Published: November 23, 2021
byMark E. Ellinghouse
Despite a global pandemic and a bingo-card full of natural disasters and calamities, the commercial real estate market has been extremely active over the past two years.While there are some signs that activity will be less frenetic in the upcoming year, most commentators project continued growth, development and overall volume.Many of our clients are already eyeing next year’s targets, beginning the negotiation process with the hopes of getting these deals under contract in the first quarter of 2021.Given these efforts, we thought it might be helpful to offer a friendly reminder regarding the importance and dangers of letters of intent.
A letter of intent is “the preliminary understandings of parties who intend in the future to enter into a contract.”[1]These documents can be a convenient way for parties to memorialize and confirm the parameters of their transaction before proceeding to a final agreement. Letters of intent are typically non-binding, providing that the document is merely a summary of critical terms and is not actually enforceable against the parties until it is reduced to a final, signed contract. These types of provisions are generally respected by California courts, as a letter of intent that unambiguously states that it is not intended to be binding will not be construed as binding.[2]
However, even though the letter of intent may include a non-binding provision, a letter of intent may create legal obligations for the parties, including the obligation to negotiate in good faith.[3]All contracts in California contain the implied covenant of good faith and fair dealing, meaning that the parties must act in good faith to perform their obligations consistent with the intent of the agreement.[4]In the letter of intent context, “[a] court will enforce a ‘contract to negotiate the terms of an agreement.’ But a party is liable under such an agreement ‘only if a failure to reach ultimate agreement resulted from a breach of that party’s obligation to negotiate or to negotiate in good faith.’”[5]This means thateven if a letter of intent is non-binding, a party can still be held liable for breaching that agreement if it does not negotiate in good faith. If one party has a change of heart or finds a better deal and terminates negotiations after a letter of intent is signed, that party may be liable for failing to negotiate in good faith.
For these reasons, parties should exercise great care in drafting letters of intent. A provision providing that the letter of intent is non-binding should clarify that this means the parties can refuse to agree for any reason or no reason at all, and that neither party has any obligation to negotiate in good faith.Moreover, parties should carefully explain their reasons for declining a proposed transaction or ultimately rejecting the transaction after a letter of intent is signed. While letters of intent serve as important tools for deal-making, they should not undermine the flexibility each party has to negotiate outstandingterms or decline to proceed with the proposed arrangement.
[1] Rennick v. O.P.T.I.O.N. Care, 77 F.3d 309, 315 (9th Cir. 1996).
[2] See, e.g., Brezoczky v. Domtar Corp., 770 Fed. Appx. 353, 354 (9th Cir. 2019).
[3] Southern Union Co. v. Southwest Gas Corp., 180 F. Supp. 2d 1021, 1043 (D. Ariz. Jan. 2, 2002).
[4] Steiner v. Thexton, 48 Cal. 4th 411, 419 (2010).
[5] A.R. Thomson Group v. Harbor Seal, 2020 U.S. Dist. LEXIS 118107, *10, 2020 WL 3628712, quoting Copeland v. Baskin Robbins U.S.A., 96 Cal. App. 4th 1251, 1257 (2002).
FAQs
Purpose of a Letter of Intent (LOI)
Parties can use an LOI to outline some of the basic, fundamental terms of an agreement before they negotiate and finalize all the fine points and details. Furthermore, the LOI may be used to signal that two parties are negotiating a deal such as a merger or joint venture (JV).
What are the risks of a letter of intent? ›
Letter of Intent Risks. The LOI may be construed as a binding purchase and sale agreement if it is improperly drafted or if it is improperly characterized in subsequent announcements or other actions of the parties.
What are the problems with letters of intent? ›
Not all letters of intent have legal effect, so the parties may not be contractually bound by their terms. The courts have distinguished between letters of intent that create rights and liabilities and those that do not. Some letters of intent are just “expressions of hope”, which are not binding.
What is the legal significance of the letter of intent? ›
A letter of intent (LOI ) is a document drawn up when two parties come to a mutual agreement, but haven't worked out all the details yet. This letter is presented before the finalized legal agreement, which means that a letter of intent is not legally binding.
What is intent and why is it important? ›
Intent is the meaning behind what you do. If a man takes a sharp knife and cuts someone, it's not the act that is good or bad – it's the intent.
What are the key points of a letter of intent? ›
Components of a Letter of Intent
- Introductory Descriptions. ...
- Terms of the Transaction. ...
- Due Diligence. ...
- Covenants and Other Binding Agreements. ...
- Closing Conditions and Contingencies. ...
- Statement Regarding Final Agreement. ...
- Seasoned Advice and Representation from a Southern California Business Law Attorney.
Letters of intent are not a panacea for engaging a contractor on a whole project, however, and they should never be viewed as a replacement for the main contract. Communications referred to by the parties as letters of intent do not always provide clarity as to the parties' rights and obligations for the initial works.
Who benefits from a letter of intent? ›
Buyer Advantages of a Letter of Intent. Strategically, it is advantageous for a buyer to execute an LOI as early in the process as possible because a properly drafted letter of intent will grant the exclusive right to a buyer to complete due diligence and to negotiate definitive transaction documents.
What are the disadvantages of LOI? ›
Disadvantages of the LOI
Potential for a Legally Binding LOI. Because the majority of due diligence is yet to be completed at the LOI stage, the parties should want the essential terms of a transaction as set forth in a LOI to be non-binding.
What should you avoid in a letter of intent? ›
Here's a look at four significant pitfalls to avoid when writing a letter of intent in business.
- Not being ready to continue the transaction. ...
- Not thinking through the right timing for success. ...
- Breaching a nonbinding agreement. ...
- Not defining the binding and nonbinding elements.
A letter of intent (LOI) may be legally binding, depending on how it is worded and, in some cases, whether a court has determined it is legally binding.
Can you terminate a letter of intent? ›
However, it is possible to break a letter of intent, and there can be severe consequences if one party breaches its obligations under this document.
Why are letters of intent a risk? ›
A letter of intent is, invariably, never adequate to protect the respective parties' interests given its specific, restricted and temporary purpose.
What is the purpose of a intent letter? ›
A letter of intent (LOI) is a written, nonbinding document that outlines an agreement in principle between two or more parties before a legal agreement is finalized.
Is a letter of intent a good thing? ›
The letter of intent typically features professional and respectful text stating one's intentions with a particular business. This document is not usually legally binding, but it shows someone has good faith in delivering their promises.
Is a letter of intent worth anything? ›
The LOI can serve as a bellwether to save both parties considerable time, effort, and money in the event you're too far apart on price, structure, or any other aspect of the transaction. Additionally, the letter of intent is an opportunity to establish trust and understanding with a potential buyer.
What are the objectives of a letter of intent? ›
The goal of this letter is to clearly define your intentions and, if you can, explain how you'll carry them out. Show off your most valuable skills and experiences and how your work and purpose align with the organization's mission and goals.
What is the significance of LOI? ›
What is an LOI? A Letter of Intent or LOI is a legal, formal document signifying the preliminary commitment of one party to engage in business with another. It plays an integral role in significant business transactions, outlining the key terms of a potential deal.
