Why Is My Letter of Intent Being Enforced? It Was Only a Letter of Intent, Not an Agreement.

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Is a Letter of Intent enforceable? There isn’t a simple answer. It could be: (a) yes; (b) no, not at all; (c) some parts yes, and some parts no; (d) no, but it will be treated as if it were; and (e) no, but it may affect the parties’ later agreement.

First, why did Ruminations pick this topic today? About a month ago, we raised the question as to whether a detailed letter of intent (which we’ll now call an LOI) would help speed up the process of getting a deal done. One particular LinkedIn Group picked up on this and there were about thirty comments with most of them focusing on enforceability of an LOI. Accurate information, inaccurate information, and lots in between were tossed on the table. That was a recipe for confusion. Ruminations stood back, unable to figure out what underlay the lack of any single useful and “true” answer thread. Standing back led to introspection – why did the answer seem so obvious to us, but not to the community of principles, brokers, and attorneys? Well, introspection led to the realization that we’d never thought the issue through. We just believed our dogma, and man’s best friend is his dogma. Fortunately for our ego, after thinking this through, Ruminations feels safe in expounding that an LOI can be enforceable (if you aren’t careful, and sometimes even if you are), but now understands better why that is or what that really means.

Please don’t forget this as you read through the rest of this piece. Very few genuine LOIs are found to be enforceable agreements. Courts really, really understand that there is such a thing as an LOI and that it is a rare day that an LOI should be treated as an enforceable agreement, at least so far as its business terms might otherwise be accepted as “the real deal.” All we want to do today is to explain the underlying basis for the rare exceptions; set out a few tips to help all of us avoid becoming an exception; and to share some pretty conventional LOI text with the reader.

Here is a key fact: If the parties intended to be bound by the LOI, the LOI will be a binding agreement. If they intended to be bound to only some provisions in an LOI, they will be bound by those provisions. To the extent that all parties to an LOI, intended to be bound, there only remains the question of whether a court can figure out whether the LOI contained enough crucial information such that a court can figure out what enforcement would entail.

Now, if no party disagrees that it intended to be bound and the LOI has a minimum amount of information (classically, but not necessarily in the modern contract world, it identifies the parties, the subject matter of the agreement, and the essential terms, generally price), the battle is not about whether the LOI is enforceable. Obviously it is because the parties agree it is. The battle shifts to “its terms” or whether there has been a breach, and if so, what the remedies will be. So, the issue of enforceability only comes up when one party insists it didn’t intend to be bound, because if all parties assert that same position, the question of enforceability doesn’t come up in the first place.

This leads us to a major point of confusion. It doesn’t really matter that a party never intended to be bound. That’s because the test is not what a particular party subjectively intended. The test is what an objective observer reasonably believed the party intended, basing that belief on the words (written or not) or the actions (and, in a limited number of scenarios, the inactions) of the party (who is now denying its intent). The question is: “would an objective observer reasonably believe that the party intended to be bound?” That may be hard to swallow by a party who sent out such signals, but that’s why we have the expression, “hoisted with his own petar[d].” [Actually, it comes from Shakespeare’s Hamlet, and a “petar” (now written as petard) was an explosive device – hence “blown up with his own bomb.”]

Many readers were raised with the belief that a binding agreement (read that: an enforceable contract) requires a “meeting of the minds.” If you paid attention to the previous paragraph, you now know that’s not an accurate statement. All that needs to happen is that an objective person, acting reasonably, believes there was a meeting of the minds, not that there actually was one (subjectively speaking). That means that, in the very limited number of cases where a letter of intent is treated by a court as an enforceable, it is because one party insisted the letter of intent should be enforced as an agreement and the other party gave out convincing signals, at the time of signing, that it agreed.

