An Overview of Letters of Intent

Because of their susceptibility to unexpected interpretation, it is easy to understand why letters of intent have been characterised as ‘an invention of the devil’. Critically discuss considering inter alia aim and purpose, pros, cons, differences with other pre-contractual arrangements, etc.

“In order to be a valid and enforceable agreement, a document must contain certain essential legal provisions and must not leave either undecided or to be determined at some time in the future any aspect of such essential legal provisions. If these essential elements are not present, then the document is not a binding one and is often referred to by courts as an “agreement to agree” or a letter of intent, both of which are not enforceable as contracts.” [1]

In drawing a letter of intent there is a memorandum of understanding or preliminary document that usually herald the transaction. These documents are often not intended to bind either party till the transaction is completely finished. [2] The purposes of waiting till the completion of the transaction include sustaining confidentiality and inimitability to impede parties from dealing with others during the period of concluding consultations and due diligence. Participants often insist that the contract in a document after an initial agreement in principle was reached to justify, in part, the time and costs involved in preparing transaction documents and conducting activities of due diligence [3] . Complacency, however, may give the idea of ​​creating a binding contract. According to one authority, “[b]ecause of their susceptibility to unexpected interpretations. Letters of intent have been characterized by at least one practitioner as ‘an invention of the devil.” [4] This paper would be discussing the aim, purpose, advantages and disadvantages among others, letter of intent and other pre-contractual agreements.

It is engrained that Michigan and other countries follow the contemporary inclination in legislation that promotes the implementation of the intentions of the parties in contract enforcement and unfavourable to hold unenforceable because of uncertainty. [5] Therefore, the courts of Michigan, like other jurisdictions do not allow the parties to be released from contract conditions as terms may be significantly established with reasonable certainty from the linguistic in terms of external and behavioural signs. [6] Courts have held that when parties to a contract have not agreed on a term, the outage is reasonable in the circumstances. [7]  The physical conditions of a contract should only be “reasonably definite or certain” because courts are reluctant to find agreements void for vagueness, the terms omitted will be supplied by the courts if an objective standard for their determination is expressed in the contract. [8]

On a broad-spectrum, courts are generally hesitant about the binding nature of letters of intent. In July 2000, a federal district court in Maryland in a case stated that:

[l]etters of intent and negotiations ordinarily do not constitute binding contracts and will not be enforced by the courts, in part because the financial community does not regard a [letter of intent] as a binding agreement, but rather, an expression of tentative intentions of the parties. [9]

Additional, it was noted in Ninth Circuit Court of Appeals that:

[T]he purpose and function of a preliminary letter of intent is not to bind the parties to their ultimate contractual objective. Instead, it is only to provide the initial framework from which the parties might later negotiate a final…agreement, if the deal works out. [10]

In addition they stated that:

calling a document [a] “letter of intent” implies, unless circumstances suggest otherwise, that the parties intended it to be a nonbinding expression in contemplation of a future contract, as opposed to its being a binding contract. [11]

Nonetheless, the court recognised that a letter of intent may create a binding agreement if the parties propose it so and it is consistent with the provisions of the law of contract. [12]

In the  Opdyke Inv case, it was found that parties to a letter of intent may have intended to create a binding agreement. [13]  Justice James Ryan clarified that “a contract to make a subsequent contract is not per se unenforceable; in fact it may be just as valid as any other contract.” [14] Retrogressing a lower court’s dismissal, the court ruled that such an agreement could be enforced:

We must not jump too readily to the conclusion that a contract has not been made from the fact of apparent incompleteness. People do business in a very informal fashion, using abbreviated and elliptical language. A transaction is complete when the parties mean it to be complete. [15]

DETERMINING INTENT

By Opdyke, the court noted that the fact that some issues are left to be dealt with in the future means the letter of intent was not meant to be binding. [16]  Furthermore, any faltering language in the letter would have its onus on whether the letter contains just expectations or objectives as opposed to contractual undertakings. If the agreement was binding, the fact that additional contracts were envisaged does not equate that there was an agreement, as the final determination of who is bound is made by the jury.

