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22 June 1999
Before parties sign a final contract, but after they have reached agreement on the basic terms of a deal, they often sign a letter of intent - a short writing containing the terms of the deal to which the parties agree. Such letters are common in US real estate transactions and they can be helpful in moving a transaction forward to negotiation of a final deal. However, they also can create significant liabilities for the parties should the deal fail. If the parties fail to negotiate a final contract, a letter of intent may nevertheless be held to bind the parties to the deal reflected in the letter or to otherwise create obligations on the part of the parties.
This article looks at some of the issues that letters of intent raise by:
A letter of intent can be any written document containing the important terms of a prospective deal that is signed by the prospective parties to the transaction or their agents. For instance, in a leasing situation the landlord and the tenant (or their brokers) might sign the letter of intent.
The document does not need to state that it is a letter of intent. It may be called a lease proposal, it may be a lease term sheet or it simply can be a letter with the parties' signatures.(1) The document also does not need to be written by a lawyer - in fact, most are written by the parties and their brokers. Frequently the parties do not even consult a lawyer because they do not think of a letter of intent as imposing binding obligations on the them.(2) Nevertheless, the parties usually contemplate that they will negotiate in good faith to reach agreement on the terms described in the letter of intent. Since such letters do not contain all the terms of a deal, they can potentially cause confusion. However, signing such letters is common practice in the United States for various types of commercial real estate transactions - especially in larger deals that are more complex(3) - because they perform several useful functions.
Signing a letter of intent can be a time saving, inexpensive way for parties to grasp and to memorialize the basic business terms of a proposed transaction, and to provide them with the comfort necessary to negotiate the remaining deal terms and finalize a contract.(4) Drafting the letter can highlight for the parties issues for future negotiations and help the parties identify any deal breaking issues before they have invested too much time in the negotiation process.
Within each entity that is a party to the deal, preparing to sign a letter of intent can also help to reach internal consensus on important deal terms.(5) For example, a director of real estate may need to secure approval from his/her company's senior management and legal counsel before signing a letter of intent. Similarly, a landlord or landlord's agent may need to obtain approval from the property's lender and legal counsel.(6)
Letters of intent can also help the parties to convey the seriousness of their intent to third parties (eg, lenders),(7) and eliminate confusion for parties who enter into a transaction at various stages (eg, agents, attorneys, architects, contractors, financial analysts, etc.).(8)
Letters of intent can be used to make the parties feel committed to make a deal.(9) They can also be used to explicitly bind the parties to certain terms of the deal or to other terms of the letter of intent (eg, provisions that impose due diligence obligations, provide for cost reimbursements,(10) impose a duty to negotiate in good faith or impose a duty to take property off the market for a period of time).(11)
The risk for parties who sign a letter of intent is that should the letter fail to ripen into a final agreement, they may end up in litigation over (i) whether the letter of intent, in the absence of a more formal agreement, is itself a binding contract and (ii) whether the parties owe obligations to each other whether or not the letter itself is a binding agreement.(12)
The first argument, that the letter of intent is a contract, requires the court to find that the letter contains the essential elements of a contract and that the parties intended to make a contract. In most states the elements necessary to create a binding contract include the following:
The terms that a court will consider essential will depend on the specifics
of the deal.(13) Moreover, in some instances
the court will supply missing terms by presumption or reference to custom.(14)
If a letter of intent contains the essential terms of the deal, the court will still need to ask if the parties intended to be bound. The determination of the parties' intent can be a highly fact-specific question, with the courts looking at a number of factors including the terms of the letter of intent, the context of the negotiations, the number of open terms, partial performance and custom in the trade.(15) Proving that the parties intended to be bound and that they viewed the execution of a formal contract merely as a 'convenient memorial' of their agreement(16) can be difficult, and case law may not be dispositive on the array of potential circumstances that may arise. For instance, it is unsettled whether a letter of intent that contains a provision that the parties' agreement is subject to legal documentation or to the approval of counsel or a board of directors indicates an intent not to be bound, at least until those conditions are met.(17)
In addition, in order to create a valid and binding contract, most contracts involving real estate must be in writing and signed by the parties in order to satisfy the Statute of Frauds. A letter of intent can meet this test. If it does, and if it meets all the other requirements of a valid and binding contract, the law will generally hold that, like all contracts, it includes an implied covenant of good faith and fair dealing that cannot be disclaimed.(18) A party who breaks off negotiations in bad faith after signing such a letter of intent could be held to have violated this covenant and thereby breached the contract between the parties.