Another reason a court will treat an LOI as an enforceable agreement, even though the parties did not initially intend it to be so, is that the court looked at what “then happened.” Sometimes parties will sign an LOI and, while they are negotiating the “final details,” one or both of them will start to actually perform under what they think their “final” agreement will be, and the other will accept that performance. If these acts look like the parties have objectively acted like they had an agreement, but just haven’t worked out the “last, little” details, courts will rule that the LOI was really a finished agreement but for the little details and the same court will be happy to fill those in (called, using “gap fillers”).

That discourse explains the absolute “yes,” and the “not at all” alternatives. What about the other possibilities? We’ll start with choice (c), “some parts yes, and some parts no.” This is a little tricky because contract law has evolved over many years from being highly formulistic to trying to match the objective expectations of a commercial society. Thus, the more commercial the subject matter of an LOI, the more likely the following will be true. Classically, courts held that “agreements to agree” were not enforceable agreements. A non-commercial example of an unenforceable agreement would be when one friend promises to take the other to the movies and to pay for the show if the “guest” would drive. When the “guest” shows up with her car and the first friend reneges, their agreement has been breached. No court would award damages to the driver because the subject matter of the agreement was purely social. That’s an actual agreement, but not one that a court will enforce.

In olden days, “agreements to agree,” though not “social” in nature, were another category of unenforceable agreements. Propelled, perhaps, by the way the Uniform Commercial Code handles such agreements when they pertain to the sale of goods, courts, for the most part, believe that when people, in a commercial setting, “agree to agree,” they have undertaken a responsibility to bargain in good faith. So, even where a LOI doesn’t bind its parties to a set of rights and duties based on the substance of the LOI, the failure of a party to bargain in good faith may give rise to damages. That obligation to bargain in good faith is the “some parts yes” piece of the answer and the possible substantive business terms of the same LOI constitute the “some parts no” piece of the answer.

In a similar way, courts may also find certain kinds of LOI provisions to be enforceable, such as those that promise: (a) access for investigation (due diligence) purposes; (b) exclusive dealing; (c) that a party won’t make material changes while negotiations are taking place; (d) non-disclosure of the negotiations; and (e) confidentiality to be enforceable. That’s true, at least until the LOI says it expires (or if there is no such date or event, for a “reasonable” time).

At the bottom of this blog piece will be some text from a common style of LOI. It will show how “unenforceable” parts of an LOI can be separated from the “enforceable” parts. Following the exemplar will probably raise the predictability of the outcome of a court challenge.

The consequence of a court finding an implicit “agreement to agree” provision in an LOI is that the parties can expect their “agreement to agree” to be enforceable. Based on that concept, one party or the other, or both, may expend money or forgo other opportunities. Those parties are accepting the risk that no deal will ever be made, but aren’t accepting the risk that the other party will just plain refuse to negotiate. So, if a party is “led on” by the other when the other party really had no intention to go forward, a court will award damages. In many cases, the court, as explained above, will treat the “agreement to agree” as an actual enforceable contract; in others, it will engage in the fiction that there was a contract to negotiate in good faith, and will rule there was a “quasi-contract.” Lawyers might identify that particular quasi-contract as one of “promissory estoppel,” but the result is the same – an award of damages.

How about (d), “no, but it will be treated as if it were”? Here, the party who denies that the LOI was intended to be an enforceable agreement induces or invites the other party to make significant changes or to take on significant commitments or to forgo significant opportunities by signaling that, despite the delays and despite some failure to settle on final contract terms, there will be a deal. A stark example is where a LOI unequivocally states that there is absolutely no possible way the LOI will be enforceable until a second document is signed in red ink by both parties, and until the company has placed a full page advertisement in the Legal News that a “deal has been signed.” An agreement has ostensibly been reached, but for a few truly minor details (perhaps the wording of the press release), and one side, in good faith, has made some significant expenditures based on the all-but signed-agreement. Then, the other side, with or without malice (but certainly for self-interest), pulls out. Apply the legal theory of your choice, but the reneging party “will pay.” Clearly the LOI was not an enforceable agreement, but when it comes to figuring out how much the reneging party will pay, it will be used as if it were. For a clue as to the various theories under which the “amount” or “kind” of damages will be figured, you’ll have to wait for an already written, but “to be published later” Ruminations series of blogs.

