You’ve just made the deal. The price or rent is set. Call the lawyer (or not), and whip out a letter of intent (LOI). Although this is perceived to be a simple step by so many, it has potentially far-reaching implications in shaping the business deal and can have quite different legal consequences than what either party intends.
Whether you’re buying or selling a business or real estate property, or entering into a lease, the thought process should be the same: Have I considered all significant business terms? Which side has the most leverage? Do I want to introduce certain key terms now or hold them back for later? Should I keep silent on a point that I know will be controversial? Should the LOI be binding or non-binding? Should it look like a lawyer has been involved?
“Decisions made at this moment can make or break your deal,” says Howard L. Friedberg, a shareholder with Katz Barron Squitero Faust. “If you’re too aggressive, the other side may decide to lease the competing property down the street or seek another opportunity and you’ll be denied the opportunity even to negotiate further.”
If you’re too weak, adds Friedberg, you may give up a key component that will plague you throughout your deal. If the deal involves a lease that could last for many years, any one omitted provision (e.g., change in use) could have huge consequences down the road.
Smart Business spoke with Friedberg about LOIs, how to truly understand them and how to know when and where to utilize them.
What terms should be included in a LOI?
If you are the party with the most leverage, you may want to include as many terms up front as you can, so they won’t have to be argued later. In the height of the real estate difficulties, some national chain tenants have been actively (although, perhaps less actively than before) doing deals. Because ‘they can,’ they seek to include more than the bare essential elements in their letters of intent.
Conversely, landlords in these troubled times, anxious to reel in prospective tenants and not scare them away too soon with extra charges, radius restrictions and kickout clauses might wish to defer the introduction of these second tier business items until later in the negotiations when the prospective tenant is more entrenched in the deal.
How should a LOI be crafted?
The letter of intent must be properly crafted to describe whether it is intended to be ‘all-encompassing’ as to material business points, or to identify only a ‘few key points on which to proceed.’ If the letter purports to be all encompassing, regardless of whether it is labeled binding or non-binding, it will be more difficult later to introduce key business points in the formal document.
Of course, the words of the letter of intent are important. Perhaps, more important, though, is the general feel of the parties in entering into the letter of intent. As you embark in the beginning of this business and legal relationship, you want to imbue confidence and good feeling in the other side, but not have them be upset or surprised if and when new items may later be introduced.
Lastly, one should also consider the real underlying purpose of the letter of intent. Is it to identify the essential elements of the deal to pave the way for a formal agreement, or is it merely to buy time while you consider other alternatives? These questions certainly impact the legal ramifications, and whether you should be careful to avoid all binding elements.
What are the legal risks of LOIs?
Everybody thinks that a letter of intent can be binding or non-binding, and all you have to do is identify which one. Not so fast! It can be a devastating legal trap for the unwary (as evidenced by the many detailed legal treatises and case law on the subject). Even a well-worded LOI may create a duty to negotiate in good faith. And the simplest letter of intent perhaps intended merely to buy time could instead pave the way for the defense of a costly and unintended lawsuit.
All legal considerations should be viewed first from a business perspective; you should consider all of the same questions described above. If you are a landlord desperate to secure a credit tenant, you might wish to create a more binding agreement to protect against the tenant later getting cold feet. Most parties, however, prefer to defer the binding elements of a deal until they are clearly and definitively stated in a formal agreement.
Just what is ‘binding’?
Many letters of intent profess to be non-binding, but contain an agreement nevertheless to negotiate for a fixed period of time or not to negotiate with others (thus, a ‘semi-binding LOI’). The legal ramifications of such a letter can be quite different than intended. While it may not create an agreement susceptible to specific performance, it may allow for damages, the measure of which just might include lost profits or merely costs incurred.
Ironically, many parties wish to sign a non-binding letter of intent. Yet, if neither wishes to be bound, wouldn’t they be better off not signing it at all? Legally, the answer to this question must be yes. However, in considering the big business picture of the blossoming business relationship, the parties often wish to sign even a non-binding letter of intent as evidence of their good faith to proceed toward the negotiation of the deal.
The next time you make a deal, you may want to give more detailed thought at the front LOI end to improve your position for the back end signed formal agreement.
Howard L. Friedberg is a shareholder with Katz Barron Squitero Faust. Reach him at (305) 856-2444 or firstname.lastname@example.org.