In the milieu of determining whether there is an oral agreement, some factors were identified by the court:

Whether the contract is of that class which are usually found to be in writing; whether it is of such nature as to need a formal writing for its full expression; whether it has few or many details; whether the amount involved is large or small; whether it is a common or unusual contract; whether the negotiations themselves indicate that a written draft is contemplated as a final conclusion of the negotiations. [17]

The Court added that “[i]f a written draft is proposed, suggested or referred to during the negotiations, it is some evidence that the parties intended it to be the final closing of the contract.”18

Applying New York law, the Second Circuit Court has devised a framework to determine whether the contracting parties in fact intended to execute a binding preliminary agreement.19 According to this analysis, there are two types of binding preliminary agreements, a “fully binding preliminary agreement” and a “binding preliminary commitment.” “[A] fully binding preliminary agreement…is created when the parties agree on all the points that require negotiation but agree to memorialize their agreement in a more formal document.”20

This preliminary agreement constitutes a binding agreement which can be enforced regardless of whether the parties actually create any “formal document.”21 A “binding preliminary commitment” describes an agreement in which “[t]he parties accept a mutual commitment to negotiate in good faith in an effort to reach final agreement.”22

In order to determine whether the parties intended to be bound by a preliminary agreement of the first type, four factors are examined: “(1) the language of the agreement; (2) the existence of open terms; (3) whether there has been partial performance; and (4) the necessity of putting the agreement in final form, as indicated by the customs for such transactions.”23 The determination of whether the parties intended to be bound to a mutual commitment to negotiate in good faith requires a consideration of the above four factors, plus an examination of “the context of the negotiations resulting in the preliminary agreement.”24

INTENT MANIFESTED THROUGH THE LANGUAGE OF THE AGREEMENT

Whether one is applying the Second Circuit’s analysis or other precedent, explicit language avoiding any binding contractual relation will usually determine the issue. The Second Circuit refers to this factor as “the most important.”25 In Arcadian Phosphates, Inc v Arcadian Corp, the parties had been conducting extensive negotiations regarding the sale of a fertilizer business to a joint venture.26 As a result of these negotiations, the parties signed two memoranda. The first outlined certain “areas of agreement” regarding the sale, such as deadlines for future action and an option for the seller to purchase an interest in the joint venture. The second memorandum incorporated the first and “specified the purchase price, the timing and amounts of the payments, the fixed assets to be purchased, and a closing date,” although some items were left open for future agreement, such as the inclusion of “additional equity participants in the joint venture.”27

Further, this second memorandum “was termed an ‘agreement’ though it was made subject to approval by the [parties’ respective] boards.”28 It was alleged that both boards approved the memorandum. After, “[t]he parties…confirmed by Telex their respective approvals and took steps to consummate the transaction.”29

The buyers contended that these steps

included the establishment of…offices at [the seller’s] headquarters; [the seller’s] obtaining lender’s consents after informing them of the “agreed upon” sale with a “signed agreement”; [and] introduction of [the buyers] as “new owners.”30

Later, the seller proposed different terms when market conditions made the sale unattractive. The buyers sued for breach of contract based on the second memorandum.

The Second Circuit Court of Appeals found, based solely on the language of the agreement, that summary judgment was appropriate on the issue of the parties’ intent to be bound. The second memorandum/agreement

provided that if negotiations for the sale failed, the [seller] would repay any capital expenditures agreed to thereafter and made by [the buyers] and if negotiations failed through no fault of [the buyers, the seller] would refund [the buyers’] deposit.31

Further, the “memorandum…stated that ‘the service and supply agreement will be negotiated and agreed to by December 31, 1986 and [a] binding sales agreement will be completed by December 31, 1986.”32 According to the court, based on the above language, the buyers “should not have believed that [the seller] intended to be bound.”33

A recent Ninth Circuit case applying California law, Rennick v O.P.T.I.O.N. Care Inc, held that summary judgment on a breach of contract claim was appropriate based on the language of a letter of intent.34 The parties in Rennick had been negotiating for the sale of an exclusive franchise of home intravenous therapy services, such as chemotherapy, nutrient infusions, and pain management infusions. After a meeting, the buyers circulated a draft letter of intent. The seller added language, which stated that “this letter of intent is of no binding effect on any party hereto.”35 The seller later declined to proceed with the transaction. The other party brought suit for breach of contract claiming that “such language in the letter of intent as ‘[seller] shall grant to buyer…,’ and ‘[seller] shall provide…,’ shows that mandatory obligations were meant to be imposed.”36

