Letters of Intent: Let the Signer BewareMay 2009
Often, we receive from a client a “Letter of Intent” that outlines the business terms pursuant to which the client intends to acquire a hotel. Potential purchasers should be aware that a letter of intent can be a binding contract, depending upon how it is worded and whether it contains the essential terms necessary to obligate two parties to a transaction.
THE PURPOSE OF A LETTER OF INTENT
Letters of intent are frequently used to document the agreement of a buyer and seller concerning the economic terms of a transaction. Owners and buyers feel more comfortable investing the time and expense that it takes to negotiate a complete agreement of sale and to perform a due diligence investigation if they first know that there is a meeting of the minds concerning price, financing, franchising and other critical elements of a deal. Parties to a letter of intent walk away from the execution of the letter with the feeling that there is a deal in place that will ultimately result in a settlement.
AVOIDING A BINDING CONTRACT
Most parties to a letter of intent believe that they are not obligated to conclude a transaction if they are unable to complete an agreement of sale or are not satisfied with their due diligence investigation. However, a letter of intent can be interpreted as a legal contract, which is enforceable, unless certain steps are taken to make it clear that a contract is not intended. For this reason, letters of intent should contain the following clauses:
- a statement that the parties do not intend to be bound to a contract by the letter of intent
- a statement that the parties will attempt to negotiate an agreement of sale that is binding, but that if an agreement of sale is not negotiated to conclusion within a specified period of time, the letter of intent is void
- a statement that the letter of intent does not include all of the essential terms required in order for there to be a contract between the parties, and a provision setting forth those essential terms that are actually missing
- a provision to the effect that either party can walk away from the transaction at any time, with or without cause, and that the parties are not required to use their best efforts, or even good faith efforts, to negotiate a binding agreement
THE DUTY TO NEGOTIATE IN GOOD FAITH
A Pennsylvania court awarded a plaintiff/prospective buyer over $30 million in a case where the prospective buyer had not executed a written agreement with the seller, but had received certain assurances from the seller that the two parties had a deal concerning the purchase and sale of the seller’s real estate. The seller sold the property to someone other than the prospective buyer, and the court found the seller liable in damages for its action. In this case, the court held, among other things, that the seller had a duty to negotiate in good faith with the prospective buyer, and that the seller had breached this duty. The court ruled that the seller had led the prospective buyer to believe that a basic agreement was in place - even though it was not embodied in a written agreement of sale - and that the seller did not act in good faith when it used the prospective buyer as leverage to sell the property to another party.
The duty to negotiate in good faith is a substantial obligation that is recognized by courts in many states. If you sign a letter of intent, it is further evidence of the duty to act in good faith by trying to negotiate a complete agreement of sale that is reasonable in its scope and content.
To avoid being faced with a duty to negotiate a contract in a situation in which you may not desire, or are not yet sure that you want, to complete a sale or purchase, you should add a statement to your letter of intent expressly disclaiming the duty to negotiate in good faith. While this may detract from the purpose of the letter of intent - which is to provide an acknowledgment by the parties that there is a basis for a deal - it is important to avoid the implication that you have a duty to try, in earnest, to complete a transaction. If you want to give yourself the right to walk away from a letter of intent - particularly if you want to have the right to change the economic terms of the letter of intent - then it is critical to avoid an obligation to negotiate in good faith towards the execution of a binding agreement of sale.
Letters of intent have legal significance and should not be taken lightly. It is a good idea to have your attorney create a form that you can use for multiple transactions. This form can be crafted to make the document binding or non-binding, as you see fit. It can also be used to accomplish both objectives - you can make certain provisions binding upon the parties, while avoiding a binding agreement upon all of the terms and conditions of a purchase and sale. For example, you can:
- agree that the seller will not market the property for sale during a specified period within which the parties will attempt to negotiate an agreement or conduct due diligence
- agree that the parties will keep the nature of their negotiations confidential
- agree that one party will reimburse the other for expenses in the event that a binding agreement is not executed
- agree on who will prepare the agreement of sale to be negotiated by the parties
Provisions such as these create the framework for a negotiated agreement of sale and make the letter of intent a document that creates a relationship between the parties, while avoiding agreement on all of the terms and conditions of a purchase and sale before a contract is signed.