Understanding Letters of Intent: What are they and why do they matter?

 

 

 

What is a letter of intent? 

A letter of intent (or “LOI”) is a written statement signed by both parties entering a transaction that outlines the preliminary understanding of parties related to the transaction. It typically does not create a binding agreement and does not prevent the parties from negotiating with a third party.[1]

What is the purpose of a letter of intent?

 The purpose of a letter of intent depends slightly on the transaction for which the letter is being signed. Generally, the LOI helps to dissuade parties’ fear that the other may not be serious about the transaction.[2] Business transactions tend to involve an extensive amount of time and effort on behalf of both parties in order to finalize the deal, and as such, signing a letter of intent prior to starting negotiations ensures that both parties are serious about the deal. For example, in commercial real estate transactions, a potential tenant and the landlord will sign a letter of intent stating that both parties intend to enter into negotiations regarding an available rental space. The letter of intent often outlines the major terms of the deal, such as the rent and term of the lease, but with the understanding that these terms may change as the parties enter into negotiations. In a real estate transaction, in which the negotiation and finalizing of a lease can take some time, a letter of intent is particularly useful as it can help a tenant secure a space in a fast-moving market. The letter of intent is also beneficial if one of the parties hopes to secure financing in connection with the transaction, as it can help lenders to evaluate the transaction.[3]

What should parties consider when signing a letter of intent?

 1. Does the letter create a nonbinding term sheet?

Parties may not want to create a binding contract when drafting a letter of intent for a variety of reasons, but before signing a letter of intent, it is important to determine whether the letter has bound the parties to the transaction. To be “bound” to the transaction means that each party is required to continue forward with the transaction by negotiating the terms of the transaction the LOI governs. Most letters of intent will include at least some binding provisions, and therefore it is important to consider the factors previously used by courts to determine whether a letter of intent is binding.

 Intent is important in determining whether a provisional letter of intent is binding. If both parties did not have an intent to be bound, courts will typically hold that the letter of intent is not binding. If the parties do not want to create a binding contract when drafting a letter of intent, the parties should avoid including the terms “agreement” or “contract,” and should instead be labeled as a “proposal,” “term sheet,” or “letter.”[4]

 2. Is there a duty to negotiate in good faith?

 Even if a letter of intent does not create a binding agreement, the letter may create a duty on the parties to negotiate in good faith. To negotiate in good faith depends in part on the terms of the letter of intent.[5] However, generally, the obligation to negotiate in good faith means the parties cannot renounce the deal, abandon the negotiations, or insist on terms that do not align with the preliminary agreement.[6] If the letter of intent creates a duty to negotiate in good faith, and one party wants to walk away from the deal, the other party may be able to take them to court in order to have the letter of intent enforced. To maintain the ability to walk away from negotiations after a letter of intent has been signed, the parties to the letter of intent should add a statement to the letter that explicitly states there is no duty to negotiate in good faith.[7]

 3. Is there a “no-shop” clause?

 Another important consideration is whether the letter contains a “no-shop” clause that prohibits one party from negotiating with a third party while negotiations related to the letter of intent are happening.[8] Depending on what the parties hope to accomplish by signing the letter of intent, a no-shop clause may prevent one party from finding a different deal that may be better suited to their needs.

 What happens after the letter of intent is signed?

 After both parties sign a letter of intent, they typically move forward by negotiating the specific terms of the deal. The terms outlined by the letter of intent are ordinarily used as a starting place for negotiations, though sometimes they are treated as final for the purposes of the negotiation. Before and during negotiations, each party will present any relevant documentation regarding the transaction (i.e. a tenant presenting a landlord with the tenant’s financial information). The parties will negotiate the transaction with the goal of coming to an agreement that works for both parties.

By Katherine Jones

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[1] Ronald Benton Brown & Joseph M. Grohman, Letters of Intent: There Ought to be a Law, a Uniform Law!, 45 Real Est. L.J. 370, 375 (2016), citing Black’s Law Dictionary (Westlaw. 2014 Thomas Reuters. 10^th ed. 2014).

[2] Thomas C. Homburger & James R. Schueller, Letters of Intent—A Trap for the Unwary, 37 Real Prop. Prob. & Tr. J. 509, 510-11 (2002).

[3] Byron F. Egan, Drafting Preliminary Agreements, Including Confidentiality Agreements and Letters of Intent, 48-SPG Tex. J. Bus. L. 1, 16 (2019).

[4] Id. at 526.

[5] Id. at 516.

[6] Thomas C. Homburger & James R. Schueller, Letters of Intent—A Trap for the Unwary, 37 Real Prop. Prob. & Tr. J. 509, 510-11 (2002), citing A/S Apothekernes Laboratorium v. I.M.C. Chem., 873 F.2d 155, 158 (7^th Cir. 1989).

[7] Mark L. Morris, Letters of Intent: Let the Signer Beware, Fox Rothschild LLP (May 2009), https://www.foxrothschild.com/publications/letters-of-intent-let-the-signer-beware/

[8] Byron F. Egan, Drafting Preliminary Agreements, Including Confidentiality Agreements and Letters of Intent, 48-SPG Tex. J. Bus. L. 1, 16 (2019).