Now to alternative (e), “no, but it may affect the parties’ later agreement.” Under this possibility, there is really no dispute as to whether the LOI is enforceable. Here, the parties moved on to an indisputably enforceable contract. But, perhaps the contract is ambiguous, i.e., it could be interpreted in more than one way and the parties disagree as to what one or more provisions mean. In such cases, courts are permitted to, and will, look outside the agreement itself, called “accepting extrinsic evidence.” It doesn’t matter if the agreement specifically says that it, and it alone, constitutes the agreement of the parties and that all prior agreements have been replaced by this one. That’s because no one is arguing that the parties have a “different” agreement than the one in front of the court. The argument is over “what did they mean?” In such cases, a court may read the LOI that led up to the signed agreement with the object of trying to figure out what the signed agreement really meant to say.

Are there any things to watch out for in the text of an LOI that might tilt a court toward or away from enforcing it as an agreement? Yes. If a critical term is left out, such as a good enough description of the item to be sold, a court wouldn’t know what was being sold, and it couldn’t enforce the LOI as an agreement. In a lot of cases, courts think they know how to find a “reasonable” price, so just leaving out the “price” might not be a critical failure. In many, if not most, cases, however, it would. Saying, “an amount to be agreed upon”, and leaving no basis or standard for a court to imply such an amount, would be a critical failure.

By saying that a party “intends to produce” a “suitable” widget, is far less likely to result in enforceability than saying the same party “shall produce a widget substantially similar to Model A, but in red.” Similarly, saying that the final agreement “shall include” certain specific terms tilts the balance in favor of enforceability, whereas saying the final agreement “would include” terms of a more general nature, would tilt it the other way. Basically, if there is little uncertainty in the LOI’s listing of the “final agreement’s” terms, it starts to look a lot like the final agreement itself.

Setting an outside date or listing an event, the happening of which ends the LOI, will less likely result in the LOI being treated as the final agreement itself.

Saying over and over, perhaps, that more negotiations are needed (and not just by way of lip service) will serve to reduce the likelihood that an LOI will be treated as enforceable. Don’t, however, make the mistake of thinking that if the document’s title is “Letter of Intent” or if it has a simple recital that “this is not an enforceable agreement,” it will be a dead end for a court. Labels and “words in the air” aren’t binding on a court.

Where a LOI spells out certain conditions that need to be met, the failure of which is intended to mean “no deal,” a court will pay close attention to them, especially if they are “real” conditions. So, if there is really a “board of directors,” and the deal is the kind where it would be expected that a board of directors would need to approve, don’t expect a court to willy-nilly make the LOI into an enforceable agreement. If the LOI said that there would be no final agreement if a party couldn’t get an opinion of counsel that the intellectual property rights were transferable, and that party really intended to seek that opinion, the LOI won’t be enforceable if the opinion can’t be obtained. Now, a careful reader might say: “well, wouldn’t a court be saying that the LOI was enforceable, but it was terminated because the approval or the opinion couldn’t be obtained?” Yes, but not exactly. After all, the court doesn’t even need to get there, and if the approval or opinion legitimately wasn’t obtained, even the duty to bargain in good faith becomes irrelevant, if not unenforceable.

So, here, as promised, is a common “template” for segregating “unenforceable” from “unenforceable” parts of an LOI. It comes, we think (it was soooooo long ago), from Steven Suleski’s “Model Letter of Intent” published by the ABA in the early ‘90s. It may have been corrupted through repeated use by others. So, take it for what it is worth, but if it doesn’t make sense, don’t blame Mr. Suleski or whoever else may have contributed to this particular version. Blame us.

PART ONE – NONBINDING PROVISIONS.

