Letters of Intent
WHAT IS A LETTER OF INTENT?
A letter of intent is a writing in which the parties to a proposed transaction state a mutual interest in or commitment to one or more important terms of an agreement and, in most cases, show a mutual intention to prepare a more definitive contract to embody the complete agreement.
A letter of intent may take a variety of forms, e.g., a commitment letter, a memorandum of agreement, or an agreement in principle. The document may be a formal writing or an informal letter. The letter of intent may be legally binding in whole or in part, or it may be legally nonbinding. In real estate sales transactions, letters of intent are usually intended to be nonbinding.
The distinguishing characteristic of a letter of intent is that it does not and is not intended to contain all the terms and conditions contemplated by the parties to be part of a final complete contract for the deal. Rather, it is intended to contain only the important business and financial terms.
Although the parties may not intend the business terms contained in a letter of intent to be binding, by using a written letter of intent the parties may implicitly agree to negotiate in good faith. By failing to negotiate in good faith a party may be subject to reliance damages suffered by the other party. . The parties may specifically provide in the letter of intent that there is no obligation to negotiate in good faith, but such a provision may have a chilling effect on the continuing negotiations.
One benefit of drafting a letter of intent is its ability to serve as a defense to a later claim that an agreement was a “contract of adhesion.” For example, in situations in which a party alleges that it is in an inferior bargaining position and therefore had no choice but to adhere to the contract provisions, courts may look to, among other things, whether the parties executed a letter of intent as evidence that the terms were negotiated. See Grand Prospect Partners, L.P. v Ross Dress for Less, Inc. (2015) 232 CA4th 1332 (involving commercial lease).
The trend is to start calling letters of intent, letters of interest, instead, in order to avoid the argument that the LOI is binding in any way or was intended to be a contract of some type.
WHEN ARE LETTERS OF INTENT USED IN REAL PROPERTY SALES TRANSACTIONS?
Practice regarding letters of intent in real estate sales transactions varies considerably. Typically, the decision to use a letter of intent is made by the parties and their brokers. When a letter of intent is used in a real estate sale transaction, its purpose is usually to obtain preliminary written confirmation of the important points in the deal before the parties incur the time and expense of negotiating the details of the transaction and preparing definitive contract documents. In large or complex real estate transactions it is extremely cumbersome and expensive to negotiate basic terms of the deal through the exchange of full-length, detailed contract offers and counteroffers.
Letters of intent can serve the useful purpose of identifying and memorializing the parties’ understanding on key points so that further negotiations on contract documents are limited to details. Letters of intent also permit the business participants to address controversial issues during the initial stages of a transaction when both sides are motivated to reach an agreement, before legal counsel begin negotiations. Letters of intent are almost never prepared in single-family residential transactions because residential brokers commonly use standard form purchase agreements such as California Association of Realtors® forms. See §6.3.
Some attorneys frequently use, or at least recommend, letters of intent because they can streamline the negotiation process. Others avoid using letters of intent if the transaction is relatively straightforward and it is more efficient to commence drafting a purchase and sale agreement. Because there does not appear to be a standard practice, the decision of whether to use a letter of intent in a particular transaction is a matter of professional judgment.
Attorney use a letter of intent in the following situations:
- The transaction is complex;
- Counsel anticipates that the principal terms of the transaction will be aggressively negotiated by the other side; or
- It would be helpful to address certain issues before drafting a definitive statement.
When Parties Prepare Letters of Intent Without Attorney’s Assistance
Before you sign an LOI, have you attorney review it.
Attorneys are often confronted with a signed letter of intent prepared by the parties without an attorney’s assistance. Although sophisticated parties may draft a problem-free letter of intent, any letter of intent can create significant problems if (1) it is unclear, (2) it fails to address one or more major transactional issues, or (3) the parties commence partial performance of the contract before executing a definitive contract.
These problems may be exacerbated if one party asserts that the letter of intent is a binding contract and the other asserts that it is merely a nonbinding statement of intent. Because the term “letter of intent” means different things to different people, the parties may honestly disagree on whether they intended to create a binding or nonbinding letter of intent. However, given that the courts have recognized the ability of parties to enter into agreements to negotiate , it may be more difficult to enforce a binding letter of intent without either definitive language in the letter or unequivocal actions showing the parties’ intent to be bound by the letter’s terms.
TIP: An attorney presented with a signed letter of intent first ascertains the client’s goals. Does the client want to have a definitive contract prepared, the letter of intent enforced, or the letter of intent defended against another party’s claim that a binding contract exists? The attorney ascertains the client’s intent and whether either party has begun performance or changed position in reliance on the letter of intent. Unless the client considers the letter of intent to be binding or the attorney forms the opinion that the letter is binding and that it is in the client’s best interest to perform, the attorney should advise the client not to take any steps to perform the proposed contract until it is properly documented in a complete, signed agreement.