The use of a Letter of Intent (often referred to as an “LOI”) has become commonplace in the business and real estate world. Often times they are referred to as “Non-Binding” LOIs. But are they really non-binding? As courts struggle with the interpretation of LOIs one strong message emerges: The parties to an LOI need to make their intentions, regarding enforceability, crystal clear.
What is a Letter of Intent? A Letter of Intent (“LOI”) is a document that sets forth one or more understandings or agreements about a basic deal that is being contemplated. It can be a very useful tool by allowing the parties to confirm, in writing, their mutual understanding of the basic deal before investing substantial amounts for legal, accounting and other services required to complete the deal. If the most basic components of the LOI can’t be agreed upon, the parties may conclude that there is no point in moving forward.
Is it Binding? Often an LOI is referred to as a “Non-Binding” Letter of Intent. But seldom does one see a Letter of Intent that has no binding provisions, whatsoever. The difficulty, in drafting an LOI lies in the fact that the LOI usually is attempting to create both binding and non-binding agreements by the parties. As a result, it is important to determine, and set forth explicitly, what portion of the LOI will bind the parties and what portion has no binding effect, whatsoever, on either party.
As an example, suppose the parties want to “spell out” the basic deal itself but they do not want to create an obligation to go forward with the deal. They want more independent research and evaluation before they decide whether or not they want to move forward. In that situation, the “non-binding” provisions should be prefaced with language indicating that the parties are confirming their understanding of the transaction that they may enter into, if they are successful in negotiating and signing an agreement. It is important to make it clear that the description of the deal is not intended to create any legally binding obligation of the parties to enter into a definitive agreement.
In 2011, the Indiana Court of Appeals found that the terms in an LOI were specific enough to create a binding contract and found that one of the parties breached by not completing the deal.
There is an important lesson to be learned from the court’s opinion. If the parties are not intending to create an obligation, by signing the LOI, to move forward with the transaction, then the LOI should contain sufficient language to dispel any such argument.
If the LOI Doesn’t Bind the Parties to Move Forward, Does it Bind Them to do Anything? Generally, even if an LOI is not intended to bind the parties to move forward with the “deal” there will be some provisions that the parties intend to be binding. Here are a few examples:
In summary, while an LOI can be an excellent tool, it is important that the intentions of the parties are made very clear, and the binding and non-binding provisions are separated and clearly designated as such. Otherwise, the parties may end up in court with one person arguing that there was no intention to bind the parties and the other arguing that a breach of contract has occurred by the other party’s failure to complete the deal. This is, obviously, a bad result for everyone.
An attorney experienced in business transactions can guide your company in drafting an LOI to be certain that such a result is avoided.
The content of this article is for informational purposes only and should not be considered legal advice.
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