the preliminary agreement.

According to Article 1541 of the Civil Code, the purpose of a preliminary agreement is to facilitate the eventual conclusion of the main contract by pre-agreeing on its essential elements. Therefore, a critical prerequisite for effectively protecting the interests of the parties involved in a preliminary agreement is that these essential elements have been agreed upon in advance.

Article 1470 of the Civil Code further clarifies the essential components of a transaction are those elements without which the transaction’s validity would be impossible. For instance, in a sales contract, the essential components include the purchase price and the subject of the sale. Without identifying these two elements, it is typically impossible to classify the transaction as a contract of sale and consequently, to execute it. [4] The conclusion of a preliminary agreement may be necessary in situations where the parties wish to engage with one another, but the final establishment of all obligations is hindered by factual or legal obstacles. [5]

Therefore, a preliminary agreement allows the parties to establish mutual obligations in a timely manner, offering both economic and legal certainty, provided the parties intend to negotiate and finalise the subsequent agreement in good faith.

In practice, an “earnest payment” is often utilised in preliminary contracts to reinforce obligations, which is a common practice in real estate transactions. The Supreme Court has highlighted that an earnest payment serves a dual purpose: proof function –  the provision and acceptance of earnest money serve as evidence of the contract’s conclusion, indicating the parties’ mutual intent to enter into an agreement; collateral function: earnest payment instils confidence in the recipient that the other party is committed to fulfilling their obligations and will strive to see the transaction through to completion.[6]

If a potential buyer can demonstrate the existence of a future sales contract that clearly defines the subject matter and purchase price (or outlines a method for determining it that is not subject to personal discretion), they are more likely to achieve favourable outcomes in proceedings related to the enforcement of the preliminary agreement and the recognition of the main contract (the sales contract) as concluded.

Furthermore, in certain cases, the transfer of an earnest payment can serve as additional evidence that the parties have agreed on the essential elements of the sales contract at the time of entering into the preliminary agreement.

Combining claims for the enforcement of the preliminary agreement and the main contract

A fundamental question the Supreme Court addressed was whether it is permissible to combine claims for enforcement of the preliminary agreement with those for the enforcement of the main contract. The Supreme Court emphasised, to ensure effective legal protection, such a combination may be permitted under the following conditions: 1) both claims must involve the same parties; 2) the preliminary agreement must clearly constitute a component of the main contract, or at least allow for the essential elements to be identified based on its content; and 3) obligations under the main contract must be performed immediately after its conclusion. However, this combination does not apply universally, and the court may identify other obstacles to the consolidation of claims based on the specific circumstances of the case. [7]

In the aforementioned judgment, the dispute involved a seller and a buyer. The preliminary agreement clearly specified the number of shares to be sold and their value, and there were no factual or legal barriers preventing the buyer from requiring the execution of the share purchase agreement (main contract) in the event of non-performance of the preliminary agreement. Therefore, the seller (plaintiff) had sufficient grounds to request the court to both declare the share purchase agreement as concluded and to seek recovery of the purchase price.

In this context, the feasibility of combining claims must be evaluated on a case-by-case basis, with a thorough analysis of the parties involved, the terms of the preliminary agreement, and the enforceability of the main contract. If consolidation of the claims is deemed impossible from the outset, it should be understood the court may not be able to recognise the main contract as concluded or enforce its execution. This limitation could significantly prolong the duration of the proceedings.

The judgment in recent case-law

Currently, the judgment examined is not widely cited in other judgments passed by the Supreme Court. However, since its issuance, it has been referenced in two cassation cases in which the Supreme Court annulled the decisions of the appellate courts due to violations of substantive and procedural rules. In both instances, the judgments specify the court must consider the findings of the judgment regarding the legal nature of preliminary agreements when re-evaluating the case. [8]

In different case, the Kurzeme Regional Court dismissed a claim from several individuals against the State City Municipality, with the Ministry of Finance as a third-party, regarding the recognition of property rights. The appellate court evaluated the plaintiffs’ historical agreements and, considering the findings of the aforementioned Supreme Court judgment, determined the transactions entered into by the plaintiffs did not constitute preliminary agreements that would justify a claim for the recognition of the main contract as concluded. Instead, the appellate court classified these transactions as future purchase agreements under Article 2009 of the Civil Code, which does not allow buyers to demand contract performance if the future subject of the contract has not yet become part of the seller’s property. Specifically, the plaintiffs aimed to acquire apartments in a building that had not yet been subdivided into individual properties. As a result, it was impossible to judicially ascertain which specific apartment each plaintiff would be entitled to under the future sales contract. [9]

In another recent case, the Zemgale District Court addressed a dispute between a buyer and a seller regarding a contract for the purchase of land associated with a preliminary agreement, referred to as a reservation agreement in the judgment. The buyer sought a declaration the contract should be recognised as concluded, thereby validating the buyer’s property rights. Conversely, the seller requested the court to declare that the preliminary agreement had been terminated.

