Letters of Intent – Don’t Give Away More than You Bargained For

Posted on Sunday, August 9th, 2015

When I was younger, I believed letters of intent were a waste of time. I would say “just give me a purchase agreement with all of the proposed terms so we know the full scope of the deal.” I’ve since come to realize that a comprehensive letter of intent or “LOI” is a great way to see if the parties are close on terms while avoiding entering into an agreement by accident. Plus, business folks can save money on legal costs if they agree on important terms in a letter of intent that consists of a few pages, instead of moving immediately to a 10-100 page agreement before the parties even agree on major deal points.

Many parties encounter problems when courts view letters of intent as an agreement on general terms that only leaves smaller details to be determined later. Sometimes one of the parties wants to back out during the negotiation of the “details.” And the other party (the “Plaintiff”) sues on the theory that the letter of intent was a binding agreement – and the court agrees with the Plaintiff. Courts have decided these situations differently all over the country, depending on the judge, jurisdiction, binding precedent and the facts.

But, for the most part, there are certain steps the parties can take to avoid having a letter of intent held binding by a court. For example, stating that there will be no binding agreement unless and until all parties sign a formal agreement for the subject matter at hand (e.g. a stock purchase agreement, asset purchase agreement, an agreement to purchase real property, lease agreement, etc.) is strong evidence that the parties did not intent the letter of intent to be completely binding. Good and current nonbinding provisions in the letter of intent should be created/reviewed by a lawyer. See, e.g. Hansen v. Phillips Beverage Co., 487 N.W.2d 925 (Minn. Ct. App. 1992). Stating that the parties will create a more formal version of the letter of intent or “reduce the LOI to a formal agreement” is generally not enough to prevent the letter of intent from being held binding (and may provide evidence that the less formal letter of intent was actually an agreement).

As another example, avoiding certain types of performance can help the parties avoid having a letter of intent held binding by a court. A buyer doing due diligence generally doesn’t create a binding agreement. A tenant that takes possession of the space could make a letter of intent (combined with the performance of the parties on taking possession and the allowance thereof) binding.

In general, once the LOI expires, the parties have no further duty to negotiate. However, in most jurisdictions there is an implied covenant of good faith that requires parties to negotiate in good faith. See, e.g. Lindgren v. Clearwater Nat. Corp., 517 N.W.2d 574 (Minn. 1994). Depending on the facts, if one party does not negotiate in good faith between the time when the LOI is signed and its expiration – that party may be liable for damages.

In many transactions, the parties want certain provisions of the letter of intent to be binding (e.g. confidentiality, non-solicitation, non-compete, exclusivity, etc.) while keeping the remaining terms (price, representations and warranties) nonbinding. This is generally allowed but must be drafted carefully to avoid unintended consequences (as described above).

Takeaway: Have legal counsel review any letter of intent before signing or acting on a potential transaction. Doing so is almost always cheaper than litigation.