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Whether you are negotiating a real estate deal, joint venture or acquisition, Letters of Intent (LOIs) are often used as a first step to ensure that the parties are sufficiently committed to negotiating a deal and aligned regarding some of the key transaction considerations. But when used carelessly, they can become binding contracts, triggering unexpected obligations and potential liability. In a recent webinar, some of Thompson Coburn's Los Angeles team members discussed real-world cases and practical strategies to help dealmakers use LOIs effectively and avoid costly missteps.
Below, we outline four key lessons every legal, real estate and corporate team should consider before drafting or signing an LOI.
1. Decide Early: Do You Want the LOI to Be Binding?
This sounds obvious, but it is often overlooked. Before you start drafting, ask yourself if you want the LOI as a whole to be binding. In a dispute regarding enforceability, courts will not care what you call it – whether it is labeled a term sheet, memorandum of understanding or letter of intent. Instead, they will look at the specific language included in the document regarding its expected binding effect, the context of the parties' discussions of the proposed transaction and how the parties behaved during negotiations, and after, to assess whether the terms included in the document should bind the parties. The parties should assess whether they expect the LOI to bind them to the deal terms included in the LOI, whether the LOI is meant to obligate the parties to negotiate in good faith to attempt to reach a definitive agreement that reflects those deal terms or whether the LOI is simply a framework for possible future discussions between the parties, with no binding effect or duty to negotiate in good faith.
2. Be Thoughtful About Any Provisions that Should Be Binding in the LOI
In many cases, the parties intend that some but not all of the LOI provisions are to be binding. That's fine, as long as the parties are clear about it. Common examples of LOI provisions that are binding include confidentiality obligations, exclusivity periods for negotiating with third parties, expense allocations, public announcements and choice of law.
If the LOI will include some binding provisions, it is important to clearly label and distinguish them from other, non-binding provisions. And don't forget to specify how long any binding obligations are intended to last.
3. Use Clear and Detailed Language to Address Your Intent About the LOI's Non-Binding Status
If you do not want your LOI to be binding, say so in the LOI. State it clearly. And say it consistently throughout the LOI. We recommend combining a few key concepts:
- Clearly state that the terms of the LOI are non-binding, with exceptions as needed for any provisions that the parties expect to be binding, as referenced above.
- Reference that neither party can rely on the terms of the LOI as a commitment.
- If it is the expectation, state that the LOI does not establish a duty to negotiate or finalize a deal.
4. Don't Act Like You Have a Deal Unless You Do
Even if your LOI says it's non-binding, your conduct can tell a different story. If one party starts performing – taking possession of property or operating a business – it can look like the LOI represents a binding agreement. As a result, the parties need to be careful to act to preserve their independence until a final deal has been struck.
Final Thoughts
LOIs are powerful tools that can assist the parties in efficiently negotiating and drafting definitive agreements, but they require careful handling. If you're drafting an LOI, take the time to think through what you want it to do. Use precise language. Be consistent in your communications and conduct. And if you are not sure, ask a lawyer to take a look before you sign.
We have seen how a few words, or the absence of them, can make a significant difference. So be careful to ensure that the LOI reflects, in clear and explicit terms, the expectations of the parties regarding any obligations, or the lack thereof, that the parties are anticipating as a result of the LOI.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
