What’s a Letter of Intent and Why Would I Use One?

by Marianne Sorensen

A letter of intent (LOI) can range from being a preliminary, non-binding expression of the parties’ intentions to negotiate and complete a transaction, typically including only the essential terms, to a document that the parties intend to be fully binding, with detailed provisions that will be in the final agreement. This range in the binding nature of an LOI can cause frustration if the LOI is not skillfully drafted so that it is clear to all concerned whether it is meant to be non-binding, partially binding, or fully binding. (Often the parties mistakenly believe that entering into an LOI will shorten the timeframe or reduce the cost of the overall transaction. However, this is not necessarily true, nor is it the primary purpose of an LOI. While the LOI can be a helpful outline for reaching agreement on essential terms, the parties often become aware of items that have not yet been considered and that they wish to include in the final agreement. This may add to the upfront time and expense of the transaction, but will help avoid the need for amendments to a final agreement or costly litigation which can result from ambiguity in the agreement).

A non-binding LOI should include the basic elements of the deal, but will not afford remedies if one of the parties fails to go through with the deal. Its value is mostly psychological. A non-binding LOI must state clearly that it is merely an expression of the parties’ general understanding; it should not contain words that might lead to the inference that the parties intended to be bound, such as “offer” or “acceptance,” nor should it require the parties to use “best efforts” to negotiate a deal.  Also, in order to counter the argument that a party has a duty of good faith and fair dealing, an express provision should be included stating that the parties have no obligation to engage in good faith and fair dealing in negotiating a binding contract.  It would be wise to expressly state that (i) neither party is to rely on the non-binding LOI as creating any promises, and (ii) it should not be interpreted as justifying action or forbearance by either party.

On the other hand, the if the LOI is intended to be fully binding, it will require much more time and care in drafting, as it may address numerous details and provisions regarding contingencies, conditions, representations and warranties, due diligence period, assignment and assumption rights, remedies, survivability, confidentiality and nondisclosure obligations. The fully binding LOI should state very clearly that it is intended to be enforceable and that the parties are bound by the duty of good faith and fair dealing; it should also set out the remedies for a breach. (Not to be overlooked – a binding LOI must also be supported by consideration).

A common misconception is that a binding LOI can substitute for the final agreement because of its level of detail. If the parties have reached agreement to the extent that no additional terms remain to be worked out, the time and expense of preparing an LOI may be unnecessary, in which case the parties should move directly to documenting the full agreement.

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