Letters of Intent - Sometimes Good Intentions Are Not Enough
September 29, 2006
Robert G. "Bob" McCauley- Atlanta
Parties involved in commercial transactions may find it possible to save time and expense by initiating their transactions with a letter of intent. A letter of intent is, at a minimum, a preliminary non-binding expression of the parties’ intention to negotiate and complete a transaction. It usually states the essential terms of the transaction (although there are reasons for omitting some of these provisions, as we will see below), such as the purchase price, the closing date, and the conditions to closing. At the other end of the letter of intent spectrum is one that the parties intend to be fully binding and contains detailed expressions of numerous provisions which will appear in the final contractual agreement between the parties.
Irrespective of the type of letter of intent employed, if improperly prepared or used, letters of intent can cause the parties frustration as well as costing precious time and expense. For example, a party disappointed that its deal fell through might claim that its non-binding letter of intent is an enforceable agreement. Conversely, a party wishing to escape the obligations of a binding letter of intent might claim that it is not enforceable for one reason or another. Sound legal advice from attorneys skilled in drafting and reviewing letters of intent will substantially reduce the likelihood of such conflicts arising, and will improve the defending party’s chances of prevailing if problems do surface.
Types of Letters of Intent
Knowledgeable lawyers prepare letters of intent to be non-binding, partially-binding, or fully-binding, depending upon a number of factors. These factors include the client’s objectives, the amount of time available to prepare and negotiate the letter of intent, the accuracy and sufficiency of facts needed for the particular type of letter of intent being prepared, the complexity of the transaction and the expected length of the due diligence or executory period of the final contract.
Non-Binding Letters of Intent
Non-binding letters of intent are designed to be entirely unenforceable, imposing upon the parties only a “psychological” obligation to negotiate and execute a binding agreement. Until the parties to the letter of intent enter into such a binding agreement, either party may unilaterally terminate discussions or negotiations with respect to the transaction referred to in the letter of intent, or repudiate its terms. Notwithstanding its unenforceability, many parties are hesitant to “walk away” from the deal without cause for fear of breaking the “gentlemen’s agreement” made when the parties signed the letter of intent. Thus, even a non-binding letter of intent is an effective negotiating tool and provides psychological or moral impetus for “sticking to the deal.” Nevertheless, a non-binding letter of intent is not intended to afford any remedies when a participant breaks off negotiations or fails to adhere to its provisions.
Non-binding letters of intent are appropriate when the parties have decided only on the most basic elements of the deal, such as the purchase price of the property, the length of the due diligence period, the closing date, the term of the lease, the rent, and terms of similar magnitude. However, other equally important provisions discussed below remain undecided. If the parties have not had a “meeting of the minds” sufficient to minimize the risk of future disagreements, they may believe they should not be required to negotiate and consummate a deal if such disagreements arise. It may be that the parties do not have the time, inclination or sufficient definite information available to enable the drafting of any type of letter of intent other than a non-binding one. Non-binding letters of intent are also appropriate when one party wants the flexibility to continue “to shop the deal” or to look for other deals.
Non-binding letters of intent should state clearly that they are merely expressions of the parties’ general understanding of the proposed deal, that the parties do not intend it to be a binding contract, that the provisions set forth are not enforceable, and that there are no obligations on either party if a final agreement is not reached. They should not contain such terms as “offer” or “acceptance,” as this is language indigenous to enforceable contracts and could lead a court to infer the parties’ intent to be contractually bound by the letter of intent as an enforceable agreement. Drafters should not require the parties to use their “best efforts” to negotiate a deal, nor promise they “will enter” into a binding contract. Inattention to these details can transform a non-binding letter of intent into an enforceable contract to work out a deal or suffer the consequences for the wrongful failure to do so.
Additionally, almost all jurisdictions imply a duty of good faith and fair dealing in contracts. Some courts have held that parties to a letter of intent, even if it is not a binding contract, also have such duties. Consequently, it may be advisable that an intended non-binding letter of intent expressly state that the parties have no obligation to engage in good faith and fair dealing negotiations toward a binding contract.
Despite all drafting precautions, however, an expressly non-binding letter of intent can be enforceable if the parties actually treat it as such. If the actions or statements of a party can be interpreted as reasonably inducing action or forbearance by the other party, and such action or forbearance does indeed occur, a court may enforce a purported promise if justice so requires. A party puts itself at greater risk when its actions or words could reasonably mislead the other party into thinking that, notwithstanding that the letter of intent is expressly non-binding, the other party is viewing it as binding. If the other party relies on the deal as done, perhaps by rejecting other offers or forgoing other possible deals, it might seek specific performance or damages when the deal addressed in the letter of intent goes south.
