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The Letter of Intent

Helpful Tool or Lurking Monster

At various stages of a business negotiation it seems inevitable that someone involved in the transaction will suggest a letter of intent ("LOI") to be signed by both parties to encapsule the terms of the transaction in an abbreviated manner. It is an effort to "freeze" preliminarily the key terms of a deal before formal agreements can be prepared and executed.

The first, obvious question: is the LOI to be legally binding? In the vast majority of cases the response is "no, it is only intended as a non-binding expression"; however, sometimes the parties do want the LOI to be legally binding where there is concern that one of the parties is skittish and may change his or her mind before the lawyers (ever the villains, naturally) can put together a final draft of a formal agreement (after a dozen revisions, etc.). The obvious problem with a legally binding LOI is the abbreviation; if it is not a full-blown agreement, what is left out? That "the devil is in the details" is never more manifest than in a complex commercial transaction; and it can be an invitation to litigation to encompass the major terms in an LOI (e.g., the price, the assets being purchased, and the time for closing the transaction) and ignore the less apparent but ultimately critical considerations which are integral to a satisfactory transaction.

Incidentally, once a legally-binding LOI has been signed by both parties, negotiating the details that have been purposely omitted in order to expedite the "freezing of the deal" can be well-nigh impossible. A party who has the security and leverage of a binding LOI can be expected to be more intransigent in negotiating any details which might diminish his or her position. As to the non-binding LOI the first question that might occur is: why bother? If it is not to have any legal effect, what is its purpose? The answer seems to lie in the moral effect of a document which contains the principal terms and is signed by both parties but specifically provides that it is not legally binding. Somehow, the reasoning is, if the LOI is in writing and signed, albeit non-binding, the parties are more likely to hang in until a formal agreement is signed. This may be in spite of the fact that the LOI may state that each party is free to continue negotiations with other parties!

Another question you might ask is: okay, it may not serve any great purpose, but what harm can there be in a non-binding LOI? After all if the letter specifically states it is not legally binding (as it always should, if that is the intention), that should be the end of it. Maybe.

In a recent case decided by the Pennsylvania Superior Court (GMH Associates, Inc. v. Prudential, et al., 752 A.2d 889) the parties had signed a "non-binding" LOI which outlined the terms of a deal until a formal agreement of sale of certain commercial real estate could be agreed upon. The seller took a further step by assuring the buyer orally that the properties were "off the market" even though the LOI provided specifically that the seller was free to negotiate with other parties. The buyer, in reliance upon the seller's promise to take the real estate off the market and with the seller's knowledge, made exhaustive efforts and spent substantial amounts to locate tenants as though it had a binding agreement.

In the end the Superior Court held that the words in the LOI meant what they said, and the seller prevailed. Obvious result? Not really. The case was appealed from a lower court which had found in favor of the buyer on the equitable principle that the buyer had substantially altered its position based on the seller's oral representations; that coupled with the terms of the LOI which set the principal terms of the "deal" was enough in the eyes of the lower court to negate the "non-binding" provision of the LOI. It should be noted also that the three-judge Superior Court panel split two-to-one in its verdict. So, on a different day with different judges, who knows?

All of this serves to illustrate the obvious: extraordinary caution must be exercised in preparing an LOI, legally binding or not; and we would argue that in most cases it would be far preferable to direct the same energy into the preparation of a formal, complete agreement. There may be situations where an LOI can be the "glue" which serves the purpose of keeping the parties together to a final agreement. We suggest that in most cases a term-sheet, containing all the vital provisions but not signed by anyone, in lieu of an LOI, would be a less volatile document and could accomplish the same purpose.

Oh yes, if you should decide to use a term-sheet, as a precaution it too should contain a statement that it is not intended as a formal offer and no one would be bound to anything until a formal agreement is fully executed. One more reason to love lawyers!

-- Ken Butera

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