Letters of Intent - LOI - The Good and the Bad - Benefits and Common Pitfalls
Brief written expressions of business deal terms, whether labeled as a “Letter of Intent” (LOI), “Term Sheet”, “Memorandum of Understanding” or something similar, can be useful but their proper use in the negotiation of a business deal requires an understanding of contract law and the inherent business and legal risks that flow from common misconceptions.
Common questions include “Are these “contracts”? and “What can be accomplished with these forms?” For simplicity here, I will use the term “LOI”, but these principles apply to any form of written outline of an agreement between two or more parties to a business arrangement.
A common misconception that some parties have in mind is that an LOI will always be non-binding and preliminary as a tentative expression of what the parties will proceed to negotiate and develop into a comprehensive and binding agreement. Regardless of what it is called, a writing (including electronic writings or even an exchange of emails) signed (or "published") by each of the parties may create binding obligations along with other provisions that may prove to be non-binding - in other words, the document may create a mixture of both.
In reviewing an LOI, before approving and signing, the central question to have in mind is whether the parties intend (or whether you or your client would benefit from having ) any, all or just some of the outlined “agreed terms” treated as one or more binding obligations, regardless of whether the parties complete and sign a further "definitive" agreement.
Further, beyond the binding/non-binding question, it is also critical to understand that an LOI can have great value when it contains the most important business terms which give deal momentum and make it more likely that the negotiated definitive agreement contains those same terms. When an LOI lacks key business terms, the parties may find the drafting and negotiation of the definitive agreement more time consuming and less likely to come to fruition.
If the intent is a nonbinding expression, it is important to include provisions in the LOI that make this understanding clear. For example, the parties could include an express provision that the LOI document “is not intended to be legally binding and that binding commitments will only arise upon the signing of a formal agreement.”
Keep in mind that these are important agreement documents and your business attorney can add a great value in the development and conception of your LOI, and you would be well advised to get your attorney involved before the LOI is proposed, instead of waiting until it is time to draft the "definitive agreement." If you wait, you may find that the document you signed was binding in at least some important degree, or that you missed an opportunity to nail down an important term before proceeding to incur the more significant legal expense of drafting the formal agreement.