A letter of intent is a document in which one or more parties signify an intention to do or to refrain from doing one or several things. Letters of intent (LOIs) are controversial under law being viewed ambiguously, as both binding and not binding. In Corbin on Contracts, a highly respected 14-volume law book updated twice yearly, the late Arthur Corbin commented on a letter of intent in the following terms: “… a letter of intent is not a useless document, but it is not, in principle, a contract except perhaps a contract to continue bargaining in good faith.”
Based on Merriam-Webster’s dictionary definition, the term evidently arose in the context of government purchases in times of war when time was insufficient for executing contracts. The ambiguity inherent in the concept (is it or isn’t it an agreement?) continues to be litigated.
The chief utility of letters of intent appears to be 1) to obtain a preliminary agreement on a matter before full details are worked out, 2) to establish confidentiality of elements being negotiated, and 3) to agree on how negotiations shall proceed. The general outlines of the deal may be included in the form of intentions, but not as binding until a final contract is negotiated. Thus LOIs have psychological value in somewhat committing both parties early; in other words, an agreement has been reached in principle. If made public, a letter of intent also serves as a signal to other interested or potential competing or hostile parties that the “deal is made.” Signers of LOIs, however, continue occasionally to back out of deals—which leads to litigation. Courts are then required to settle which parts of LOIs are and are not binding.
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Gregory Gosfield, writing for the American Bar Association’s Business Law Today, suggests that LOIs can be put into four groups arranged from least to most binding. The first type openly disclaims any contractual force to the letter, but as Gosfield points out, the letter will have “contractual effect as to the disclaimer.” He places letters that deal only with rules for negotiation into the second group and views this type as the best use of LOIs. The third involves letters of intent that clearly spell out elements of the agreement in such a manner “as to permit a competent drafter to complete final documentation without a tremendous amount of additional negotiation.”
Letters of this type will specify a condition, left to the future, which will make the agreement legal, e.g., approval by a board of directors or signature by a specified officer.
The last and fourth type of LOI Gosfield labels “letters of intent that have failed.” In fact they are contracts. Gosfield suggests that “To reduce the risk of litigation, the single most important provision of the letter of intent is to disclaim contractual effect as to all but specifically preserved terms, a key one being the disclaimer itself.”
Vasilios Kalogredis, writing for Physician’s News Digest, provides categories typically listed as binding.
He includes 1) confidentiality agreements relating to mutual information sharing, 2) non-disclosure of information to third parties, 3) “no-shop” clauses under which, for instance, a seller is prohibited from dealing with others during the negotiation, 4) setting of break-up fees in advance should the deal collapse, 5) termination dates and conditions to limit the negotiations, and 6) allocation of expenses to each party. Kalogredis suggests that non-binding aspects would deal with terms of the transaction itself. Finally, he indicates that closing conditions are often included in LOIs. These would include financing contingencies such as loan approvals, thirdparty approvals if needed, etc.
Pros And Cons
In complex negotiations such as, for instance, the purchase or sale of a business, multiple contracts between buyers and sellers usually take place, many things are discussed, many things are said. The process may also take substantial amounts of time. Oral transactions of this type are subject to misinterpretation later, and oral agreements also have contractual force. In such situations a letter of intent written at the proper time—before final closing and drafting of actual language—can fix the main issues under discussion in written form and also clearly lay down rules which may be hampering negotiations, such as confidentiality of information. One may also have tactical advantages in having an LOI, especially in cases where multiple buyers are competing for one property. Writing the LOI serves to focus issues and to identify neglected matters. The LOI may also assure an insecure seller that the buyer is serious—and vice versa.
LOIs also sometimes produce momentum and clarity and hence speed up a process that both wish to conclude.
Finally, a well-written LOI is of substantial help to those charged with drafting the final contract.
On the negative side, LOIs take time to prepare and may turn into final negotiations which are supposed to follow the LOI. This can happen because parties may feel that even non-binding terms will become non-negotiable later, so why not negotiate them now? Thus time delays may be introduced. An LOI opens up channels of information for at least one of the parties—which may harm the other party if the deal ultimately fails. Letters of intent, by nature ambiguous, may become public (at least internally) and produce expectations or anxieties on the parts of employees, vendors, and customers. Kalogredis in addition points to “no-shop” clauses which may prevent a seller from discussing alternative deals, thus losing time, if in final negotiations an impasse arises.
To Sign Or Not To Sign
Judith Silver, writing for Intellectual Property Law Server, headlines her story saying: “Letters of Intent: Why Business People Love ‘Em and Lawyers Hate ‘Em.” Business people love them because they help to move negotiations along, provide protections along the way, and occasionally garner positive press and upticks in stock values. As for lawyers, Silver says: “Letters of Intent, legally, are the worst of all worlds. In law, you either have a contract or you don’t. LOIs are the legal equivalent of ‘almost pregnant.’ Letters of Intent emphatically state that they are not formal agreements and then often proceed to set forth agreed terms of the proposed transaction. Given this paradox, if the deal goes sour, one party can argue that those agreed-upon points were, in fact, agreed upon—or, in fact, a binding contract and, in some cases, furthermore, that the party relied on the LOI and has monetary damages based on such reliance.” The emphasized phrase in the quote (the emphasis is ours) tells the whole story—and further underlines the difficulties: because, in advance, no one can be certain that the deal will not go sour. When all goes well … all goes well. But when not, and the LOI is poorly written, that is not likely to be the end of the story.
Fortunately, in the overwhelming majority of small business transactions, good faith negotiation to a finished contract is very often achievable without letters of intent.
If not, the letter should be written with the same care as the contract—and reviewed by a lawyer, however much he or she may hate the job.