Letters of intent often are used in complex transactions when the parties want to tie down the principal terms of the deal early in the negotiations. A letter of intent (sometimes referred to as a memorandum of intent or a term sheet) is simply a writing signed by all parties to a proposed transaction that states general agreement to one or more key terms, such as the price and terms of sale. Letters of intent contemplate the negotiation and signing of a final, “definitive agreement” containing all the terms of the transaction. Most letters of intent are intended to be non-binding, although they may include some terms that the parties want to bind them even if the definitive agreement is not signed and the deal does not close.

Letters of intent are not mandatory, and there is no reason why the parties cannot proceed directly to the final agreement. However, letters of intent can help streamline negotiations where the proposed transaction is complex, where the principal terms have not been agreed to, or where certain issues need to be resolved early in the negotiations. In these situations it may be beneficial to obtain the parties’ written agreement on some of the “deal-breaker” issues before incurring the cost and expense of preparing and exchanging the final agreements. For example, if the parties cannot agree on price, then there is no need to spend time or effort on negotiating representations and warranties.

Given the informal nature of letters of intent, the parties themselves often attempt to draft them without the assistance of legal counsel. We recommend that legal counsel at least review a letter of intent before signing, however. As discussed below, letters of intent can create binding obligations beyond a party’s intentions, and review by legal counsel can help avoid this surprise.

Creating Binding Agreement on Certain Matters

Letters of intent sometimes are used to create binding obligations on limited matters while being non-binding generally. Examples of provisions that are sometimes intended to be binding include the following:

• Confidentiality. Although most attorneys prefer to have a formal non-disclosure agreement signed before due diligence materials are exchanged, this subject is sometimes addressed through a “binding” provision in a letter of intent. Thus, even if the parties are unable to negotiate final agreement and the transaction does not close, the parties will be bound by the obligation to maintain due diligence materials confidentially.
  
  
• Public announcements. A letter of intent may require the approval of all parties to any public announcements regarding the pending transaction.
  
  
• Preliminary due diligence. A letter of intent may require the disclosure of certain due diligence materials (for example, financial statements) to enable the receiving party the opportunity to decide early on whether it wants to proceed.
  
  
• Obligation to negotiate in good faith. Letters of intent frequently state that although no binding agreement is intended until the final agreement is signed, the parties are nevertheless obligated “to negotiate the final agreement in good faith” in accordance with the general structure of the transaction outlined in the letter. The concept of “good faith negotiations” is fuzzy, however, and we generally do not recommend that provisions like these be used. Indeed, in most instances we recommend that the notion of good faith negotiations be disclaimed and that the parties be free to terminate negotiations at any time for any or no cause. If one party anticipates spending significant sums before the final agreement is signed, perhaps the other party might agree to reimburse some of those sums if it unilaterally terminates negotiations.
  
  
  

Principal Risks of a Letter of Intent

The parties to a proposed transaction usually intend that their letter of intent will be non-binding (except for certain limited provisions as discussed above) and merely a guide for further negotiations that might lead to a final agreement and the closing of the transaction. Creating an unintended binding obligation is the major risk of using a letter of intent. Because of sloppy drafting or the actions of the parties after signing the letter of intent, a court might find levels of enforceability that the parties did not intend, including:

• A Binding Contract. A contract is formed when the parties have evidenced an intent to enter into a mutual agreement. Courts have considered factors such as the following in determining whether the parties intended that a letter of intent be a binding obligation:
  
  
• The Parties’ Conduct. If upon signing a letter of intent the parties issue press releases announcing the transaction, cease negotiations with others, begin to perform under the terms of the letter of intent, or take similar actions, such conduct is evidence that an agreement has been made without the need for further substantive negotiations. Consequently, any press releases, public filings, or other notices should make it clear that the letter of intent is nonbinding and the transaction is subject to the negotiation and signing of a final agreement.
  
