Letters of Intent Basic Information and Do s and Don’t s
Letters of Intent (“LOI”) are commonly used in transactions so that the parties can set forth in a non-binding writing, terms that they have agreed upon to be incorporated into a “to be reached” final agreement.
Legal risks arise when one party wants to back away and the other party wants to proceed. The proceeding party may claim the LOI is a binding agreement. Care should be taken in the drafting of the LOI to avoid this result.
The LOI should clearly state that neither party intends to be bound by the terms of the LOI. It is also wise to state that the parties will only be bound by a formal agreement to be executed by both parties including additional “to be negotiated” terms as part of the final agreement. There is no need to worry as the lawyers for the respective parties in converting the LOI to a binding contract will inevitably add additional terms to which the parties have to negotiate and agree.
In California, courts have held that a LOI can create a contractual obligation to negotiate in good faith. One way to reduce the risk of this result is to specifically provide that there is no duty to negotiate in good faith and either party may terminate negotiations at any time for any reason. It is also a good idea to include a fixed expiration date at which time the LOI will expire, even if negotiations are ongoing. This creates a natural end to the process. If the parties mutually agree to continue, they should do so by a written extension of the LOI.
The parties may want certain terms of the LOI to be specifically enforceable. Typical examples include (i) confidentiality/ non-disclosure (ii) non-circumvention and (iii) exclusive negotiations. If this is done, the LOI must be very clear that only these specific terms are intended by the parties to be enforceable.
Lastly, the parties must match their behavior to the non-binding nature of a LOI to avoid it becoming binding. For example, a tenant should not be allowed to move into space based on a LOI. The parties should avoid declaring they have reached an agreement or acting in reliance upon the LOI.
Often it is a good idea to have counsel draft the LOI. It is also important from a negotiating posture to be careful about what is included in the LOI. Even though it is non-binding, one or the other (or both) parties may find occasion to point to the LOI terms as leverage in the negotiations – “that’s not what our LOI says” is a fairly common negotiating position.