One of the most frequently, and incorrectly, used items in business transactions is a letter of intent (the “LOI”). It is meant to be a shorthand expression of the parties’ general agreement of principal terms, yet can become a binding quagmire to the unwary. Improperly done, a “non-binding letter of intent” becomes a fully enforceable, poorly drawn contract.
The purpose of a letter of intent is usually straightforward. It is a way for two negotiating parties in a more complex transaction to make sure they have reached terms on the most important points of a business transaction, before going to the time, effort, cost and expense of entering into a fully-binding contract and due diligence. Perhaps party A is negotiating with party B to purchase party B’s business. This is a complicated transaction that will involve non-competes, extended due diligence, inventorying of assets, reviewing of accounts, etc. All of that is expensive and time consuming. But before going to that trouble, the parties want to make sure that they at least agree in theory on the basic terms: the price of the purchase, whether it will be all cash or partly financed, how long party A has to close, etc. The parties often sit down—before the involvement of costly legal counsel—and hammer out the basic bullet point terms. Once they’ve reached a consensus on these basic terms, they then want to memorialize them with a non-binding LOI until a proper binding contract, with full details, is reached.
Unfortunately, however, parties often accidentally create a binding non-binding letter of intent. That is, through their loose language they create something that could be legally binding in a way that is not intended. Here are some examples of how that happens—have you ever seen them before?
- The LOI provides that it will be the binding agreement of the parties until a full-fledged contract is reached. Sometimes this is not accidental but intentional, the idea being that even if the parties for some reason fail to reach a full agreement on details, they still want the basic terms to be binding. But sometimes transactions are complicated, and two well-intentioned parties may have very different views on how the details should be resolved. If you have created an LOI that simply states that a buyer is going to buy the “business” for $X, to be closed within Y days, are those details enough to satisfactorily close a deal? What is the “business”—goodwill only? Assets? Inventory? Some combination? Did the buyer desire to negotiate a non-compete? The fact is, there are too many details still to nail down, and relying on a short LOI to be the binding agreement if the parties don’t actually reach a full-fledged agreement, is a recipe for litigation.
- The LOI contains mandatory language in it. The letter of intent may state that it is non-binding, but there will be a conflict in the language if the parties then put in specific mandatory provisions in it, such as:
“The parties will reach a full contractual agreement within 15 days from this non-binding letter of intent.” Or “The parties will use their best efforts to reach a binding agreement.” Or best yet, “The Seller will not market its business while the Purchaser and Seller attempt to negotiate a contract.” All of these are real examples I have witnessed. Once again, the parties have created legally binding language with such provisions—though wading through the interpretation of such provisions would make such an LOI ripe for litigation.
- The LOI, though intended to be a non-binding letter of intent, never explicitly states it is non-binding. Calling a document a “letter of intent” does not mean that it is binding or non-binding. But when you specifically refer throughout the LOI to the document as being an “agreement,” you’re very likely going to have it considered binding—regardless of what your true intent may have been.
When I prepare a letter of intent for a client, I do a few things to make it clear, throughout, that it is a statement of intention and not binding.
- State the purpose of the LOI. I often draw my clients’ letters of intent like an actual letter, communicating to the other party that we have been in discussions toward a possible business transaction. I then go further and state that the parties are interested in negotiating a transaction, containing certain terms, terms upon which the parties desire to reach a full-fledged contract. Prior to spending the time and cost of negotiating a contract, however, we wanted to determine that both sides acknowledge the principal terms such a contract should contain. This procedural history helps reinforce the purpose of the LOI, and clarify that it is not binding.
- Disclaimer language. At the beginning and the end, I typically insert language that, “notwithstanding anything contained in this letter to the contrary, nothing in this letter constitutes a binding agreement between the parties.”
- I clearly avoid using words like “agree” or “agreement,” or set out bullet points that appear to have statements of agreement. Say, for example, that as part of a business sale, the buyer wants the seller to enter into a three year, 30-mile radius non-compete. The wrong way to address this would be to put in the LOI “The Seller shall enter into a three year, 30-mile non-competition agreement.” Instead, at the beginning of the LOI, I state something like this: “It is intended by the parties that an agreement shall be drafted that contains the following relevant provisions:
- A three year, 30-mile non-competition agreement…..”
See the difference? We still are laying out the substantive points of what each side expects the deal to obtain, but it is clear that no party is actually bound yet.
- If there is an intent that some portion of the LOI should be binding, we specifically include that in the language of the disclaimer. Wait, isn’t that at odds with what I just said? Not really. Even parties who want a LOI to be non-binding sometimes need certain binding provisions—most often, a confidentiality and non-disclosure provision. That is, even though the parties are still in beginning stages of discussions, they want the discussions to be kept confidential[1]. So in this instance, the disclaimer at the end of an LOI might read:
“Notwithstanding anything contained in this letter to the contrary, nothing in this letter, other than the confidentiality and non-disclosure provisions of Paragraph X constitutes a binding agreement between the parties.”
While creating a non-binding letter of intent seems easy, in fact it is actually quite easy to mess up and create a document that is legally binding in ways you didn’t intend. If you’re trying to draft an LOI yourself, take these tips to heart and you can avoid problems down the road
If you need help negotiating a business transaction, feel free to call The Deaton Law Firm, PLLC, at 704-489-2491.
[1] It’s actually better that a non-disclosure agreement be reached prior to the parties even entering into informal discussions, but that’s another blog post in itself.