The court “wonder[ed] how such an argument [could] be made with a straight face, in light of the [previous] language” explicitly denying liability.37 The court further noted that

the rights of private parties to enter into contracts also embraces their rights not to, and there is no contract where the objective manifestations of intent demonstrate that the parties chose not to bind themselves until a subsequent agreement is made.38

Language that does not unambiguously and expressly deny the binding nature of a letter of intent may result in contractual liability. In Arnold Palmer Golf Co v Fuqua Industries, Inc,39 the Sixth Circuit Court of Appeals found that the language of a memorandum of intent stating that the parties’ respective attorneys “will proceed as promptly as possible to prepare an agreement acceptable to (the parties)…” did not establish, as a matter of law, that no contract existed. The court found “that this paragraph may be read as merely to impose an obligation upon the parties to memorialize their agreement.”40 The court acknowledged that “the provision is also susceptible to an interpretation that the parties did not intend to be bound.”41However, given the facts and circumstances, including extrinsic evidence, summary judgement on this issue was not proper.

Likewise, in Heritage Broadcasting v Wilson Com, the parties entered into a letter of intent, which provided:

The obligation of the Purchaser to acquire the Assets shall be subject to the further condition that the Purchaser and the Seller shall enter into a definitive agreement relating to the sale and purchase of the Assets…within a period of 45 days from the date of this letter.42

After 45 days, the seller decided not to enter into a definitive agreement, claiming that any obligations existing under the letter of intent had expired. The buyer sued for specific performance. The trial court found, among other things, that the obligation to enter into a binding contract did not necessarily expire after 45 days since

there [was] no express provision in the letter of intent stating that it expired within forty-five days unless a definitive agreement was reached, and nothing compelled a conclusion that such a definitive agreement was mandatory within forty-five days.43

After losing a bench trial, the seller appealed claiming

that there was no “meeting of the minds” as to the legal import and operative effect of the letter of intent after expiration of the forty-five-day exclusive dealing period, and that therefore no binding agreement was formed on this issue.44

The seller contended that all obligations were discharged after 45 days while the buyer claimed that obligations persisted.

The Court of Appeals upheld the trial judge. The court noted that

[a] meeting of the minds is judged by an objective standard, looking to the express words of the parties and their visible acts, not their subjective states of mind.45

The court found that

[t]he evidence…shows only that [seller] may have subjectively entertained a different interpretation of the letter’s effect upon expiration of the forty-five-day period…[and]…this is insufficient to show that a meeting of the minds did not occur.46

What are their aim and purpose?

Fekkes Micheal, ‘Purpose of A Letter Of Intent’ (Charlotte Business Brokers, 2010) < http://charlotte-business-brokers.com/purpose-of-a-letter-of-intent-loi/>

. What is the contractual significance of a Letter of Intent?

It is a matter for analysis but if any contract does come into existence following a letter of intent it may take one of two forms, either it will be:

1. An ordinary executory contract, under which each party assumes reciprocal obligations to the other; or

2. There will be what is sometimes called an “if” contract, i.e. a contract under which A requests B to carry out a certain performance and promises B that, if he does so, he will receive a certain remuneration for his performance. This contract is no more than a standing offer, which if acted upon before it lapses or is lawfully withdrawn, will result in a binding contract.

A LOI is a written document summarizing that party’s intention in performing a transaction and sets forth some of the critical terms and conditions of the proposed deal. LOI’s are generally prepared by the buyer and will detail a variety  of points including: which specific assets & liabilities are being acquired, purchase price, terms of payment, deal contingencies, whether it will be a stock or asset deal, asset allocation, data needed to complete due diligence, and the expected dates for the definitive purchase agreement submittal and closing.  The majority of letter of intents do not bind either party legally, although some can include specific provisions that could be legally binding, such a “stand-still” or “no-shop” clause, a covenant implying good faith negotiations, and Confidentiality Agreements (CA).  Many legal experts advise, that a separate CA (aka Non-Disclosure Agreement [NDA]), be executed before a LOI is drafted.  This Confidentiality Agreement typically has binding non-disclosure requirements that survive the letter of intent document.  LOI’s can be helpful to the buyer as well as the seller as they are utilized as a precursor to negotiating the details of a formal contract which governs all aspects of the transaction.  A key purpose of the letter of intent is to bring clarification to the major issues and details involved and, in certain situations, to provide safeguards should the negotiation process fall apart and the transaction fails.  Having a ‘meeting of the minds’ prior to either party making significant investments of expense, time, and energy can be very beneficial.

