A “letter of intent” is one of those amorphous terms often used in contract negotiations but which mean different things to different people. Some people use it as synonymous with a binding contractual obligation; some use it as an outline of what may be the final contract, but it is not binding in and of itself; some use it interchangeably and this confusion can lead to dispute and bitter litigation. In reality, depending on the parties’ intentions, it can mean any of those things and more.
It is imperative for those engaged in contractual discussions to be crystal clear as to what a document labeled “letter of intent” is to constitute. Ideally, it is a nonbinding document that provides the broad parameters of an understanding to be later reached by the parties but does not provide all the details which will be subsequently reduced to a binding contractual document. But note that depending on its terms, a letter of intent may be binding in and of itself or may be nonbinding with the parties only obligated once the final agreement is signed.
In short, it means many things to many people and can lead to confusion and turmoil if not properly constructed with clear provisions. This article shall discuss the essential terms that should be incorporated to create a useful letter of intent and briefly describe both the benefits of detriments of using this type of document.
What is a Letter of Intent?
As the name implies, a letter of intent expresses the intentions of the parties to enter into a contractual relationship. It usually states the underlying premise of the potential contract and summarizes the most basic terms. Thus, a letter of intent between the parties for leasing a commercial building would have the location to be rented, the proposed lease term and rate, the essential terms as to use of the premises and names of the parties but does not include the many pages of standard lease terms inherent in every commercial lease which would be formalized into that multi-page binding document to be executed later.
The purpose of a properly prepared letter of intent is to cement in writing the underlying contractual relationship each part wishes so that the parties can determine if it makes sense to proceed to the trouble and expense of reducing the future binding contractual obligation to a full writing signed by the parties. It is a tool which allows the parties to confirm their intentions so they can expend the resources necessary to move to a binding contractual culmination.
It can also serve to halt ongoing negotiations with other parties that would interfere with the obligations in the letter of intent. Thus, a common term is that neither party will take any steps, such as entering into a contract with a third party, that would interfere with the ability to culminate the contract. In the above example, the landlord could commit not to rent the premises to anyone else and the tenant could agree not to lease any other property. Time limits on the noninterference commitment are critical, such as the final agreement being executed within X days or the parties are released.
The letter of intent often has preconditions that must be met before the final contract is to be agreed upon. Thus, one could enter into a letter of intent to buy X goods if Y price arises before Z date. If the preconditions are not met, no later agreement is entered into.
In short, the letter of intent is a preliminary document to lead to a later binding agreement of the parties if the parties achieve the preconditions.
Is the Letter of Intent Binding?
Whether a letter of intent is binding depends on its terms and herein lies the greatest danger of the letter of intent. If the letter of intent is vague or ambiguous on whether it is binding, the parties may disagree as to whether they are bound. To make it more complicated, parts of the letter of intent may be binding while others are not.
As an example, I may enter into a letter of intent to lease your premises for a certain term and rent and agree not to rent other premises while we negotiate for the next month but the actual detailed terms are not spelled out in the letter of intent and there is wording that those terms, “…are to be negotiated and agreed upon by the parties by June 1….” There is no question I cannot rent another premise before June 1, but what if the parties cannot agree upon those detailed terms? Can I rent alternate premises on June 2 in that case?
Probably. But it would not be “probably” if the letter of intent was properly drafted specifying precisely what parts of the letter of intent specify intentions but are not binding and what parts are binding. For example, in the above terms it should also state, “If the parties do not agree upon all terms of the rental by June 1, then both parties are released from any obligations existing in this letter of intent.” It may be noted that in reality that letter of intent does not bind the parties to much of anything since all a party need do is not agree to any of the later terms and it becomes void.
And note that if I rent other premises before June 1, then I am in breach of the letter of intent even if I later do not agree to the detailed terms proposed.
Best practice is to specify precisely what terms, if any, are binding on the parties. A common provision in letters of intent are along the following lines: “This letter of intent expresses the current intentions of the parties but is not binding upon them, in whole or part. Only a later fully executed agreement between the parties will bind the parties.”
A variant could be that certain provisions, such as not entertaining alternative offers for X months, are binding but no other provisions are binding.
The Letter of Intent which becomes a Binding Contract:
At times one encounters a letter of intent which becomes a binding contract if the parties do not enter into a subsequent agreement. At times we see a time limit that exists in the letter of intent and if no later contract is signed, the letter of intent becomes the final binding contract. Occasionally, the parties intend to write up a later contract, the press of business interferes with that, and they end up simply proceeding forward with the transaction with only the letter of intent existing as the understanding between them.
Such methods are by far the worst manner to conduct contract negotiations.
There is a reason that the letter of intent is not meant to be the final contract. Numerous terms that are of vital import in a successful contract (arbitration to resolve disputes; attorney fees to the prevailing party in a dispute; what occurs if a party dies or an entity goes out of business; what happens if disaster occurs before the contract is finished; what law applies; who has authority to do what; can the agreement be assigned; who owns the intellectual property; is it confidential, etc.) are usually not in the briefer letter of intent. Absence of those terms can spark later litigation.
And once the parties know the letter of intent is to be binding if not supplanted by a later contract, there is a tendency to slow down on negotiations figuring that at least there is some written understanding existing. This can be a matter of strategy: often one party does not want effective enforcement terms, so just refuses to sign any later agreement and the parties are bound to what is often in incomplete understanding, the letter of intent. See our article on contracts and breach of contracts.
One experienced attorney described such transitioned letters of intent which become binding as a gift to attorneys who want to make a lot of money. And the best way to avoid that danger is to provide that the later contract must be agreed upon or the letter of intent becomes nonbinding.
So, Why Use a Letter of Intent?
The best use is to allow the parties to determine if the underlying basic deal is what they want. By reducing it to writing executed by all of the parties, it cements the essential terms and makes the later expenditure to create the full contract worthwhile.
It can also allow the parties to bind themselves to specific preliminary terms that may be useful for later negotiations. Prohibiting the parties from entering into conflicting commitments while the negotiations progress; the parties agreeing to keep the negotiations confidential or the terms confidential; the parties agreeing on a firm date for a final agreement or the parties are free to go their own ways; these and other specific terms can be made at least temporarily binding.
Most agreements are negotiated, however, without a letter of intent. The parties simply move directly to proposing drafts to each other and redline the documents back and forth until a final deal is made…or not.
Often, in international negotiations in which different cultures view contracts differently and language and related matters can cause problems and the cost of legal counsel can be major, letters of intent are wise. Since communications are made more complex in the international arena, a writing specifying what the parties generally intend to happen can be valuable.
Or, as one client put it, “The longer the final contract, the more expensive. That’s when I want a letter of intent before we go the full mile.”
Like so much in life and law, the problem with letters of intents arises when this often-useful tool is misunderstood and used without requisite knowledge of its unique characteristics. Too often it is seen as a short contract rather than an outline of what may later be a binding contract and that short contract often misses terms that should have been agreed to before the parties began performing.
This writer well remembers a commercial client who suddenly received a truck load of women’s’ shoes while he was still waiting to determine if his retail outlets would be restocking that month. What he considered informal discussions of preliminary terms was considered by the out of state manufacturer as a final, binding order. With a product so dependent on timing as women’s fashions, the manufacturer had quickly filled the order and our client suddenly faced a large bill for product that no one might want. Both parties used the term Letter of Intent in their communications: neither really thought as to what that meant and assumed the other party had the same concept as they did. Neither specified in the exchanged documents whether the letter of intent was binding or not.
The only persons who made a profit from that transaction were the lawyers.