“A good intention, with a bad approach, often leads to a poor result.”
— Thomas A. Edison
Parties to commercial transactions often enter into letters of intent prior to negotiating and documenting a definitive agreement regarding the transaction. For example, a potential seller and purchaser of real property may sign a letter of intent outlining the major terms of the transaction, prior to signing an actual purchase agreement. Parties who sign letters of intent do not necessarily intend to be bound by the terms of the letter of intent. You may ask- why sign a letter of intent if you don’t intend to commit to the transaction? The reasons for documenting the parties intent at the early stages of negotiation may be to simplify the main points of the deal to make sure all parties understand and want to move forward, to provide for a due diligence or exclusivity period prior to committing to the transaction, or to simply test the waters before committing to the time and expense associated with negotiating and documenting a complex agreement.
However, before signing a letter of intent, the parties should think through carefully whether they want any portion of the letter of intent to be binding and draft accordingly. Otherwise, a party signing a letter of intent may find themselves subject to liability for breach of contract for failing to comply with the letter of intent. When determining whether to enforce a letter of intent, courts look at the intent of the parties, the language of the document, the context of negotiations and whether all essential contract terms are included in the letter of intent. The following are some tips to avoid unintentionally binding yourself to an enforceable agreement (and creating potential liability) when signing a letter of intent:
- Identify binding and non-binding provisions.
Clearly state in the agreement whether any of the provisions are binding. For example, if the purchaser has an exclusive due diligence period and the parties want that provision to be binding, the parties should say so. Similarly, the parties may intend certain other provisions such as confidentiality or dispute resolution provisions to be binding. Otherwise, the parties should clearly indicate that the remainder of the document is not binding and is intended as a guide to negotiations only.
- Include Broad Termination language.
Consider including language that provides that you may terminate negotiations at any time in your sole and absolute discretion. Otherwise, a party seeking to enforce the letter of intent may argue that you had an obligation to negotiate in good faith to reach a definitive agreement. In fact, the parties should specifically disclaim any duty to negotiate in good faith.
- Don’t Use Words Suggesting Agreement.
Avoid using words that suggest an agreement, acceptance of an offer or commitment to take certain action. For example, words such as “agree”, “accord”, “understanding”, arrangement”, “offer” or “acceptance”, suggest that the parties have reached an agreement or entered into a contract. Further, words such as “shall” and “must” indicate a binding commitment.
- Avoid Subsequent Communications Indicating Commitment.
Even if the letter of intent is clearly non-binding, avoid subsequent communications, whether written or verbal, that suggest that a deal has been finalized. Include language in the letter of intent that clearly states that the parties will not be bound to an agreement unless and until a definitive written agreement is drafted, negotiated and signed.
- State that All Essential Contract Terms Are Not Included.
A court is more likely to enforce a letter of intent if all essential contract terms are outlined in the letter of intent. Therefore, the parties should state in the letter of intent that not all essential terms of a contract are included. The parties should also identify the missing terms that remain subject to negotiation.
In short, a letter of intent may be an important and practical first step in documenting a potential commercial transaction. Before signing a letter of intent, however, you may wish to consult with legal counsel to review the letter of intent and avoid inadvertently committing to a transaction or specific deal terms that can later be enforced in a court of law.