Depending on the type of transaction, a letter of intent has many other names, including term sheet, memorandum of understanding, agreement in principle, binder, and commitment letter. Regardless of the name, the function is the same: to outline the basic terms of a transaction. What differs is why a party decides to use a letter of intent and whether it is intended to be binding or non-binding.
There are three primary types of commercial real estate transactions: purchase and sales; leases; and loans. All three usually begin with the parties on each side discussing the terms of those transactions. Once the primary terms are decided, the parties will document the transaction. Some, but not all, transactions are documented with a binding or non-binding letter of intent before the parties enter into a formal agreement. It is important to know when and how to use a letter of intent.
A letter of intent can have several advantages. It allows the parties to focus on the essential terms (usually price/rent/loan amount and closing/occupancy date) without having to determine the specific legal terms before it is necessary to do so. Additionally, by having identified the essential terms, it can then be easier to identify the remaining open items and address them when appropriate. Even where the letter of intent is specifically non-binding, the identification of a term, especially price, can result in a party feeling morally committed to that term. The party would, therefore, be less likely to try to renegotiate the terms listed in the letter of intent.
Initially, documenting a transaction with a letter of intent is sometimes seen as a way to keep a transaction moving forward before signing a formal agreement. There are times when a party may want to flush out problems in a transaction before going too far. Also, having something in writing will often make a party more comfortable about further investigating the property and incurring the expense of the investigation, which they might not do without that written assurance. Often, the letter of intent will be the written authorization for a party to actually begin the due diligence or investigation of the property. Additionally, it takes much less time to draft a letter of intent than it does to prepare a purchase and sale agreement, a lease, or a set of loan documents.
Furthermore, a letter of intent can be helpful in addressing third-party issues that often arise in a transaction. The letter of intent can serve as a blueprint for preparation of the formal transaction documents by the parties’ attorneys. When board approval of a transaction is necessary, a letter of intent can be presented to a board as the outline of the transaction, allowing the board members to avoid having to wade through the formal transaction documents. Many times, the letter of intent will provide for the commission to be paid to the broker in the transaction. Also, the letter of intent can be the documentation presented for a lender’s or investor’s consideration in determining their willingness to be involved in the transaction as equity is needed.
Of course, there are also disadvantages to using a letter of intent. Some parties will show a letter of intent to other parties in order to shop the deal or to see whether other parties would be willing to beat the terms spelled out in the letter of intent. Another potential disadvantage is the difficulty in determining the duties, if any, of the parties. A binding letter of intent does not contain all the obligations of the parties and that can result in a conflict between the parties when the time comes to determine those additional terms.
The biggest disadvantage to using a letter of intent can be its unintended consequences. Most letters of intent are labeled “Non-Binding,” leading the parties to expect that they have no actual obligations under the letter of intent. Rarely is that true and the issue of binding obligations has been the center of numerous court cases. If a letter of intent is found to be a “contract” or agreement, then the parties will generally be obligated to negotiate in good faith. Regardless of the title “Non-Binding,” the language within a letter of intent can create binding obligations of the parties. As courts do not like to invalidate agreements, they easily and often find enforceable provisions that most people would not have otherwise thought created an enforceable agreement. Despite the “non-binding” language in a letter of intent, a court has found binding a provision as simple as that the parties will execute a definitive lease “in the usual standard form of business leases in the area . . . .”
The language itself of the letter of intent is also not dispositive of whether a letter of intent will remain non-binding. The parties’ conduct can lead a court to interpret as binding an otherwise non-binding letter of intent. In one case, a party signing a letter of intent said a “deal” had been made and that they should keep the pens as souvenirs. A court found the parties’ actions sufficient to determine the terms of the non-binding letter of intent were binding on the parties. In another case, after signing a non-binding letter of intent, the parties held a press conference to announce their “deal.” That press conference was later used by the court to determine the parties’ conduct resulted in a binding agreement.
Breaching a binding letter of intent can be expensive both in the cost of litigation and in damages to the other party. Remedies sought and awarded by courts have included lost profits, benefit of the bargain, consequential damages, specific performance, fraud, negligent misrepresentation, and breach of the implied duty of good faith.
Use It Correctly
When using a letter of intent, first decide whether you intend it to be binding or non-binding. If you intend it to be non-binding, remember that your conduct after signing can result in a “deal” and carefully review the letter of intent for a clear statement that it is non-binding. Sample non-binding language, while not appropriate for all transactions, may look like the following:
This letter is not contractually binding on the parties and is only an expression of the basic terms and conditions to be incorporated in a formal written agreement. This letter does not obligate either party to negotiate in good faith or to proceed to the completion of a formal written agreement. The parties shall not be contractually bound unless and until a formal written agreement is executed by the parties, which must be in form and content satisfactory to each party and its counsel in their sole discretion. Neither party may rely on this letter as creating any legal obligation of any kind.
What many people think of as a “simple” letter of intent that will allow parties to merely walk away from a transaction has cost some parties tens of millions of dollars when the letter of intent and the parties’ conduct resulted in unintended consequences. Letters of intent, regardless of their brevity, should be viewed like any other legal document, should be carefully drafted, and should be fully understood before being signed. It is much less expensive to draft carefully than to litigate later. Don’t risk signing a letter of intent unless you fully understand its use and the legal consequences of its misuse.