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Letter of Intent
As commercial transactions become increasingly complicated and often drawn out over a long period of time, letters of intent are becoming more popular. A letter of intent can also be known as heads of terms or memorandum of understanding. They are generally used in commercial transactions and also in the construction industry. Simply put, a letter of intent is a means for parties to document the way in which the negotiations prior to the final contract being agreed are progressing.
The most important thing to bear in mind with a letter of intent is that it can be a complicated legal situation that rarely looks the same way twice. Below is a brief introduction to the general issues with a letter of intent; however, each case must be considered in its own right during any detailed discussion of the area.
A letter of intent will generally contain all of the agreed terms in a broad sense and form the basis of more detailed negotiations prior to the forming of the final contract. It will commonly include the key areas that have been agreed between the parties which will be completed in more detail when the negotiations have been concluded. It has been decided by the High Court that a letter of intent can, in fact, be legally binding in its own right and. Therefore, particular care should be taken when drafting such letters of intent.
Advantages of a Letter of Intent
One of the major benefits of a letter of intent is that it documents the position that the parties have reached so far. A letter of intent can be a good way of laying out categorically what has been decided upon and what remains undecided. In doing this, the letter of intent can be referred to throughout the following negotiations and it can help to ensure that there are no misunderstandings in terms of what was intended by the parties, at the outset.
Furthermore, the letter of intent can be a very handy commercial tool in terms of guiding and timing the transaction. A letter of intent will commonly have timetabling details in it that ensures the parties remain focused on the vital points of the commercial negotiation. Letters of intent are particularly useful in the construction industry where the relationship may be very long-term. By agreeing a letter of intent, each party shows a degree of commitment to the transaction and this could then be used as a basis for the parties to instruct other professional advisers who could get underway with ground works, in the case of the construction industry.
A letter of intent is also a good indication that the two parties did intend, ultimately, to contract with each other. Moreover, although the letter of intent itself may not be legally binding, it does give both parties a strong moral commitment to each other.
Disadvantages of a Letter of Intent
One of the major disadvantages of using a letter of intent is that one party may rely on it whilst the other party may simply see it as part of negotiations. This could lead to one party commencing work and exposing themselves to large expenses, while the other party has little or no intention of finally completing the contract.
Even when both parties are focused on completing the contract, the letter of intent may serve to divert their attention. Once a letter of intent is in place, parties may no longer be interested in entering into a commercial contract and they then begin to focus on actually undertaking the work, without thrashing out the detailed points. Another negative feature of the letter of intent is that it can limit the negotiating scope for the professional advisers, when it comes to the main contract. Once something has been agreed in the letter of intent, it can be very difficult for a professional adviser to renege on the point or enter into negotiations on the issue.
Is a Letter of Intent Legally Binding?
There is a high level of debate in relation to whether or not a letter of intent is legally binding or not. Unfortunately, there is no conclusive answer to this question and it depends largely on the facts of the case and the conduct of the relevant parties in entering into the letter of intent. Typically, the courts will take into account issues such as the language that was used in the letter of intent and the degree of certainty in the terms when deciding on whether or not the letter of intent is indeed a legally binding document.
The Letter of Intent as a Commercial Tool
Although strictly speaking a letter of intent is a legal document, in reality, the major use of a letter of intent is found in the commerciality of the process. Due to the potential strength of a letter of intent, it is wise that any such document is drafted by professional advisers and is given almost as much consideration as the full contract itself.
There are some key considerations that should be borne in mind when drafting a letter of intent. Firstly, it is important to recognise that the letter of intent is simply an outline of the main terms that will become part of the main contract. A letter of intent should, basically, be the bare bones and any attempt to go into huge detail in the letter should be avoided, as this is something that should be reserved for the main contract. Furthermore, due to the lack of certainty in terms of whether or not a letter of intent is legally binding or not, it is wise to ensure that there is a term in the letter of intent that categorically states whether or not the terms are intended to be binding.
A useful tool for ensuring that the final contract remains in focus for both parties is to put a duration period on the letter of intent, with a long-stop date. Putting it in the letter of intent ensures that both parties continue to negotiate the final contract for fear that the letter of intent will simply become invalid, due to the length of time it has taken to negotiate the final contract. It is also important to ensure that issues such as jurisdiction and duration are covered in the letter of intent. Just because a letter of intent is merely an outline does not mean the vital issues such as jurisdiction and duration should be avoided.
Another term commonly seen in a letter of intent is a requirement for both parties to negotiate the ultimate contract in good faith. This prevents one party holding another party to ransom and enforcing terms on them. When the final contract has been entered into, the status of the letter of intent should be considered. Has a letter of intent been fully superseded by the final contract, or do certain terms prevail and should the letter of intent be read alongside the final contract? It is also vital to ensure that both parties sign a letter of intent in order to show that it was fully agreed upon.
Once a letter of intent has been agreed by parties, it is quite common for the parties to use this as a public relations exercise, or as an exercise to raise funds from third parties. It indicates how serious negotiations actually are and that there is a strong likelihood that the contractual relationship will be formed, imminently. Due to the strength of a letter of intent, it is also wise to enter into a confidentiality agreement in relation to any communication between the two parties.
A letter of intent can be a very useful commercial and legal tool, but at no point should it be regarded as an adequate substitute for a fully negotiated and thought out contract. A full contract remains critical and the letter of intent should simply facilitate this, rather than substituting for it.
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