Letters of Intent – What They Can and Cannot Do

Letters of Intent – What They Can and Cannot Do

by Janet L. Eveland, Esq.

A business transaction usually starts with a conversation between businesspeople. Eventually, the parties will want to spell out the major terms and issues of the deal in writing. This initial document is frequently referred to as a “letter of intent (LOI),” “term sheet,” or “memorandum of understanding (MOU).”  I’ll refer to them all as a letter of intent for convenience sake but the purpose of all of them is the same: to summarize the major deal terms and set forth the steps to the completion of the deal. The letter of intent can outline how the deal will be structured before substantial time and money is spent on the final agreement and due diligence.

General Structure

The letter of intent should include all of the necessary aspects of the business deal – the points that, if the parties are not in agreement, there will not be a deal.  By discussing the major points at the early stages, the parties can settle differences about key issues such as the deal structure, price, management, post-closing, and financing of the transaction.  All parties can test the level of interest and capacity to perform of the other parties.

Binding or Nonbinding

Because the parties may have differing objectives, one party may want the letter of intent to be binding and the other party many not. Often, letters of intent are non-binding; in this case the letter of intent functions to help the parties determine whether they agree on the important aspects of the deal and create an outline of the final, binding, and detailed agreement between the parties.  In a non-binding letter of intent, the parties can agree to what the material terms are but can all walk away if the final agreement does not meet all parties needs.  Letters of intents may also be binding so that, for example, the parties can agree on a sales price and a due diligence time period which will not change in the final agreement.  In general, a binding letter of intent will contain legal consequences if the parties fail to come to final agreement.

Letters of intent can also be a hybrid of these two forms, with both binding and nonbinding provisions. It is important that the parties know, agree, and clearly set out the nonbinding and binding provisions

Typical Provisions

The letter of intent can outline how the deal will be structured before substantial time and money is spent and often includes the following provisions:

  • Confidentiality, including of information exchanged during negotiations
  • The basic form of the proposed transaction (merger, real estate sale, or stock purchase)
  • Assets to be purchased and liabilities to be assumed
  • Purchase price, payment terms, form of payment
  • List of conditions that must be satisfied
  • List of representations and warranties
  • Termination Fees and Terms
  • Exclusivity period (parties will not negotiate with others)
  • Provisions for deal termination
  • Allocation of costs and fees at various stages of the deal

Potential Problems

Careful parties know that the exact wording in the letter of intent is important – both for what it includes and what it fails to include.  Some of the issues that can arise if the parties are not careful in drafting:

  • Binding or non-binding – if the language is not clear and is not clear as to exactly which provisions are binding and which are not, then the matter may be litigated.  When a case goes to Court then a judge will decide what the parties meant to say.  Most judges have never been businesspeople.
  • Deal breaker or not – after the letter of intent is signed by the parties then the negotiation of the full agreement is usually undertaken.  If a term in the final agreement doesn’t meet one party’s requirements, then the issue may arise as to whether the parties are still bound by the letter of intent or the letter of intent (and the deal) can be terminated and, if so, what are the consequences and/or penalties to the parties.
  • Specific or general terms –the parties will need to decide how specific they wish to be in the terms of the letter of intent.  If the parties are too specific in their initial letter of intent negotiation then they may spend more time and money than they need to on a deal that will ultimately not work.  If the parties are not specific enough, however, they may end up with a letter of intent that provides little guidance, and little benefit, to the parties in drafting the final agreement.
  • Description of what is being purchased.  Parties may not fully consider, or even agree, on what is being purchased.  This problem often happens by accident or inattention.  For example, the buyer may believe they are buying a fully functioning business in leased space but the parties fail to consider the terms of the existing lease.  Landlord’s should and often must, be consulted and/or consent to the business transfer and fees may be required.
  • Parties and Approvals.  It is sometimes the case that parties negotiate a letter of intent but leave out a crucial party.  For example, a subsidiary enters into a letter of intent without the knowledge or consent of its parent corporation, or a tenant enters into an agreement to share space with a third party without involving (or getting the consent of) its landlord.

A Business Lawyer’s Role

The parties often have initial discussions about the terms of a transaction.  It is almost always, however, to the advantage of all parties to have the parties’ attorneys draft and help negotiate the letter of intent.  The buyer’s attorney generally creates the first draft of the letter of intent but it may benefit the seller to have the seller’s attorney start the drafting and set the tone for the deal.

Your business attorney can help draft the letter of intent and ensure the following:

  • That the letter of intent doesn’t include any terms you don’t mean to include in order to prevent you from creating an obligation you didn’t mean to create.
  • That the letter of intent does include terms you mean to include in order to protect you from a deal you don’t want to make.
  • That you understand the terms of the deal and the legal ramifications of these terms.
  • That you have considered terms that the parties often don’t think of without legal counsel. 

Psychological Factors

An important factor is the strategy involved in deciding which party’s lawyer drafts the letter of intent. In general, it is advantageous to have your own attorney draft the letter of intent.  The drafter can establish the basic outlines of the deal, characterize certain parts of the deal, and set the tone for the deal.  

Trust your instincts in negotiating a deal.  If you feel uncomfortable or feel that something is wrong with the deal, pay attention and work with your attorney to determine what is behind your feelings.  Remember, if the other party is difficult to deal with and doesn’t engender trust during the negotiation of the letter of intent, they are unlikely to be any different in negotiating the final agreement, completing due diligence, or closing on the deal.  You may be better off leaving some deals on the table.

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