The court determined the preliminary agreement was enforceable and concluded the parties had indeed entered into a valid contract of sale. It ordered the buyer to pay the purchase price, and upon payment, the buyer’s ownership of the disputed plot would be recognised. A significant point of contention arose regarding the seller’s announcement of a price increase and the buyer’s objection to this change. The seller argued this conduct justified the termination of the contract based upon the unilateral termination clause included in the preliminary agreement. However, the court, in interpreting the terms of the preliminary agreement, found that it did not grant the seller the right to alter the purchase price or terminate the contract unilaterally due to such an increase. Consequently, the court concluded the preliminary agreement clearly established the essential elements of the contract of sale. In line with the findings of the Supreme Court judgment, this clarity provided the buyer with sufficient grounds to seek both the conclusion of the main contract and its enforcement through judicial means.[10]

Conclusions.

According to the Supreme Court, when parties enter into a preliminary agreement that outlines the essential elements of the main contract and obstacles to its conclusion are alleviated, in case of default both parties have the right to initiate legal action against each other and seek judicial recognition of the main contract as concluded, along with its enforcement. While this possibility exists, it may not always be practical or advantageous. Nevertheless, it is important to note the significance of the preliminary agreement within the Latvian legal system has been reinforced.

This development provides a party with legal remedies in cases of non-performance of the preliminary agreement. Furthermore, the trends and findings in case-law can be applied to disputes involving obligations that are agreed upon but not yet established at a given time. This framework serves to protect the rights of a party and offers support in situations where the other party may act in bad faith by evading their agreed-upon obligations.

When concluding a preliminary agreement, it is crucial to clearly define not only the essential terms of the main contract, but also establish a detailed procedure for the parties to follow. The agreement should specify the steps to be taken once any obstacles to finalising the main contract have been removed. If such obstacles remain unresolved within a set timeframe or can only be removed later, the agreement should outline how the parties may modify both the preliminary agreement and the main contract to accommodate these changes.

The agreement must also clearly define the consequences of non-fulfilment or improper performance, such as incomplete or delayed execution of these obligations. By setting out these provisions, the preliminary agreement ensures both parties have a clear understanding of their rights and responsibilities, as well as the legal ramifications of their actions, creating a well-structured path forward in the event of any challenges.

[1] Judgment of the Senate of the Republic of Latvia dated 5 July 2023, in Case No. C29244819 (SKC-19/2023), paragraph 10.5.

[2] Judgment of the Senate of the Republic of Latvia dated 21 February 2019, in Case No. C02043013 (SKC-36/2019), paragraph 8.1.

[3] Judgment of the Senate of the Republic of Latvia dated 5 July 2023, in Case No. C29244819 (SKC-19/2023), paragraph 10.4.5.

[4] Kalniņš E., The Binding Force of the Preliminary Agreement, p. 224.

[5] Ibid., pp. 225, 226.

[6] Judgment of the Supreme Court Senate of the Republic of Latvia dated 26 March 2024, in Case No. C30467822 (SKC-162/2024), paragraph 11.1.

[7] Judgment of the Supreme Court Senate of the Republic of Latvia dated 5 July 2023, in Case No. C29244819 (SKC-19/2023), paragraph 11.

[8] Judgment of the Supreme Court Senate of the Republic of Latvia dated 15 November 2023, in Case No. C24086817 (SKC-25/2023), paragraph 9.4; and Judgment of 27 December 2023, in Case No. C73324321 (SKC-775/2023), paragraph 12.

[9] Judgment of the Kurzeme Regional Court dated 25 October 2023, in Case No. C69333422, paragraph 10 [the judgment has entered into force].

[10] Judgment of the Zemgale District Court dated 27 May 2024, in Case No. C73455623 [the judgment has entered into force].