The following numbered paragraphs of this Letter (collectively, “Nonbinding Provisions”) reflect our mutual understanding of the matters described in them, but each party acknowledges that the Nonbinding Provisions are not intended to create or constitute any legally binding obligation between Prospective Buyer and Prospective Seller, and neither Prospective Buyer nor Prospective Seller shall have any liability to the other party with respect to the Nonbinding Provisions. Only when a fully integrated, purchase agreement (“Purchase Agreement”), and other related documents, are prepared, authorized, executed and delivered by and between all parties, would there be a binding agreement. If the Purchase Agreement is not prepared, authorized, executed or delivered for any reason, no party to this Letter shall have any liability to any other party to this Letter based upon, arising from, or relating to the Nonbinding Provisions.

1.

2.

35.

PART TWO – BINDING PROVISIONS.

Upon execution by Prospective Seller of this Letter or counterparts thereof, the following lettered paragraphs of this Letter (collectively, “Binding Provisions”) will constitute the legally binding and enforceable agreement of Prospective Buyer and Prospective Seller (in recognition of the significant costs to be borne by Prospective Buyer and Prospective Seller in pursuing this proposed transaction and further in consideration of their mutual undertakings as to the matters described herein).

A. Nonbinding Provisions Not Enforceable. The Nonbinding Provisions do not create or constitute any legally binding obligations between Prospective Buyer and Prospective Seller, and neither Prospective Buyer nor Prospective Seller shall have any liability to the other party with respect to the Nonbinding Provisions until the Purchase Agreement, if one is successfully negotiated, is executed and delivered by and between all parties. If the Purchase Agreement is not prepared, authorized, executed or delivered for any reason, no party to this Letter shall have any liability to any other party to this Letter based upon, arising from, or relating to the Nonbinding Provisions.

B. Purchase Agreement. Prospective Buyer and its counsel shall be responsible for preparing the initial draft of the Purchase Agreement. Subject…

C. Access.

D. Exclusive Dealing.

E. Break-up Fee.

F. Conduct of Business.

G. Disclosure.

H. Confidentiality.

I. Consents.

J. Termination; Survival.

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Comments

  1. Ira: Here is a question I always pondered; If an LOI is enforceable, how do the parties (or a court) write a lease from it? If the LOI calls for CAM and provides an estimate, how does one deal with the 30+ categories of contention, i.e. inclusions and exclusions, since the tenant was not aware of the landlord’s view of what constitutes CAM that drove that estimate? How do you write the exclusive clause (unless it is fully negotiated in the LOI)? How do you write damage and destruction and insurance clauses, default clauses and remedies (outside of California), assignment clauses and all of the other clauses that come up in a lease but are not mentioned in the LOI? What if the parties fail to agree on these matters during the negotiation? Enforceability of an LOI to me means that the parties are bound by those provisions in it, assuming they are detailed enough, but nothing else. There is no final deal until a lease is fully negotiated.

  2. Great question, Joel.

    Some issues that I have with the LOI process include the following: All too often,

    1. where I may take great pains to craft detailed language addressing one concept or another in a lease offer, and where the other side may even repeat my language in subsequent counteroffers back to me, when the lease document is presented, the language upon which I thought we had agreement does not appear.

    2. I encounter brokers who insist upon including in the letter of intent detailed provisions addressing maintenance and repair and assignment and surrender and insurance provisions, etc., etc., each of which might require nuanced negotiation by an attorney. It seems to me that this kind of defeats the purpose of the letter of intent. If we;re going to get that deeply into language, then we might as well just go right to the lease document. This approach makes me very unhappy.

    3. although I am authorized to speak for my tenant clients, the landlord or the landlord’s agent insists that my client sign the (final) letter of intent. However, when I seek a return copy signed by the landlord, that request is often met with resistance.

    4. I’m commonly asked by my clients (on the tenant’s side of the table) whether or not the letter of intent is legally binding. My answer most commonly is that it is not (assuming one version or another of the disclaimer language commonly bandied about is included). Your article is highly illuminating.

    Thanks.

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