You are discussing the terms of a possible deal—maybe it’s a sale agreement or a lease. But now you want to take the next step. Should you negotiate and sign a letter of intent? If so, what should it say?
Should you proceed with an LOI? While some lawyers advise clients to avoid this step (based on the client’s needs and other risks), there are advantages. First, the LOI can identify key business terms and protect the parties from later selective memory. Parties stuck on a point in the final documents may find that the specific issue previously was addressed in the LOI. Further, the LOI can be a good time to address difficult issues up-front, before going to the time and expense of working on a full blown agreement.
Deals can be a process, and the parties may circle each other first to see if a deal makes sense. An LOI can emotionally (if not legally) commit the parties to a transaction, while at the same time initially minimizing potential third-party costs.
The parties, however, must be careful not to inadvertently legally bind themselves to a transaction (unless that is their goal). A party also may decide that an LOI is a waste of time and expense, as it creates two sets of discussions—first, the LOI itself, and then the actual deal documents.
If the parties decide to proceed with an LOI, the key business terms should be described, but should be made expressly non-binding. Those terms can include:
ν Purchase price (or rent)
ν Terms of payment: Earnest money? When is money nonrefundable? Holdbacks? Rent? Seller financing?
ν Timelines and closing dates (including length of lease term)
ν Special conditions or contingencies (e.g. due diligence rights)
ν Non-compete provisions
ν Special or critical representations or covenants
In drafting a letter of intent, care must be taken not to inadvertently bind parties to a transaction, unless that is their goal.
ν Significant required consents (e.g., board or executive committee)
Other provisions, however, should expressly bind the parties. These can include:
ν A confidentiality clause (stating the parties will treat the existence of the deal and the LOI as confidential. This is especially important if there is no pre-existing confidentiality agreement.)
ν No-shop clause (e.g., a seller/landlord may be asked to agree to take the property off the market and deal exclusively with a buyer/tenant for some period of time.)
ν Expenses: Who pays what?
ν Is there a duty (or not) to negotiate in good faith? Oftentimes the parties do not want to impose such a duty.
An LOI, however, can become the basis for a lawsuit if ultimately no final agreement is signed. If that happens, all bets are off and a court may determine whether the LOI is binding. That fact-intensive answer often depends on whether the parties intended to be bound—are all of the essential deal terms included in the LOI? Are further approvals or conditions required? Is a separate definitive agreement a mere formality, or is it central to the negotiations of the parties? How detailed is the LOI? Is it even executed?
A disgruntled party also may argue that the other side reached a duty to negotiate in good faith. Does the LOI address this? If not, will a good-faith duty be implied?
There can be at least two other risks. First, an aggrieved party may claim there is tortious interference with its contract. The argument here is that party A and B signed an LOI (which is found to be binding). Party C (knowing that a signed LOI exists) then cuts a deal with A, thus giving rise to B’s claim that C tortiously interfered with B’s contract.
Second, a court may find that a “non-binding” LOI is nevertheless enforceable, because the actual conduct of the parties is inconsistent with a non-binding LOI. This can occur where one party relies on the other side’s conduct pursuant to the LOI.
Whether or not to use an LOI in any given deal depends on many factors. If the parties proceed with an LOI, and depending on their goals, they should make it expressly non-binding (with carve-outs) and make clear there is no duty to negotiate in good faith, and should not act in a manner that is inconsistent with the LOI.