Elements of an LOI
A Letter of Intent ("LOI") has many definitions and many forms. In short, an LOI is a simple document that demonstrates the intent of the parties to participate in further negotiations with respective rights to continue or halt the transaction at any time. When organized properly the LOI covers binding and non-binding provisions, such as price , exclusivity, confidentiality, and diligence. A common use for an LOI is in a business or legal transaction to provide the necessary confidence needed by one party in order to proceed. It is usually organized in a short form that includes a signature block, and upon execution a formal deal is expected once remaining issues of importance are addressed.
When Does an LOI Become a Binding Contract?
The essential question in any dispute over whether a particular letter of intent is binding or non-binding involves analysis of the terms of the document and the intentions of the parties as reflected in those terms, considered in the context of the particular negotiations in which they were engaged at the time the document was created. In this context, the specific terms of a letter of intent, and the circumstances under which they were negotiated, are critical to the inquiry.
There is no bright-line rule that terms must be included in a letter of intent if it is to be deemed legally binding upon the execution of the document. Conversely, the inclusion of particular terms does not necessarily render a letter of intent binding. What matters is what the particular document states. But while the terms of each document will control, there are certain terms that tend to indicate more likely intent to be bound at the LOI stage.
Generally speaking, a binding LOI contains a "binding language" provision, and contains sufficient detail regarding the terms of the deal the parties negotiated as to evidence intent to contract at LOI stage, including price, scope of work, duration and other essential deal terms.
A binding language provision is one which specifically states that the LOI is binding. In addition to the plain language of the provision itself, however, courts will also consider the language of the document as a whole to determine whether the binding language is clear and unequivocal. If the entire set of agreements entered into by the parties as a whole, including the LOI, is sufficiently detailed and specific, the mere inclusion of a non-binding language provision in the LOI will not preclude enforcement:
Frequently, a party will attempt to argue that the inclusion of required terms such as due diligence rights or contingencies in the LOI indicates an intention to be bound only at the definitive agreement stage. But while such provisions may indicate that the parties intended to delay the closing of the transaction, and perhaps ease the parties out of making certain commitments until later in the dealmaking process, it may not necessarily evidence an intent not to be bound at LOI stage.
Hot Terms and Clauses to Beware Of
Even if a Letter of Intent is non-binding on its face, it may still contain contractual terms or clauses which run contrary to the intent of the parties and, inadvertently, create a legally binding commitment. Specifically, the inclusion of provisions under which one party has the right to demand exclusivity or a period of due diligence can result in a relationship that is more similar to a contract than to an expression of interest. In South Shore Hospital, Inc. v. Sellors, 308 Mass. 454 (1941), the Supreme Judicial Court ruled that an LOI is binding on a buyer even though the final terms were to be agreed upon in the future, and the seller had been allowed to negotiate with other buyers because the writer of the letter: "… promised to buy… if an acceptable record of care, treatment and expenses should be made out. He expressed in writing his desire to buy, and then qualified that desire by saying that the buyer would ‘not consider any transaction which might result in financial exposure to our hospitals and assets greater than that which is produced by the terms of our existing rental agreement.’ That showed decisively that he was not willing to pay a price marked by a potential net loss of $2,000,000 imposed by seller, for its lease." While the South Shore ruling indicates that the language in an LOI that establishes binding rights is found in the details, rather than the broad strokes, it highlights the danger of listing out specific areas in which the parties are willing to engage. As such, a written expression of interest can be deemed to be a binding contract. One way to avoid this situation is to list specific SATISFACTORY criteria of approval, meaning the approval of which will not bind the parties to a purchase agreement. An example of this can be seen in Dwyer v. American Exp. Co., 335 Mass. 549, 551 (1957), where the court determined that the language "…unless and until a typewritten contract shall have been signed by all parties" was enough to avoid binding legal action.
Legal Fallout from a Binding LOI
Language contains a significant variation from jurisdiction to jurisdiction. Please review your lawyer’s options.
A legally binding Letter of Intent (LOI) is essentially an agreement between the parties on how they should proceed with a business transaction. In the case of an acquisition, the LOI outlines the agreed terms of the transaction between a buyer and a seller – this includes price, structure, payment terms, and timelines of actions each party will undertake to get to a closing. In a commercial lease, the LOI will include the basic terms required by the Landlord to document the transaction by which the Tenant will lease office space in the future.
The LOI will also include conditions which must be fulfilled before the transaction can close. Sometimes, the LOI will also include conditions if the transaction does not close. For example, indications of whether the Seller incurs any costs if the Transaction does not close for any reason (other than the failure of the Buyer to complete due diligence).
The parties should specify how the costs incurred by each of them in doing their part to get the deal closed are to be paid if the deal does not close.
A party who signs a legally binding LOI may have obligations or liabilities to the other parties involved in the transaction. In addition to the terms and conditions set out in the LOI, the parties may be subject to implied obligations that come into play if the deal is not perfected. Generally speaking, the legal consequences of not completing a deal are limited to the express terms and conditions contained in the LOI.
A Buyer who does not complete a deal may be liable, however, for any other broken promises it made to the Seller if the Seller relied on those promises to its own detriment. These additional obligations may include liabilities relating to payment of costs or liabilities incurred in the course of negotiations.