Certain professionals may use the phrases Term Sheet, Memorandum of Understanding (MOU), and Letter of Intent (LOI) synonymously; however each document will have slight style differences.

Term Sheet:

A Term sheet is an agreement used to assist in the foundation of a business working relationship between two parties, commonly in the M&A industry. These agreements are generally less formal and shorter than a letter of intent and are laid-out in bullet format as opposed to a narrative. Term sheets are frequently used as a ‘stepping stone’ proposal which detail the intent of 2 or more parties to enter into an agreement based on specific, but often incomplete terms. When formally executed, the term sheet provides a guideline to finalize the remaining terms of the agreement, often with respective counsel.

Memorandum of Understanding (MOU):

From a business perspective, a memorandum of understanding can be  defined as an informal agreement between 2+ party’s before the ultimate agreement is finalized. The signatory page is the major difference between a LOI and MOU as all the parties involved in the transaction will be signatories to the agreement while the LOI only necessitates the party who proposes the agreement to sign the document.

The acquisition or sale of a privately held business can become very complicated and time consuming for both sides and the agreements reviewed earlier can provide many advantages to assist both parties in the negotiating process.  At times, they may not be appropriate for every type deal.  For smaller less sophisticated transactions, a buyer may have already covered a lot of ground having examined the business’ financial & business documents as well as completing a site survey where they are more secure in skipping the letter of intent and, in its place, will choose to submit a Definitive Purchase Agreement.   In these situations, both the buyer and seller are able to negotiate the minor details in the DPA and save a considerable amount of expense and time.

What is its remit and use?

Hutchinson, Thomas N. ‘Letter of Intent’ (CPA Resource)

Horowitz Marshall ‘Letters of Intent’ (Smart Business, 31 March 2006)

How do they differ from other pre-contractual arrangements?

Hutchinson, Thomas N. ‘Letter of Intent’ (CPA Resource)

Stellingwerf Frank and Mantese Gerard, ‘Letters of Intent’ (Business Law)

The pragmatic distinction is that a letter of intent is usually more of an outline of a potential business deal. The parties lay out the basic principles behind a deal and highlight some of the main points, but don’t describe in writing all of the details. In a contract, you want your i’s dotted and your t’s crossed.

The other distinction is that contracts with definitive documentation would almost always be binding, whereas only certain provisions are usually intended to be binding in letters of intent.

What are the pros and cons of letters of intent?

Parties sometimes resist using letters of intent because, like the definitive acquisition agreement, the LOI is a negotiated document. Negotiating and drafting an LOI will invariably involve additional front-end time and expense for the parties. Often the parties are reluctant to want to take the “bloom off the rose” so to speak by having to undertake tough negotiations when they are just getting to know one another. Additionally, either party may be reluctant to enter into an LOI for fear of conceding a particular point that has not been fully vetted. This may be less of an issue for the buyer because in all likelihood the buyer will have only undertaken limited, if any, due diligence up to that point and will typically reserve its rights to modify certain deal terms based on the results of its due diligence review. Often the letter of intent will provide for a limited period of exclusive negotiation between the buyer and seller. This is disadvantageous for the seller, but it is one of the primary reasons why buyers often insist that the parties execute an LOI.

Binding or Non-Binding

Generally, an LOI will be non-binding with respect to all but a few certain provisions. Typically, the binding provisions in an LOI will involve:

• confidentiality obligations of the parties;

• an exclusivity period (i.e., no shop) running to the benefit of the buyer; and

• the right of the buyer to receive a termination or break-up fee in the event the seller walks away from the deal.

If the parties have not previously entered into a confidentiality agreement, it would be prudent for them to do so at the time they undertake negotiation of an LOI. Once an LOI has been executed, the parties’ focus generally shifts to the due diligence investigation, timing considerations and negotiation of the definitive acquisition agreement. It is important not to let the confidentiality agreement slip through the cracks.

Do you agree with the statement that they are ‘an invention of the devil?

This is your opportunity to critically assess the ‘devil’ statement. This will form your concluding part where it is all your opinion.

Thomas, David, ‘Letters of Intent’, (May 2005)

This is your most valuable of the resources as it is packed full of relevant UK case law. You could probably find a case for every one of these areas I have split the question into.