Letters of intent (a.k.a. term sheets) are frequently used in commercial transactions as parties negotiate the design of their deal. Even though they are preliminary documents, and generally non-binding, they are fiercely negotiated. This makes sense. Once something is offered to an opponent it can be difficult to pull back from it. A letter should focus on key terms, the key terms being what ever is most important to you. These key terms may include business elements and legal elements, but need not include every term of the final contract.
Because a letter of intent is simply a tool of negotiations, it generally does not create any binding obligation. Courts have recognized that participation in negotiations does not create a binding agreement even if the parties agree to all the terms proposed. There must be intent to create a contract and be bound, rather than the parties merely agreeing that a given set of negotiated terms and provisions is the most attractive structure of a deal. There may be several letters involved in the course of contract negotiations, and the last letter in time may not be perfectly reflected in the final agreement.
So how then do letters of intent become binding?
- The parties expressly intend the letter to be binding. OK, if you know what you’re getting yourself into and mean to do this.
- The parties implied it was binding. Oops.
Keeping Letters of Intent Non-Binding
Unintentionally binding letters of intent tend to fall into one of two camps. The first of these, The Fully Binding Preliminary Agreement, results when the parties have agreed on every issue that could be negotiated including the intent to be bound. These letters of intent are considered complete contracts and are preliminary only in the sense that the parties intend to write a more elaborate final contract in the future. Courts treat this second stage as merely desirable to the parties, instead of necessary. A good way to think about these letters/term sheets is that they are similar to oral contracts. The lack of a formalized agreement does not mean that an agreement was not reached.
The second unintentionally binding letter, The Binding Preliminary Commitment, result when instead of reaching a final agreement (as in the previous paragraph) the parties make a commitment to negotiate in good faith. This means that a party has promised not to renounce or walk away from the proposed contract, abandon the negotiations or demand conditions that vary from the letter of intent.
There are two simple steps you can follow to keep yourself from implying either through text in your letter or the actions following your letter that the letter of intent or term sheet is binding. Remember, “An Ounce of Prevention is Worth a Pound of Cure.”
Step 1- Language
Do NOT state or imply the letter is binding anywhere in the text of the letter, and Do NOT state or imply that there is any commitment to negotiate in good faith. Avoid using terms like “the parties agree”, “[Party 1] offers”, “[Party 1] promises”, “[Party 2] accepts” and never ever say anything like “[Party 1] and [Party 2], intending to be legally bound, hereby agree as follows….”. The more complete the letter’s terms are the more careful you should be NOT to use in words or actions that imply a binding agreement. You SHOULD include in the letter clear language that each party has the right to terminate negotiations in its sole discretion.
Step 2- Action
Do NOT perform any act included as a term in the letter of intent. Complete or partial performance of the letter’s terms is a significant factor showing that the parties intended the letter to be a binding contract. You should also stop your opposing party from any performance that you become aware of.
DO treat the letter of intent as though it is not binding. Include within the letter a clear expression that the letter is non-binding and that negotiations may be terminated at either party’s discretion when you create the letter. Don’t tell the other party that they will be breaching if they don’t do something. Remind everyone that the letter is not binding by referencing its non-binding nature in your communications with the opposing side, particularly email since it’s written.
Binding Letters of Intent
If you find yourself in a situation where a binding letter of intent is absolutely necessary, just remember this. There’s really no such thing as a binding letter of intent; you’re entering a contract. Make sure the key terms are structured in a way you are happy with because even though you may me able to add additional terms in a later formalized agreement, you will have already agreed to what is in your letter. Whenever you’re faced with a potentially binding letter of intent make sure to consult your attorney. This is a contract and whatever time pressure or total domination of negotiations makes the binding letter seem attractive, an attorney’s counsel can help avoid rushing into a bad decision or falling prey to a situation that seems to good to be true. Again don’t be so caught up in the business element of the deal that you forget the legal element.
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© Christopher Way 2017