Even if a letter of intent is drafted carefully enough to convince a court that it is not a contract, in the wake of failed negotiations a party may be held to have liability to the other based on the equitable theory of promissory estoppel. This theory allows recovery by creating an exception to the Statue of Frauds and to the requirement that the parties reach an agreement on all the essential terms. It recognizes that there may be situations in which, although two parties may not have entered into a binding contract, one party has acted toward the other party in a manner that would create an inequity if the first party were not bound by their agreement.(19) For instance, a tenant may have relied on the landlord's statements that it would execute a lease with the tenant in terminating its existing lease. Or, the landlord, in reliance on the tenant's promise to lease a particular space may have stopped negotiating with other prospective tenants or begun making improvements that the tenant requested.(20)
In order for an aggrieved party to succeed on a claim based on promissory estoppel, the aggrieved party must prove the following:
The parties may also use the theory of part performance to remove the parties' agreement from the requirements of the Statute of Frauds. This exception to the Statute of Frauds allows enforcement of an oral agreement relating to real property. It may apply in situations in which a promise was made that the promissor should reasonably have expected would induce action or forbearance of a material character, and the promise in fact induced such action or forbearance.(22)
Generally, part performance must consist of performing something required by the contract and the party relying on it must show that the partial performance was more consistent with the terms of the contract than with some other arrangement.(23) For example, a court found an oral lease to be enforceable based on part performance where a tenant, in reliance on an oral agreement with the landlord, plowed the subject premises to prepare it for planting crops and purchased fertilizer.(24) The court said that part performance must be substantial, must be premised on the alleged agreement and must be known to the other party.(25) Thus, parties should be aware that, even if their written letter of intent is not a binding contract, their discussions surrounding the drafting of the letter of intent could support the existence of an enforceable oral contract.
Moreover, even if the court finds that an enforceable contract does not exist in the letter of intent, the court may construe individual terms of the letter of intent as binding (and the parties may desire and plan for this result). For instance, although in general no pre-contractual implied covenant to negotiate in good faith exists, a covenant of good faith negotiation may be expressly written into a letter of intent. As a result, while such a letter may not be enforceable as a contract or as a lease, a breach of the express covenant of good faith negotiation may be actionable.(26)
While the dangers described in the foregoing paragraphs may seem extraordinary, the parties can take steps to reduce those risks and to maximize the benefits of using letters of intent. The parties should consider having a lawyer review the letter of intent to help them accomplish their goals. The parties should attempt to draft a fairly simple letter. Letters that include irrelevant details can lead to confusion and time consuming negotiations which are more appropriate for the negotiation of the formal contract or lease.(27) Moreover, the more comprehensive and legally articulate the letter of intent, the more it looks like a contract, and the more likely a court may be to deem it a legally binding document.(28)
The letter of intent should contain specific language addressing just what the parties' intentions are. If the parties do not want the letter to bind them, they probably need to include language that goes beyond stating that they intend to sign a more formal agreement.(29) They should consider including a clear statement that the letter and other negotiations are prefatory and that the consummation of the transaction is subject to the negotiation and execution of a definitive agreement.(30) The parties can tailor their statement of intent to include any specific conditions precedent they might have to entering into a final agreement, such as approval by a parties' board of directors or senior management, as in the following sample language:
This letter of intent does not constitute an offer, acceptance or a contract to lease, and it is not intended to impose any legally binding obligations upon any party, but rather to set forth certain criteria as a basis for further discussion. A lease agreement may be executed only after a mutually acceptable lease agreement has been negotiated and the approval of tenant's senior management has been secured.(31)