Fully-Binding Letters of Intent
Fully-binding letters of intent stand in stark contrast to non-binding letters of intent. Fully binding letters of intent are valid contracts that obligate the parties either to complete the transaction or to pursue in good faith a definitive contract incorporating the letter of intent’s terms. Fully-binding letters of intent are usually longer, more detailed, and require much more time, care and thought in drafting than their non-binding brethren. They often address numerous provisions not found in a non-binding letter of intent and may go on to provide alternate sets of solutions to particular circumstances or problems which the parties anticipate may arise or be uncovered during the due diligence or executory period. The more detailed terms likely to be found in fully-binding letters of intent include provisions detailing the contingencies and conditions to closing, representations and warranties, the respective rights and obligations of the parties during the due diligence period, the assignment and assumption of certain contracts, remedies upon breach, surviving provisions, governing laws, and confidentiality and non-disclosure provisions. If the parties have negotiated these finer points of the deal and are confident that they want to consummate the transaction subject to the negotiated contingencies, they will likely want to fix the terms of the transaction by entering a binding letter of intent. Parties who believe they have secured extremely favorable deals may also want binding letters of intent to insure that they receive the benefit of their bargains. When considering fully-binding letters of intent, courts will generally look askance at a party’s efforts to unilaterally change the provisions, back out of the deal, or refuse to negotiate a full contract (or at least award damages when a party does so or attempts to do so).
To ensure that binding letters of intent are construed as binding, and that remedies and causes of action for breach are preserved if the deal falls apart, lawyers skilled in these matters will act precisely the opposite as he or she would act if the letter of intent were non-binding. Binding letters of intent should be clearly designated as enforceable. Ideally, binding letters of intent will expressly provide that the parties are bound by the duty of good faith and fair dealing, and that the parties may not renounce the deal, repudiate any of the letter of intent’s provisions, stop negotiations, or insist on terms contrary to the letter of intent. Additionally, binding letters of intent should set forth remedies for a breach.
Since enforceable contracts must contain all essential elements of a transaction with sufficient definiteness and clarity, careful drafters will ensure that all such elements are included and described. The parties do not need to work out every minute detail, but they should understand the material terms of the transaction and intend to be obliged to negotiate a full contract, which will include those terms, in good faith. Binding letters of intent also must be supported by consideration, a requirement usually met because both parties make legally detrimental promises to the other.
Partially-Binding Letters of Intent
In some transactions, the parties may have not yet determined all of the material or essential terms of the transaction, but wish to protect certain interests as they proceed with negotiations. Consequentially, partially-binding letters of intent will exclude such protected matters from the non-binding portions of the letter of intent, thereby facilitating and streamlining the negotiation process, such as:
• no-shop provisions, in which one or both parties agree to deal exclusively with the other for a period of time
• confidentiality provisions, which ensure that the information provided or uncovered in the exercise of due diligence shall not be disclosed to third parties without a need to know
• due diligence provisions, which grant the parties access and inspection rights to the property, provide indemnification provisions for liabilities arising out of such inspections, and allocate expenses incurred during the process
• representations stating that neither party has engaged the services of a broker or agent with respect to the transaction, or specifying the brokers or agents so engaged and indemnifying the other party for any expenses or claims arising from the breach of such representation
• governing law provisions, which specify the jurisdiction that will adjudicate disputes and claims arising under the letter of intent
By carefully ascertaining the type of letter of intent appropriate to a given transaction, the parties can increase the chances that differences will be satisfactorily resolved. However, it is also important to ensure that a court will construe a letter of intent in accordance with the parties’ intentions.
Partially-binding letters of intent are especially complex. Customarily, they are drafted to make all provisions non-binding by default and then specifically carve out the binding terms and identify them as such. This is because the parties usually would rather risk the binding provisions to be held non-binding than vice-versa. The binding provisions should be clearly and unambiguously marked, and should include an express survival clause providing that remedies or causes of action arising from a breach of the binding provisions will survive the termination of the letter of intent. This ensures that the parties can obtain relief for breach of contract if the deal falls through.
Just as with a fully-binding letter of intent, the binding terms of a partially-binding letter of intent must contain all elements of a valid contract. The promises must be drafted with sufficient definiteness and clarity, and must be supported by consideration. Establishing consideration can be problematic because the enforceable provisions of a partially-binding letter of intent are often one-sided, with only one party incurring legal detriment. To ensure that the provisions are enforceable, the drafter should state that the binding provisions of the letter of intent must be read as a whole, and that they are supported by the consideration of the mutually-enforceable promises of the parties.
Conclusion
As demonstrated above, letters of intent can be useful tools for proposing and laying the groundwork for final and comprehensive contracts even in moderately complex transactions. Absent the use of a letter of intent, one alternative is for the parties to immerse themselves in negotiations, hammering out the fine details of the contract while assuming the risk that a final agreement may not be reached. Another alternative is to commit orally to the basic terms of a transaction, while presuming that the other party does not have selective or faulty memory, and is psychologically committed to unwritten agreements. However, some oral agreements also risk being enforced as valid contracts.
Letters of intent can offer clarity and direction in complex negotiations, provide a framework within which parties may commit to the idea of a transaction, reduce the chances that negotiations will break down at the eleventh hour, and resolve basic points of contention at the outset. However, all of those benefits can only be achieved by legal counsel skilled in drafting and structuring letters of intent to facilitate, rather than hinder, successful transactions.
For more information, e-mail Robert G. McCauley at bob.mccauley@hklaw.com or call toll free, 1-888-688-8500.
We would like to acknowledge the assistance of Matthew Joe, a summer associate in Holland & Knight’s Atlanta office, for his contributions to this article.