  
• Whether Further Documentation is Contemplated. If the letter of intent does not mention the necessity of further documents or agreements, a binding contract is indicated. To avoid this, the letter of intent should include the unconditional statement that the parties do not intend that any legal obligation is created by the letter of intent and that the only legal obligation among them will arise only when a final, definitive agreement is signed by all parties.
  
  
• Language. Sometimes letters of intent include language like “we have agreed” or “we agree” and use legal terms like “offer” or “acceptance.” Letters of intent prepared in connection with real estate transactions sometimes even conclude with, “This offer will remain open for 72 hours. If it is not accepted within that time, it shall terminate.” Such language indicates that a binding agreement has been made.
  
  
• Inclusion of Essential Terms, Complexity of the Transaction. The more of the transaction terms that are included, the more a letter of intent will look like a binding agreement. Obviously, the more complex the transaction, the more terms will need to be included in the letter of intent for a court to find that a binding contract has been created. In a situation where many of the essential terms have been included, it is good practice to include a provision that states that the letter does not contain all of the terms of the transaction.
  
  
• An Obligation to Negotiate in Good Faith. Many letters of intent specifically state that they obligate the parties to negotiate the definitive agreement “in good faith.” Language obligating the parties to “negotiate in good faith,” to “use their best efforts to negotiate the definitive agreement” by a certain date, or to negotiate an agreement containing terms “usual and customary for transactions of this type” is common and indeed does impose the obligation of “good faith” negotiations on the parties. At the letter of intent stage, all parties are convinced that they themselves will negotiate in good faith, and including such a provision seems like a good idea and of little risk; the other parties are the ones that might not negotiate in good faith.
  
  

The problem arises when the parties are unable to reach a final agreement and negotiations break off. If a seller then proceeds to negotiate with another buyer, it could find the disappointed first buyer claiming that the seller did not negotiate in good faith, especially if the second buyer is willing to pay more than the first. Whether the final agreement was not reached because the parties simply could not agree, or whether negotiations terminated because one party failed to negotiate in good faith, can be difficult to determine except in the most egregious cases. We therefore generally recommend that the letter of intent specifically disclaim the obligation to negotiate in good faith and permit either party to terminate negotiations at any time for any or no reason. If one party will incur expenses after the letter of intent is signed and is concerned about giving the other parties the absolute right to terminate negotiations, the letter of intent might provide for the other parties to reimburse a portion of those expenses.

• Protective Language. Language contained in the letter of intent specifically negating the creation of a contract, and stating that no party will be liable to any other party even if the other party acts in reliance on the language of the letter of intent, should be used to protect the parties against unexpected claims. Here is a sample:
  
  

This letter of intent is not intended to be a binding agreement, but rather a basis for negotiating a final, definitive agreement among the parties containing the terms of this letter of intent, as well as other terms and conditions to be determined. No party will rely on this letter of intent as binding, nor will any party be bound unless and until a final agreement has been signed and delivered by all parties.

This letter of intent does not include all the essential terms that are expected to be included in the definitive agreement. Further negotiations among the parties are contemplated before a binding agreement will be prepared, but no party shall be bound to continue negotiations, which may be terminated by any party at any time for any or no reason. Efforts by any party to obtain financing, or take any actions in contemplation of a final agreement, shall not be deemed evidence of intent of any party to be bound by this letter of intent.

The performance by any party before signing a final agreement of any act that may be included in the final agreement shall not be considered evidence of intent by any party to be bound by this letter of intent.

A letter of intent can be a valuable document to streamline negotiations by bringing the parties into agreement on the major terms of the deal. A letter of intent is not necessary in an M&A transaction, and the parties should consider whether it might be more efficient to simply proceed directly to the final agreement. However, a letter of intent can be especially valuable in complex transactions where it is important for the parties to determine early in the negotiations whether they agree on the transaction’s price and fundamental structure so that time and effort is not wasted in drafting lengthy documents. A letter of intent can contain both binding and non-binding provisions. However, unless it is carefully drafted, a letter of intent also can have the consequence of creating binding obligations not intended by all the parties.