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As new real estate transactions begin to heat up, Letters of Intent or “LOIs” (also sometimes called term sheets) will become relevant again. This article briefly describes issues to keep in mind as you begin to get back into the trenches for new deals.
First, as a primer, what are the purposes of LOIs? LOIs assist parties in determining economic terms, provide a checklist of the basic substantive terms and are a starting point for attorneys to draft the formal agreements. As one court explained, a “letter of intent” is not a legal term of art. Generally, “letter of intent” refers to a writing that documents the preliminary understandings of parties who intend to enter into a contract in the future. “[T]he purpose and function of a preliminary letter of intent is not to bind the parties to their ultimate contractual objective. Instead, it is only ‘to provide the initial framework from which the parties might later negotiate a final . . . agreement, if the deal works out.’” As these authorities imply, calling a document a “letter of intent” implies, unless circumstances suggest otherwise, that the parties intended it to be a nonbinding expression in contemplation of a future contract, as opposed to its being a binding contract.[1]
Second, the question to ask is do you want the LOI or some portions of it to be enforceable? The courts typically rely on the language used to draft the LOI to make that determination, so boilerplate terms and conditions may be insufficient to convey the intent of the parties. For example, one court held that the following language did not constitute a legally binding commitment:
The parties intend this statement to reflect the basic understanding between them, but agree that the transactions contemplated herein shall be subject to the execution of mutually acceptable definitive and final agreements to be negotiated . . . [and] subject to the approval of the Board of Harbor Commissioners . . . and by [COSCO] . . . . This statement does not constitute a legally binding commitment.[2]
Another court found that the following language made that same point that the LOI was not enforceable with the blunt language: “In no event shall any parties be bound unless and until the transactions described in this letter and the attached Term Sheet have been made the subject of definitive agreements executed by all the parties thereto.”[3]
Regardless of what you intended, the court may find your LOI is binding depending on a list of factors, including:
- You include all material terms, including representations and warranties.
- Alternatively, you agree that the parties will be bound by commercially reasonable and customary practices in determining their representations and covenants.
- You agree that your failure to achieve a more complete formal agreement will not limit enforceability of the LOI.
But in California, be careful: an agreement for the purchase or sale of real property in California does not have to be evidenced by a formal contract drawn with technical exactness in order to be binding.[4]
If the parties don’t want the LOI to be binding, various courts and practice guides have suggested using the following language:
- Nonbinding/Not contractually or legally binding on the Parties.
- Expression of the parties’ desire to negotiate the formal agreement in accordance with the terms and conditions set forth in the LOI.
- Notwithstanding anything to the contrary in this LOI, the parties expressly acknowledge and agree that the LOI does not include all the material terms that would be included in the formal agreement and thus does not constitute a contract for the transaction described in the LOI, but only expresses the interest of the parties to negotiate and attempt to agree upon a formal agreement.
- Neither party shall rely on this LOI or any discussions regarding the transaction as a commitment, offer or agreement of the other party.
- Except for Paragraphs which shall be binding on the parties, this LOI does not create any legally binding obligations on the parties at law or equity.
- The LOI does not impose any enforceable obligations.
- Preliminary expression of general intent and to be used for general discussion purposes only. It is not an offer, acceptance, or a contract.
- Does not create any agreement, obligations, rights, or duties by either party to negotiate the formal agreement or to continue to further discuss or negotiate the formal agreement. No duty to negotiate. No duty to conclude a formal agreement.
- The parties may negotiate with third parties, enter into agreements with third parties, and propose different terms than are in this LOI.
- The parties may unilaterally terminate negotiations without liability.
- Any party who relies on this LOI does so at its sole risk, costs, and expenses.
- Practical: Adding headings like “Nonbinding” and/or “Prospective Buyer/Seller”
Again, you still need to be careful, because subsequent conduct matters and can be relied upon by a court to determine that the terms of the LOI are, actually, binding on the parties.
