September 14, 2018
Author: Erik Piazza
Organization: PHELPS DUNBAR LLP
Letters of intent can be both helpful and harmful in commercial transactions. A letter of intent may help to: reduce certain aspects of a contemplated deal to writing so that the parties know where they stand and what points still need to be resolved; identify potential sticking points so that the parties can evaluate whether the expense of further due diligence is warranted; gauge the intentions of the other side; or bring to light certain issues that need to be discussed. A letter of intent can also be problematic. For example, in small deals, the parties may not be willing to pay the costs of negotiating a detailed letter of intent and instead sign a letter of intent without giving much thought to the terms or potential consequences of the agreement. The trouble occurs when one of the parties wants to change an aspect of the deal or terminate the deal entirely.
There is much conflicting case law and very little instruction as to if and when a letter of intent will be considered binding on the parties. However, there are certain factors that emerge from this body of case law that can help determine when your client may be bound to act in accordance with the terms in the letter of intent.
Among the most noteworthy factors that courts tend to look for when interpreting whether the parties intend to be bound by the letter of intent are the following:
(1) All material terms are contained in the letter of intent.
(2) The letter of intent makes clear that the parties intend to enter into a subsequent agreement.
(3) A court can ascertain the material terms from the letter of intent.
(4) The parties have partially performed the terms of the letter of intent.
(5) Terms proving the intent of the parties to be bound are contained within the letter of intent.
(6) Non-essential terms may be inferred.
On the other hand, there are also factors that help courts infer that the parties did not intend to be bound by the letter of intent, such as:
(1) Nature of the letter of intent (ambiguous, non-specific);
(2) Conduct after letter of intent is executed (e.g., failure to provide consideration);
(3) Duty to negotiate in good faith for a limited period as agreed in letter of intent provides no ongoing obligation between the parties; and
(4) Parol evidence indicating unenforceability.
These factors will help the attorney discern how broadly or narrowly to draft the provisions of the letter of intent, depending on how certain the client is that he wants to proceed with the deal.
Courts have held that where the letter of intent appears to be nothing more than an agreement to agree it will be unenforceable. It is important to keep in mind that this factor is not conclusive, and courts usually try to look at the agreement in its entirety to see if the reasons to allow enforcement outweigh those for rendering the letter of intent unenforceable. The jurisprudence on this subject is not uniform and has left a very muddy framework for practitioners to follow when advising clients whether or not to sign a letter of intent. If you are representing a client who does not desire to be bound by the letter of intent, you might decide to omit material terms or to condition the parties’ obligations on the drafting of a subsequent written contract.
In Louisiana, \"[t]he settled jurisprudence of this State is that an agreement between parties, where their minds have met upon all essentials, constitutes a contract between them and binds them at once although they may have agreed that they would thereafter execute a formal instrument containing the terms of their present agreement.” The Louisiana Supreme Court has interpreted the term \"preliminary\" to describe an agreement that suggests that other agreements are expected to follow the initial agreement. However, calling an agreement \"preliminary\" does not \"preclude the agreement from being final until later agreements are reached or from being the only agreement in the event no other agreements are confected.\" Mermelstein V. Scwab, 64 So.2d 37.
Often, letters of intent will contain some binding provisions and some non-binding provisions. If the parties are required to resort to litigation based on the letter of intent, the courts are left to discern exactly which portions of the letter of intent should be binding. Since the reason parties enter into a letter of intent is to reduce uncertainty, this attempt by the courts to rewrite certain provisions of the letter of intent can leave the parties in a very different situation than originally contemplated. Clearly setting forth the intent of the parties in the letter of intent is a good way to avoid forcing a court to determine the intent of the parties.
Often setting a time period for the parties to negotiate the deal to completion in good faith helps to give credibility to the fact that the parties did not intend for the letter of intent to be binding. Of course, you will still want to make explicitly clear that certain clauses, such as the choice of law provision, will survive past the termination of the letter of intent so that if the parties do find themselves in court at least the law to be applied to the transaction will be certain.
It is also wise to have a binding provision regarding the maximum amount of damages. A merger clause requiring all amendments to the letter of intent to be in writing and signed by both parties may reduce the risk that a court would look to extrinsic evidence such as emails or other oral communications to determine the intent of the parties or to try to construe those communications as the final contract between the parties. Certain other provisions to consider adding to a letter of intent are:
(1) An intent warranty explaining that the parties only wished to be bound by the provisions of the letter of intent that are explicitly stated to be binding;
(2) Provisions regarding allocations of costs between the parties;
(3) Confidentiality provisions, where applicable;
(4) Contra proferentum language when necessary due to unequal bargaining leverage between the parties or when using form documents; or
(5) Representations and warranties to be contained in a final agreement.
