The Non-Binding Letter of Intent
The legal documentation that is involved in the purchase or sale of a business, or in other major business transactions, can be complex. To assist with flushing out the main points of the deal (e.g., transaction structure, price, etc.), many parties in commercial transactions typically enter into a “Letter of Intent” (“LOI”) (also referred to as a “Memorandum of Understanding” or “Term Sheet”).
These letters are drafted prior to the parties negotiating and finalizing the definitive binding agreement and outline the basic terms of the deal. They are intended to create an atmosphere of good faith between the parties and are usually expressed to be provisional and non-binding, except for a few provisions (discussed below), which are intended to be (and should be) binding.
The problem that may arise when dealing with LOIs is that sometimes the language contained in the LOI or the activities undertaken in relation to the LOI can have the unintended consequence of turning a non-binding LOI into a binding commitment. The best way to avoid LOI disputes is to establish at the outset whether it should be a legally binding contract and draft it properly. For example, the following drafting techniques will help ensure that a LOI is not legally binding:
- Avoid use of the word “agreement” and use terms of intention instead (e.g., instead of saying “it is agreed”, say “it is intended”).
- Expressly state that the LOI is not legally binding (except for the provisions contained in paragraph(s) “XX”) and that binding commitments will only arise upon the signing of a formal agreement in writing.
Just as important as careful drafting of the LOI is the parties’ actions during the negotiation period. Certain activities taken by the parties can cause a non-binding LOI to become binding. For instance:
- Trying to satisfy conditions, such as obtaining zoning or other approvals to the transaction.
- Conducting inspections or tests on the property that are usually done during the conditional phase of the binding agreement.
- Beginning work on the site that was agreed to be completed by one of the parties to the deal.
- Making public announcements (e.g., seller announcing that he’s retiring upon the sale of the business) that could be interpreted to mean the deal is binding.
- Any other activity by one party that reasonably gives the other party the impression that there is a legally binding agreement.
If the parties want to perform an activity in relation to a non-binding LOI while the binding agreement is still being negotiated, they should agree in writing prior to engaging in such activity that neither the actual activity (e.g., doing work on the site) nor any conduct in pursuance of the actual activity (e.g., spending money in preparation for doing work on the site) will make the LOI binding.
Even with LOIs that are intended to be non-binding, there are a few provisions usually included that should be expressed as being legally binding. Because it will almost always be necessary that the parties disclose certain confidential information to eachother in order to engage in meaningful negotiations towards the formal agreement, a paragraph in the LOI that addresses such confidentiality between the parties should be designated as legally binding. You do not want to enter into a non-binding LOI with a competitor business partner without such a binding confidentiality provision, for fear that a binding agreement is never reached or the deal does not close. In addition, from a buyer’s perspective, a “no shop” clause should be included in a LOI as a binding clause to restrict the seller from “shopping the deal” to other potential buyers while the buyer is conducting his or her time-consuming and expensive due diligence.
If you are presented with a LOI by another business partner, you should seek the advice of a lawyer before signing. These documents can be lengthy, complex and the legal significance of certain clauses can easily be disguised in what can appear to be simple language.