LETTERS OF INTENT – A TRAP FOR THE UNWARY
Business owners like letters of intent (LOIs) because they offer a confirmation that the parties are serious about a proposed deal. Business lawyers hate them because they often contain traps for the unwary that may have disastrous consequences. Even if a letter of intent says that it is not a final and enforceable agreement, it may be enforceable for its terms, leaving a party with an obligation to move forward on terms that they never intended.
SO, WHAT IS A LETTER OF INTENT?
A letter of intent is a document that is often represented by a seller of property or of a business as a nonbinding document that outlines a tentative agreement between the seller and a buyer. In many instances the LOI will states that it is not a contract and the buyer thinks that he or she still has the option to walk away from the transaction.
However, many LOIs are written so skillfully that though the entire document may not be binding, significant portions of it will be. For example, terms set out in a well written LOI are often legally enforceable as a part of a contract. Unwary buyers who do not realize the legal weight of the LOI might sign one before finishing their due diligence and find themselves locked into a financially disastrous deal.
WHAT ELEMENTS ARE NORMALLY INCLUDED IN A LOI?
Confidentiality agreements, due diligence agreements, and terms regarding transaction costs are standard in most LOIs and are usually binding. A typical LOI will include a basic description of the transaction, payment terms, and warranties. Often closing provisions and indemnification clauses are included.
LOIs often have a “stand still” or “no shop” provision which establishes that the seller and buyer are in talks exclusively with one another. This gives potential buyers some assurance that they are not wasting their time with a seller who is still shopping around and sometimes monetary remuneration if this clause is breached.
A covenant to act in good faith is another common feature of a LOI and can be a horrible trap for the unsuspecting buyer. A covenant to act in good faith in a skillfully written LOI may obligate the buyer to follow through with the tentative deal and deny the buyer the right to walk away from a bad purchase. Courts commonly interpret phrases such as “good faith” as an agreement to complete an agreement. Other phrases to watch out for include “best effort” and “every reasonable effort.”
No matter how carefully buyers scrutinize the elements of a LOI some courts have interpreted them as giving the buyer an ironclad duty to bargain in good faith and have found buyers liable for reliance costs when a definitive agreement was not reached.
HOW TO AVOID THE LOI PITFALLS:
• Work from a notepad instead of signing a LOI.
• Read a proposed LOI carefully.
• Don’t sign anything until it has been reviewed by a competent business attorney.