The parties may also choose to provide that neither party is obligated to enter into a final agreement and either may refuse to do so in sole discretion.(32) In addition, if the parties wish to avoid a claim that they had a duty to negotiate in good faith based on the letter of intent, they should avoid language such as the parties will 'negotiate in good faith' or will 'make every reasonable effort to reach a final agreement.'(33)
To the extent that the parties want to make certain provisions in the letter binding - even though they may not want the letter as a whole to be a binding contract - they should state this intention clearly. In the text of the letter they might physically separate the binding provisions from the non-binding provisions.(34) Provisions that the parties might want to make binding, in addition to the provisions listed earlier, include:
In addition to making clear whether the letter of intent or certain of its terms are intended to be binding, the parties can include language to deter claims for recovery which might succeed even in the absence of a binding written contract. For example, to protect against future claims based on promissory estoppel, the parties might include language addressing subsequent acts of the parties. One court rejected a prospective purchaser's claim of reliance based on the promissory estoppel theory where the letter of intent contained the following language:
"Notwithstanding the foregoing ... or any other past, present or future written or oral indications of assent or indications of results of negotiation or agreement to some or all matters then under negotiation, it is agreed that no party to the proposed transaction ... will be under any legal obligation with respect to the proposed transaction ... and no offer, commitment, estoppel, undertaking or obligation of any nature whatsoever shall be implied in fact, law or equity, unless and until a formal agreement providing for the transaction ... has been executed and delivered by all parties intended to be bound."(36)
The court found that the letter of intent "specifically state[d] that neither party [was entitled to] rely on any representations made by the other party regarding whether the transaction would be consummated."(37)
Parties to a letter of intent should be careful that their behavior conforms to that stated intent. During lease negotiations, for instance, the exchange of correspondence and drafts can cause the parties to be bound to complete the transaction, even though a final lease has not been executed, based on the theories discussed earlier.(38) Thus, draft leases and any correspondence should include a statement that the submission of the lease or the correspondence does not constitute an offer to lease.(39) In addition, if the lease or contract contains a time of the essence provision, the parties should not continue to negotiate beyond the date specified unless they are willing to waive the protections of such provision.
Furthermore, the parties should be aware that their oral statements may be admissible under a theory of recovery (eg, part performance) which is removed from the requirements of the Statute of Frauds. In any case, the parties should calculate the risk that an aggrieved party may choose to litigate on the grounds of the letter of intent, regardless of its terms.(40)
The use of letters of intent is common in large real estate transactions in
the United States and a carefully drafted letter can confer great benefits on
both parties. However, for parties who do not reach the stage of signing a final
contract, a letter of intent that does not accurately address the parties' needs
can have the unintended effect of being transformed into a binding agreement
or otherwise create significant liabilities. For this reason, when considering
whether to sign a letter of intent, in addition to the considerations described
above, a party might also consider the likelihood of reaching final agreement
with its counterpart. Hopefully, this article will be of use in guiding parties
through such issues when faced with a letter of intent, or when considering
whether to propose a letter of intent to memorialize the parties' agreement
and to help usher the parties through negotiations to a final and binding contract.
Newsletter prepared by Greer M. Hersch.
For further information on the above topic contact Barry C Ross or Sandor A Green at Robinson Silverman Pearce Aronsohn & Berman LLP. Barry Ross can be contacted by telephone on +212 541 2255, by fax on +212 541 1455, or via email at firstname.lastname@example.org. Sandor A Green can be contacted by telephone on +212 541 2049, by fax on +212 541 1449 or via email at email@example.com.
(40) 433 PLI/Real 619, 622.
The materials contained on this web site are for general information purposes only and are subject to the disclaimer
The materials contained on this website are for general information purposes only and are subject to the disclaimer.
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