A Seller who arbitrarily fails to complete a deal for opaque reasons may risk liability. This liability could arise from the Buyer’s reliance on the Seller’s word to its detriment, such as if the Buyer invested funds to prepare the business for the acquisition or if the Buyer had to find an alternative location for its facility.
In some circumstances, failing to complete a deal could also expose the parties to claims relating to an expectation of negotiating the deal in good faith. Good faith is a term that is inherently vague and is subject to wide interpretation. While not explicitly defined in the LOI, a party has an obligation to negotiate in good faith, which means doing so reasonably and honestly, which has been interpreted by Courts to mean:
Because of their inherent nature, the consequences of a legally binding LOI are fact-specific and vary from context to context. The consequence of signing a legally binding LOI is that the parties are legally obligated to fulfil the provisions of the LOI and to account for the other party’s performance or non-performance of the same. If the parties do not, the parties may be liable for any damages incurred by the other party. The damages may be limited to what is expressly defined in the LOI or may extend beyond the confines of the LOI to include other damages, depending upon the intentions of the parties as expressed in the LOI.
If a party intends to reserve the right to walk away from the deal at a later date or to otherwise leave its options open without appearing untrustworthy, it is suggested that the LOI is subject to an explicit clause allowing for unilateral termination.
Case Examples: Binding LOIs vs. Non-Binding
In real estate, case studies offer a practical lens through which to examine whether an LOI is in fact legally binding. The facts set forth in the case studies below show how the presence of key elements of a contract (like a purchase price or earnest money deposit) can have significant bearing on how a court may view an LOI.
Ellis v. O’Donnell 166 S.W.3d 202 (Ark. Ct. App. 2004). In Ellis the owner of a tract of land entered into a letter agreement with a prospective buyer prior to drafting and exchanging formal counter-offers. The letter agreement (1) provided the purchase price, (2) created an obligation on the seller to hold the property for 30 days following receipt of a title opinion, and (3) stated that the seller reserved the right to market the property until it issued notice that buyer was not in default. Buyer failed to obtain a loan to buy the property and purchased a different property instead. The Court of Appeals in Arkansas held that the LOI was enforceable because the LOI was a valid contract for the sale of land.
Cardwell v. Perla 2001 WL 1218485 (Tenn. Im..gration 2001). In Cardwell the sellers of property signed a letter of intent that (1) contained when the seller would be paid for the property and how long the seller would have a deed that contained a vendor’s lien as security for the deferred payments, (2) promised interest payments of 7% per annum on the deferred payments until one year after the sellers were paid in full , and (3) made a reference to an "additional agreement to follow." The sellers sued to enforce the LOI. The court found that the LOI was not enforceable because the sellers refused to disclose documents concerning their credit, offered on contradictory terms, and could not produce a credit report.
United Rentals Northwest v. Cerniglia et al. 2004 WL 1790805 (D. Or. 2004). In United Rentals Northwest the parties exchanged a series of emails about the sale of a crane. After buyer’s agent sent the final email stating "Great, let’s do it," the parties never reduced the deal to a formal contract. The parties then disagreed about a $20,000 price reduction. The court held that the LOI was not enforceable because (1) buyer had not presented the seller with a complete offer and (2) none of the essential elements of the contract were included in the final email communications. The Court of Appeals for the Ninth Circuit upheld this decision.
Clausen v. Intermountain Intern., and Intercontinental 2006 WL 3782857 (E.D. Wis. 2006). In Clausen the parties entered into a term sheet. The term sheet (1) stated that seller was to receive $150,000 and (2) contained a confidentiality provision. The parties never agreed on any other terms or conditions. The court found the LOI unenforceable because (1) the LOI lacked a meeting of the minds as to a material element (price); (2) the LOI obligated no one to take any further steps; and (3) there was no consideration.
How to Craft a Non-Binding LOI
In addition to making it explicit that the letter of intent is non-binding, there are other strategies that may assist in keeping your letter of intent non-binding. For example, other than your statement that the LOI is not binding (or words to that effect), you could include a statement that neither the LOI nor the LOI’s terms shall create or form the basis of any binding obligation with respect to the transaction. Furthermore, you may choose to include a provision that gives either party the right to terminate the LOI at any time without notice, or alternatively, you could indicate that the LOI is terminated after a specific period of time with no opportunity to renew. Another suggestion is that you and the other party should initial every page of the LOI. Whether or not this will be an effective strategy depends on what not just what your LP says, but also how the LOI and its terms may be used in court.
A non-binding LOI is important for several different reasons. A binding LOI may prevent you from being able to enter into other offers or negotiations for a certain period of time. The purpose of a non-binding LOI is to provide you some comfort with the possibility of proceeding without committing you to anything at all.
Get a Lawyer
As Letters of Intent can carry binding implications, it is vital to consider the expertise of legal professionals when either drafting or entering into an agreement. Professional advisors can highlight provisions that may lock parties into a binding agreement or, on the contrary, which may not reflect the intentions of the parties and, therefore, provide the parties with unwanted or unnecessary exposure , costs or lengthy negotiation processes. Legal practitioners can also assist in reflecting the clear and considered bargain that the parties are prepared to make with each other by ensuring that the Letter of Intent provides necessary exclusions and conditions for the relevant context within which it will operate. Depending on the type of transaction being undertaken, there are many relevant specialties that could also be considered to ensure that the relevant Letter of Intention meets the needs of the relevant context….