Third, other than the material terms of the deal to be formalized, there are other provisions to consider when drafting the LOI. These provisions typically are specifically stated to be binding even if no formal deal is consummated:
- Confidentiality Agreement/Non-Disclosure Agreement
- Non-Circumvention Agreement
- Exclusive Negotiation Agreement
- Duty to Negotiate in Good Faith
- In the absence of a provision discussing a duty of the parties to negotiate the formal agreement in good faith, a California court has found that the implied covenant of good faith and fair dealing implies a duty of the parties to negotiate in good faith. The court held that if, despite their good faith efforts, the parties fail to reach ultimate agreement on the terms in issue the contract to negotiate is deemed performed and the parties are discharged from their obligations. Failure to agree is not, itself, a breach of the contract to negotiate. A party will be liable only if a failure to reach ultimate agreement resulted from a breach of that party’s obligation to negotiate or to negotiate in good faith.[5]
For a party found to breach this agreement to negotiate in good faith, the damages are not arising from what the ultimate agreement may have provided. Instead, the appropriate remedy for breach of a contract to negotiate is not damages for the injured party’s lost expectations under the prospective contract but damages caused by the injured party’s reliance on the agreement to negotiate.
- In the absence of a provision discussing a duty of the parties to negotiate the formal agreement in good faith, a California court has found that the implied covenant of good faith and fair dealing implies a duty of the parties to negotiate in good faith. The court held that if, despite their good faith efforts, the parties fail to reach ultimate agreement on the terms in issue the contract to negotiate is deemed performed and the parties are discharged from their obligations. Failure to agree is not, itself, a breach of the contract to negotiate. A party will be liable only if a failure to reach ultimate agreement resulted from a breach of that party’s obligation to negotiate or to negotiate in good faith.[5]
- Liquidated Damages in the event that the formal agreement is not executed.
- Miscellaneous Provisions such as who pays the expenses, that the LOI may be signed in counterparts, and governing law.
- Common Interest Agreement
- For those States that enforce such agreements, a common interest or joint defense agreement can block production of attorney-client privileged documents from a third party who is the adversary to both parties to the transaction. For example, if the two parties are negotiating a joint venture agreement with respect to the purchase of real property owned by a third, the common interest agreement may allow the two parties – even though they are adverse in negotiating their own joint venture agreement – to discuss privileged issues with respect to their efforts against the third party seller. In addition, use of a common interest agreement could provide the same benefits in the lender-borrower or private party-government situations. As one court held, the common interest doctrine allows parties with a community of interests to preserve the privilege’s protections where the parties had joined forces for the purpose of obtaining more effective legal assistance.[6]
- For those States that enforce such agreements, a common interest or joint defense agreement can block production of attorney-client privileged documents from a third party who is the adversary to both parties to the transaction. For example, if the two parties are negotiating a joint venture agreement with respect to the purchase of real property owned by a third, the common interest agreement may allow the two parties – even though they are adverse in negotiating their own joint venture agreement – to discuss privileged issues with respect to their efforts against the third party seller. In addition, use of a common interest agreement could provide the same benefits in the lender-borrower or private party-government situations. As one court held, the common interest doctrine allows parties with a community of interests to preserve the privilege’s protections where the parties had joined forces for the purpose of obtaining more effective legal assistance.[6]
- Termination of the LOI, and does the termination also terminate LOI provisions such as the non-circumvention, NDA, and common interest provision?
Last, in an ideal world, the drafting of the LOI would be by your lawyer. Oftentimes, it is the brokers who handle the drafting of the LOI and take the lead in the drafting. While that may be commonplace, it is strongly recommended that the LOIs be reviewed by your lawyer to make sure your rights are protected. “Standard” forms, whether prepared by a broker or a principal, may be a good starting point, but the final LOI should be carefully drafted and reviewed before signing.
Jeff Brown is a partner in the Firm's litigation department and focuses on real estate, finance and commercial litigation. He can be reached at jbrown@thompsoncoburn.com.
[1] Rennick v. O.P.T.I.O.N. Care, Inc., 77 F.3d 309 (9th Cir. 1996).
[2] City of Vernon v. Board of Harbor Commissioners of the City of Long Beach, 63 Cal.App.4th 677 (1998), disapproved on other grounds, Save Tara v. City of West Hollywood , 45 Cal.4th 116 (2008).
[3] Radomile v. Marriott International, Inc., 2002 WL 313167 (Cal. App. 1 Dist.) (unpublished).
[4] Patel v. Liebermensch, 45 Cal.4th 344 (2008).
[5] Copeland v. Baskin Robbins U.S.A., 96 Cal.App.4th 1251 (2002).
[6] Nidec Corp. v. Victor Co. of Japan, 249 F.R.D. 575 (N.D. Cal. 2007).