Perhaps another unintended consequence of a letter of intent is the possibility that along with the agreement comes the implied duty to act in good faith. For example, in Channel Home Ctrs., Div. of Grace Retail Corp. v. Grossman, 795 F.2d 291 (3d Cir. 1986), a prospective commercial tenant for a mall prepared a letter of intent at the request of the prospective landlord so that the landlord could begin to obtain financing. The letter of intent included the following detailed material terms: description of site, term, rent, option periods, provisions for payment of taxes, CAM provisions, landlord’s responsibility for maintenance and signage provisions. The landlord maintained that the parties agreed to circulate a draft lease within the next 30 days, although the tenant disputed this. Although the tenant continued to proceed with its preparations, it received notice from the landlord on that the deal was off because of the tenant’s failure to submit a signed and mutually acceptable lease within thirty days of the of the letter of intent. It was soon discovered that the landlord had entered into a lease with another tenant on terms much more favorable to the landlord than the contemplated terms in the letter of intent with the plaintiff. The plaintiff argued that the letter of intent was \"enforceable as a mutually binding obligation to negotiate in good faith.\" The Court agreed and found \"that the record contains evidence that supports a finding that the parties intended to enter into a binding agreement to negotiate in good faith, \"and remanded the case to determine if the parties intended to enter into an enforceable contract. The Court stated that \"[i]f parties use a letter of intent or other preliminary agreement and they do not intend to require good faith negotiations going forward, they should explicitly disclaim the obligation to deal fairly and in good faith in a manner sufficient to abrogate the implied covenant.\"
SAMPLE LETTER OF INTENT.
We are pleased to submit the following proposal outlining some of the basic business terms and conditions under which ________________ is willing to negotiate a lease for the premises identified below:
Tenant/Guaranty: Tenant shall provide financial information sufficient for Landlord to determine the financial condition of the Tenant prior to final lease execution. Notwithstanding anything contained to the contrary contained herein, ____________ will personally guaranty Tenant’s obligations under the primary term of the lease in an amount not to exceed $__________.
Lease: Landlord Lease Form to be negotiated and accepted by tenant
Premises: Approximately _________ square feet of leasable space (the “Premises”), further shown attached hereto (“Site Plan”).
Term/Options: Five (5) year term with one five (5) year option
Year Rent psf
6-10 (option) $______
The base rental shall be subject to additional rental for ____% of the amount of sales that exceeds the annual natural breakpoint.
Additional Charges: Tenant’s Pro-Rata share of CAM, taxes and insurance, and any merchant’s association fees will not exceed $______ per square foot for the first full lease year, with Tenant’s Pro-Rata Share being equal to the square footage of the Premises divided by the total square feet in Town Center. Tenant’s Pro-Rata Share is estimated to be ___ %. Taxes, insurance and electrical utility cost shall be excluded from CAM charge annual cap on increases.
Rent and all additional charges shall commence on the date which is 120 days from later to occur of: (a) the date on which Landlord has completed all Landlord’s Work and delivered possession of the Premises to Tenant; or (b) the date that Tenant receives all permits, variances and governmental approvals necessary to construct and operate Tenant’s store in the Premises. Notwithstanding the foregoing, rent and all additional charges shall commence not later than the date on which Tenant opens for business to the public.
Delivery Date: Landlord shall give 30 days prior written notice of Landlord’s delivery of the Premises to Tenant. The Delivery Date is estimated to be ___________. If the Delivery Date is overdue by more than 7 days, Landlord will credit Tenant one day’s rent for each day after the Delivery Date until such time as the Premises are delivered to Tenant. Tenant will have the right to terminate the Lease if Landlord fails to deliver the Premises within 45 days after ______________.
Use of Premises: Operation of a restaurant, which cooks food for on- and off-premises consumption.
Exclusive Use: Landlord agrees that it shall not enter into any leases with tenants whose primary business is the sale of __________________
After receipt of building elevations from Landlord, Tenant’s sign company will draft sign exhibit for Landlord’s approval. Landlord agrees to let tenant use second story sign band as shown on the attached signage proposal.
The standard “Cold Dark Shell” with description of Landlord’s Work (“Work Letter”) attached hereto. Landlord to demise space.
Landlord Allowance/ Maintenance:
Landlord will provide Tenant with a cash allowance (the “Allowance”) of $____.00 psf, due upon Tenant’s opening for business. Landlord shall maintain roof, slab, and building structure., and HVAC.
Broker Fees Landlord acknowledges that ______________ is acting as Tenant’s broker. Landlord shall be responsible for payment of the commission due to Tenant’s broker in accordance with a separate listing agreement.
Tenant will have the right to terminate the Lease if it is unable to obtain all permits, variances and governmental approvals (“Permits”) needed for the lawful construction and operation of its store within 90 days after the date Tenant’s plans have been approved by Landlord. Landlord will cooperate with Tenant and will execute any necessary applications for such Permits. Landlord to provide non-disturbance agreement from its lender
Parking: Tenant shall be provided minimum parking spaces per franchisee requirements. The parking area is held in common for all tenants and there are no designated spaces for specific tenants. This letter of intent is merely an expression of interest and shall be non-binding upon the parties hereto. Each party shall have the unilateral right to terminate negotiations at any time, for any reason or for no reason, without liability to the other party. If and when a lease has been negotiated and executed, the terms thereof shall supersede the terms of this letter of intent. This proposal shall expire on ______________.