The economy’s emerging recovery is causing many businesses to increase the pace of their transactions. In the race to show good faith and serious intent to proceed with deals (including, but not limited to, the sale or lease of real estate or business assets), parties are moving quickly through the process of memorializing the terms of their proposed business arrangement—the negotiation of a “letter of intent,” “memorandum of understanding,” or similar agreement.
A letter of intent generally takes less time to negotiate than a final purchase agreement and related transaction documents and enables the parties to memorialize their agreement on the critical business terms prior to spending material amounts of money and time on due diligence. However, with business picking up and parties rushing to move before their competition acts, the market rises, interest rates climb, or some combination of all three, parties often do not seek counsel at this early stage of their transaction. Instead, they race to finalize the letter of intent, sometimes with dire consequences.
Generally, the parties to a letter of intent prefer that these preliminary “agreements” be non-binding. But they often include limited provisions, like those related to confidentiality and exclusive negotiation/non-solicitation, that are intended to be binding on the parties. Parties should take special care to clearly define what is intended to be binding and what is not by creating separate sections within the letter of intent for each type of provision.
In light of recent cases in this area, extra care must be used to ensure that the other provisions of the letter of intent are not deemed to be binding, in whole or in part, on the parties. For example, careful attention must be paid to make sure that what was intended as a period of exclusive negotiation (or some other provision) does not become an additional, binding obligation broader than what the parties intended. The key factor that courts use to determine whether or not a letter of intent (or a specific provision thereof) is binding has been the intent of the parties. However, the course of conduct after the execution of the letter can provide further evidence of the parties’ intent. Juries have determined that public actions of one party have the power to revise the interpretation of the terms of otherwise very clearly drafted language in a “non-binding” letter of intent.
Once a clearly “non-binding” letter of intent has been executed, parties still need to be concerned about potential legal liability and obligations that exist prior to the execution of the formal binding purchase agreement. Regardless of “intent,” the parties to a contract are bound by an unwritten or implied covenant of good faith and fair dealing. This is also true during the period of time between the execution of a letter of intent and a formal contract, when the parties are bound by a lesser standard, the duty to negotiate in good faith.
While seeking to memorialize key business points in a letter of intent, it is essential for the parties to ensure the only binding provisions in a letter of intent are those that were intended to be binding. During the period of time leading up to the execution of a formal contract, the parties should continue to act in a manner consistent with the legal obligations and implied covenants that come with operating under such an agreement. Without due care, parties could find themselves bound by provisions they thought were non-binding.
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