Letters of Intent--Nonbinding Agreements or Not?

It's not uncommon for parties to enter into a letter of intent or term sheet prior to proceeding to negotiate a purchase agreement. The purpose of a letter of intent or term sheet is to identify the key terms of a transaction, such as the sale of commercial real estate, upon which the parties mutually agree to negotiate a purchase agreement.

In most situations, I find the use of letters of intent or terms sheets (LOIs) to be useful. It makes sense for parties to ensure they are in agreement on the critical business terms before running up too many legal fees on a purchase agreement to nowhere. I know that others in my profession don't always agree and prefer to go straight to negotiating the purchase agreement. Each transaction is different and it's best to take into consideration the unique characteristics of each deal and exercise common sense. Sometimes it will make sense to negotiate the LOI first and sometimes it won't.

The reason some prefer to skip the LOI is the risk that an LOI, which most consider to be nonbinding, ends up being binding upon the parties when one party doesn't want it to be.

Here are a couple of examples how that can happen....

Many business clients like to negotiate the LOI on their own. On more than one occasion, I've had clients email signed LOIs to me and I cringed when I saw what they agreed to in their LOIs.  If an ill conceived provision was agreed to in the LOI, that party will likely have to live with it.  It is difficult, if not close to impossible, to keep negotiations amicable and moving towards a successful closing when one party starts reneging on terms it had previously agreed to in the LOI.

Sometimes, the LOI is extensively negotiated by each party's counsel and each side proceeds to negotiate the purchase agreement. However, prior to signing a definitive purchase agreement, a better deal comes along for one of the parties to that LOI. That party decides to walk away even though the other party has met every obligation and spent considerable sums to move the transaction along.

The common element in each of these examples is that one party wants out or regrets agreeing to certain terms and conditions and wants a 'do over'.  However, while LOIs generally may not be considered binding, parties are expected to negotiate in good faith. On more than one occasion, a court has enforced an LOI when it determined that a party to it was not acting in good faith.

Potential buyers and sellers of real estate should take care regarding what terms and conditions they agree to in LOIs, and consider bring their legal counsel into the loop before signing on the dotted line.

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